Risk Management For Endowment And Foundation Portfolios

When applied by the largest investors, the endowment model has created impressive returns over the past 20 years. However, this style of portfolio management comes with a special set of risks.

First, portfolio managers need to be concerned about the interactions among spending rates, inflation, and the long-term asset value of the endowment.

Second, a portfolio with as much as 60% invested in alternative assets raises concerns of liquidity risk and the ability to rebalance the portfolio when necessary.

Finally, portfolios with high allocations to assets with equity-like characteristics and low allocations to fixed income require the portfolio manager to consider how to protect the portfolio from tail risk, which is a large drawdown in portfolio value during times of increased systemic risk. Those wishing to replicate the results of the most successful endowment and foundation investors need to consider the risks to inflation, liquidity, and extreme market events, while adding value through rebalancing and the successful selection of active managers. A focus on alternative investments also requires a greater degree of investment manager due diligence, evaluating both investment and operational risks.

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