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Global Fund Advisory - Pension Portfolio - Economic Time Package
Endowment Management – An Investment Adviser’s Perspective
The endowment fiduciary’s primary task, in my judgement, is the
establishment of a charitable corporation’s total financial policy
insofar as it relates to the endowment. So, my first goal will be to
set forth a personal catechism for how I belive fiduciaries should
discharge their responsibility in this regard. Second, I will attempt
to provide a ‘tour’d horizon’ of the capital markets in terms of the
available and accepted investment media through which that financial
policy should be executed.
I. Financial Policy ² – An endowment’s financial policy is essentially
a set of internal imperatives (external imperatives, in the form of
‘legal lists’ or donative restrictions, for example, may impact as
well). However a given endowment resolves the various issues discussed
in this essay, it is imperative that the results be embodied in a
formal, written record. This document is generally known as an
investment policy statement’ and bears periodic revisit and occational
revision for any endowment. While this essay does not address the
legal context affecting endowments as they construct and implement
overall financial policy, it should be noted that most states have
enacted two so-called uniform acts (one for endowments organized as
corporations and the other for those as trusts) that are directly
applicable. Each contain a version of the ancient ‘prudent man rule,’
and both have fairly specific prescriptions and proscriptions about
investment policy. Private foundations are also subject prescriptions
and proscriptions about investment policy. Private foundations are
also subject to certain provisions of the Internal Revenue Code that
speak to these matters. Every endowment, large or small, should
consult with councel to determine its precise legal context. Two are
statistic in nature, in the sense that they do not require frequent
review and modification. The first of these is the determination of
what I would call an endowed institution’s terminal goal – its
expected life. The range of choised runs from perpetuity to, I
suppose, ‘as long as the money lasts.’ For most, the answer is self-
evident – perpetuity is a demanding goal. Indeed, in my own
experience, I have watched a large endowment lose more than three-
quarters of its net asset value as a result of overspending during a
period of poor performance in the capital markets, yet all the while
it maintained an explicit policy of an ‘aspiration to perpetuity.’ The
contradiction at least raises a presumption of imprudence, in my view.
A second static issue is the creation of an appropriate structure for
the management of an endowment. Fundamentally, this is a question of
delegation (and accountability) – where will operational
responsibility be lodged? A range of choises presents itself: the full
board or a subcommittee may retain authority for the investment of the
endowment, initiating or at least approving every transaction, or more
likely it may delegate the perpetuity. Endowments must also consider
other ways of achieving their asset allocation objectives, depending
on their circumstances. Unlike pension plans, however, insurance-based
approaches offer no promise because in general endowments have no long-
term liabilities and therefore no actuarial reason to pay for this
means of balancing (or form of intermediation between) asset and
liability. For small endowments, mutual funds bring a very sensible
way of achieving all of liquidity, diversification and professional
management. There really is no better way to put ‘non-institutional’
money to work – the principal reason, I might add, that my own firms
uses mutual funds as the sole means for managing clients assets. At
the other end of the spectrum lies passive management or indexation.
Large pension funds(which are many times the size of large endowments)
have increasingly recognized that in various respects they are the
market. Therefore, many have elected simply to ‘buy’ the market by
allocating most if not all of their equity assets to index funds.
Whether or not a large pension fund’s fiduciaries subscribe to the so-
called Efficient Market Hypotesis and therefore no longer belive it
possible to ‘beat the market,’ transaction costs, which go well beyond
commissions, alone make this choice compelling if not imperative. Few
endowments suffer from this compulsion, but some have elected to
pursue indexation. The Efficient Market Hypothesis(the‘EMH’) states
that assuming normally functioning markets, security prices at any
given time reflect all known information and thus are, in colloquial
terms, fair and accurate. It assumes or implies that investors are
rational economic beings. Portfolio Theory in general and its
corollary (or predicate), the EMH, in particular have become the
prevailing orthodoxy over the last 30 years or so after successfully
challenging more conventional, ‘practice’ – based thinking about the
capital markets, but recently they have witnessed the arrival of a new
heterodoxy called behavioural finance. If Portfolio Theory sprang from
the academic field of statistics, behavioural finance comes from the
school of social psychology. To explore behavioural finance in this
essay would take us too far afield, but suffice it to say that its
theorists and practioners say that security prices simply are and
never represent some pure standard of accuracy or fairness. To them
value is in the eye of the beholder, and since that beholder is
generally human and therefore fundamentally irrational, security
prices will only coincidentally and occationally represent ‘fair
value.’ They point to all of the manias of the last 300 years – from
tulips to tech stocks – and say simply, QED. Today, many larger
endowments implicity embrace behavioural finance especially in their
use of private equity and hedge funds since both presume that
securities are systematically misprized. To our network for individual
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Mr Roger K. Olsson
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