Key Questions From Endowment Management

8/13/2019 Key Questions From Endowment Management

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Endowment Management: Key Questions

Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

Cambridge Associates report, Endowment Management , summarizesour thoughts on best practices and the keys to success in endowmentinvesting. In this abstract, we highlight the major questions outlinedin Endowment Management , as a kind of checklist for investmentcommittees. These questions focus on four attributes we regard asprerequisite to investment success: a strong governance structure,appropriate policies and objectives, adequate implementationcapabilities, and a systematic approach to performance measurementand evaluation.

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C A M B R I D G E A S S O C I A T E S L L C | Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

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Effective endowment management requires the asking and answeringof many key questions. The broadest of these are:

Does our governance structure facilitate sound, disciplineddecision-making?

Do those individuals charged with responsibility for overseeing theassets have sufficient understanding of institutional investing andsufficient information at their disposal to make informed decisions?

Are they spending enough time to do the job right?

Do we have explicit, written policies that describe the endowmentsobjectives and the means taken to achieve them?

Do we have the knowledge, experience, and resources needed toimplement those policies effectively?

Are we monitoring and measuring the results of our decisionsin ways that tell us whether we are succeeding in achieving ourobjectives?

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Should We Hire Professional Investment Staff?

Few institutions have the good fortune to be served by an investmentcommittee whose members have sufficient time, knowledge,experience, and commitment to oversee the fund as effectively ascapable professional staff could do.

But whether an organization should hire professional investmentstaff is primarily a function of the incremental return expected fromsuch an investment. The right questions to ask are:

Can we expect to perform better if we hire full-time professionalinvestment staff than if we do not?

If yes, by how much?

If we do not hire full-time professional investment staff, are we indanger of exercising inadequate oversight of our endowment fund?

If the investment committee lacks the necessary expertise and/ortime and resources to oversee the fund properly, are there viablealternatives to in-house professional staff?

Successful investing requires as much perspiration as inspiration, butinvestment committee members rarelyspend enough time on endowmentmanagement to break a sweat.


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Introduction

Endowment funds are not ends in themselves, but the means to anend, which is to provide financial support to their organization. Untilthe organization defines its financial objectives for the endowmentfund, it cannot begin to construct investment objectives designed torealize those ends. Consequently, the trustees first responsibility is todefine the funds financial objectives and their second is to articulate

commensurate investment objectives.

Spending

The answer to How much can we spend? is contingent on answers tofour other questions:

Do we want to grow, maintain, or liquidate the endowment fund?

If we decide to maintain the fund, how much risk of failing torealize that objective will we tolerate?What average annual real rate of return can we expect to earn overthe life of the fund?

How much variability in the level of spending can we stand?

Asset Allocation

A funds strategic asset allocation should be articulated in the formof a long-term policy portfolio, reflecting the asset mix best suitedto realize the funds investment objectives over the long term. Theinvestment committee must also decide whether the endowmentshould engage in tactical asset allocation, which is the attempt toadd value by tactical deviations from the strategic asset mix. Suchdeviations should be deliberate and purposeful, rather thanaccidental and random, and the results of such decisions should beclosely evaluated.

Asset Allocation Modeling

The sloppy approach to asset allocation is to run a model designed tooptimize the trade-off between risk (defined as volatility) and return,and allocate accordingly. Although model enthusiasts often presentthemselves as rigorous statisticians, model inputswhich determine

the outputsare in fact no better than educated guesstimates.Consequently, although models are extremely useful to inform onesthinking about risk and return, they should never be used as the soledeterminant of an asset allocation.

Until the organization de nes its nancialobjectives for the endowment fund, itcannot begin to construct investmentobjectives designed to realize those ends.

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Introduction

Many endowmentsparticularly smaller funds managed byinvestment committeessquander the value of carefully designedpolicies by careless implementation.

Resources

Here, the first question to ask is not, What do we want to do?but, What can we do, given available resources and expertise? Inparticular, investors intending to diversify their portfolios intoalternative investments should first assess the resources required todo so successfully.

The Role of Each Asset Class

The second step is to match the form of the investment with the role

it is designed to play in the portfolio. For example, a bond allocationdesigned as an anchor to windward in times of economic stressshould not be implemented by investing in low-quality credits.

Indexing and Active Management

In asset classes where index funds are available, active managersshould be considered only when a compelling case can be made thatthey are likely to add value, net of their higher fees and greater riskof underperforming the asset class in question.

In general, the dos and donts of active manager selection intraditional asset classes are relatively straightforwardandconsistently ignored. The simplest of these are:

Dont hire managers on the basis of good recent performance.

Do hire managers with coherent, disciplined philosophies andprocesses that have generated good long-term results, when theyhave recently suffered a period of relatively weak performancesolely as a result of sticking to their knitting.

Dont fire managers solely on the basis of poor recent performance.

Alternative Assets

In so-called alternative investmentsparticularly hedge funds,private markets, and private real estatethe dispersion of returnsamong managers is so broad that the consequences of poor managerselection can be severe.

Consequently, investors should not heed the siren song of alternativeassets until and unless they have answered four key questions:

Do we understand the risk and return characteristics, and theunderlying source of return of these prospective investments?

Do we know what additional resources are required to investsuccessfully in these areas?

Are we prepared to pay what is needed to succeed?

What are our implementation options and how should weevaluate them?

I M P L E M E N TAT I O N


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O F F I C E L O C AT I O N S

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Key Questions From Endowment Management

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