The Endowment Model of investing, brainchild of Yale CIO David Swenson, has come under fire of late (a Google search produces headlines such as 'Time to ditch the Yale endowment model,' 'Is the Yale Model Past it?' and 'The Curse of the Yale Model'). But author and marketing consultant Cathleen Rittereiser believes the model is alive and well—just misunderstood.
Rittereiser, co-author of Foundation and Endowment Investment, recently hosted the Portfolio Whiteboard Project (pdf), a financial brainstorming session during which investors and asset managers were challenged to update—or even break—Swenson's 30-year-old investment model.
“Supposedly the way that David Swenson came up with the Endowment Model was by getting a group of colleagues into a room with a blank sheet of paper and saying, 'How would we allocate this portfolio if we could start from a clean slate, a blank white board?'” Rittereiser told FINalternatives during a recent interview. “And I thought, 'What a great way to get people together to think about asset allocation.'”
Rittereiser's event attracted about 40 investment advisors and asset managers, all members of what she calls “the next-generation cohort”—the senior number twos and CIOs with less than five years' experience who are “poised to be the leaders of the next generation.” In an attempt to test the viability of classic Endowment Model investing, they were asked Swenson's question: “How would you allocate your portfolio if you could start from just a blank whiteboard?”
“What we really came to realize,” said Rittereiser, “is that a lot of people have made the Endowment Model [broadly, high allocations to equities, portfolio diversification, avoidance of market timing and investment in private markets] a euphemism for a particular form of asset allocation,” whereas “the real contribution David Swenson made was the process that the endowment model represents.”
Participants boiled that process down to three main components—governance, asset allocation policy and execution—and Rittereiser said the key takeaways from the event are that governance is lagging, asset allocation is transitioning and execution has become more complex.
“[T]here's all kinds of best practices but there really seems to be a consensus that governance is an issue for a number of institutions, and needs to have more structure, more defined responsibilities,” said Rittereiser.
As for asset allocation, “What we're seeing...is that asset allocation is in transition and it's transitioning from an asset-class oriented to an objectives-based approach. And that involves really looking at the portfolio more through a risk lens and being more asset-class agnostic—in other words, defining asset classes in broader ways and also being vehicle agnostic, which means that you're not necessarily going to have an allocation to hedge funds because those are a vehicle. You want to allocate to a certain kind of asset, you're going to try to find the best manager or the best way to execute not the best fund structure.”
And when it comes to execution, she said, participants “broke that down into two really key ideas. One was that, despite the fact that people are becoming more vehicle agnostic and they're more broadly defining asset classes, they still have to rely on asset classes to execute their portfolios. There really, currently, aren't enough ways to execute your investment that are objective-based. You can't find a 'risk- reducer fund' or the 'inflation hedge fund'—asset classes remain the key way to execute.
“And the second part of that is that all of these things that I'm talking about—essentially the asset allocation and the execution, the selection process—are adding more complexity to the portfolio. So, you need to have the right staff and you need to have the ability to have the systems and processes in place to monitor this investment approach.”
Rittereiser said there's a message in this for asset managers approaching institutions:
“If you are an asset manager, you do need to be thinking...'What role does my fund play and how does it fit in this person's portfolio? What does it do and what objective does it achieve?' And then, 'Will it fit?' In some cases, it might fit with certain investors and it might not with certain others. But you do need to understand what your fund's really there to accomplish in the portfolio...and be able to present it from that context.”