The Investment Committee at LeoGroup has extensive experience reviewing, analyzing and locating unique investment opportunities that are tailored to meet specific and expressed client investment objectives. We provide an institutional quality approach to individual portfolio management.
The “Endowment Model” is the investment model used by most large university endowments and large foundations. The model employs a disciplined asset allocation approach with a focus on value and risk management. In addition to traditional asset categories (stocks/bonds), the model utilizes alternative investments and non-traditional assets to reduce downside risk.
According to the National Association of College and University Business Officers (“NACUBO”; www.nacubo.org ), the Endowment Model has provided outperformance with lower risk than virtually all other models over any reasonable period of time.
For years, the investment industry has touted traditional investments in stocks and bonds for retail investors through the use of mutual funds, money managers, and other similar investment pools. Traditional portfolios might have a simple investing model such as a 60/40 stock/bond split. However, such simple investing comes at a cost in terms of both performance and risk. In addition, the costs often include high fees and/or hidden fees for relatively efficient assets. Efficient assets are generally broad-based stock or bond investments where outperformance compared to broad market indexes is difficult to achieve.
By contrast, the Endowment Model seeks to provide diversification not only by asset categories, but also within asset classes while integrating alternatives and non-traditional investments as part of the total portfolio. Furthermore, the portfolio is implemented utilizing a Core & Satellite approach where the core investments consist of efficient assets with much more favorable fee structures compared to traditional portfolios. Where inefficient markets exist in the so-called Satellite Strategies and Alternative investments, more active management should be employed strategically all the while being conscious of fees. The result is a portfolio that is reasonably priced with less risk than a traditional portfolio. After all, comparative performance should only be measured net of fees and risk-adjusted. The Endowment Models achieves this mandate.
LeoGroup believes that individual investors can benefit from employing the techniques of the Endowment Model and achieve similar results. Some critics believe that individuals cannot replicate the Endowment Model. Critics contend that individuals cannot successfully implement the model because they do not have the same: (1) access to investments, (2) liquidity needs, or (3) long-term horizon of endowments or institutions. For most wealthy investors, we disagree. Let us briefly address each issue:
- Access to Investments: LeoGroup clients are part of an exclusive group that has access to most, if not all, of the same or similar investments as endowments. In reality, most of our recommended portfolios have a large portion invested in passive strategies or other low-cost alternatives, which is how endowments invest the majority of their core portfolios as well.
- Liquidity Needs: As a percentage of assets, most wealthy investors do not withdraw more from their portfolios than endowments draw on an annual basis. Besides, any needs for the outlay of capital are part of the design of any portfolio, regardless of whether you are a wealthy individual or an endowment.
- Long-Term Horizon: In theory, endowments have longer time horizons than individuals. However, in practice, the investment time horizon is different for endowments than individuals in degree, but not in kind. First, most college endowments do not have investments tied up indefinitely. There is significant liquidity within most endowments in spite of the allocation to alternative investments. Even allocations to the most illiquid investments, such as private equity, do not have anticipated time horizons that extend more than 10 years. When all factors are considered, the time horizon of an endowment is similar to the time horizon of wealthy individuals. Even less wealthy individuals that do not need capital for many years can benefit from the tenets of the Endowment Model.
We are risk managers first, investors second. Risk is the most underrated factor for most investors. “Risk,” or rather, the acceptance of risk or the unwillingness to take risk, will affect a portfolio far greater than any other factor. Yet defining or truly understanding the risk of any investment is difficult. When we analyze the risk of an investment, we may do so quantitatively (e.g.- standard deviation) or fundamentally (e.g.- understanding how an investment makes or loses money).
The objective of risk management when it comes to portfolio construction is simple: do not lose money. This objective must be reconciled with the fact that any investment that takes risk, almost by definition, will likely lose money from time to time. However, we can mitigate risk by diversifying a portfolio and being keenly aware of the likely downside of a portfolio under various market conditions. Furthermore, most investors do not actually stick to a portfolio model that exhibits high levels of risk, even if over the long-term that portfolio achieves a high level of absolute return. In fact, most investors do exactly the opposite of what traditional models suggest: they sell stocks at the bottom and buy more at the top of the market. This leads us to Behavioral Finance.
Behavioral Finance is a field of study that we encourage all clients and investors to explore. This field examines the effects of social, cognitive, and emotional factors on the economic decisions of individuals. One specific item of behavioral finance that affects traditional investment models more so than the Endowment Model is the assumption that investors will behave rationally at all times. For example, when the stock market is down significantly, traditional models assume individuals will have no issue rebalancing their portfolios to the desired target of say a 60/40 stock/bond allocation. This could not be further from the truth. In fact, if stocks are down significantly, most investors are too scared to reinvest. This is why risk management becomes so important and gives further support to the Endowment Model. Even when stocks are down significantly, the Endowment Model is generally down much less than traditional portfolios. What the field of behavioral finance has shown us is that investors are more likely to “stay the course” when losses are minimized, particularly as compared to losses that others are experiencing at the same time.
