Forget hedge funds and family offices. When it comes to assets under management, or AUM, few institutions rival the endowment sizes of the top private U.S. post-secondary institutions.
Harvard University manages an endowment of around $53.2 billion. Yale University comes in second with an endowment of $42.9 billion, and Stanford University trails behind in third place with $37.8 billion in AUM.
These endowments provide schools with a stream of investment returns that fund operational expenses, research and scholarships for students. Their investment strategies are designed to maximize risk-adjusted returns, achieve resiliency under most market conditions and ensure a perpetual stream of income.
[Sign up for stock news with our Invested newsletter.]
Here are seven lessons retail investors can learn from how college endowments invest their capital:
— Consider private equity.
— Match fixed-income asset duration to expected liabilities.
— Try absolute return strategies.
— Don’t over-allocate to equities.
— Don’t neglect international stocks.
— Keep contributions consistent and high.
— Have an investment policy statement.
Consider Private Equity
Private equity refers to the common shares of companies not traded on public exchanges. Access to private equity is often locked behind private equity and venture capital firms, which only open up funds to high-net-worth or institutional investors.
Most college endowments qualify as both, and thus can make use of this asset class. As an investment, private equities can potentially offer stronger returns than public equities along with a lower correlation to the market.
The downside here is illiquidity, as many private equity funds subject their investors to lock-in periods. Still, this isn’t an issue for endowments, which typically have a long time horizon. Retail investors can copy this with funds that offer private equity exposure or hold publicly traded private equity companies.
Match Fixed-Income Asset Duration to Expected Liabilities
Endowments often have planned liabilities that are expected to become due in a certain time frame. Examples might include construction of a new library building or sports stadium, expected to be fully funded and finished within 25 years.
The endowment can purchase a zero-coupon fixed-income asset like a STRIP Treasury bond with a maturity of 25 years. In this case, interest rate and reinvestment risk are nullified. Even if rates go up and the price of the bond drops, the endowment is unaffected as long as it holds the bond to maturity.
Upon maturity, the endowment can redeem the bond for its face value and receive the original investment back plus interest. Retail investors can copy this. For example, if you’re retiring in 10 years, buying a 10-year Treasury bond guarantees your money back plus interest when it matures and shields you from rising interest rates.
Try Absolute Return Strategies
Most stock and bond investors attempt to match or beat a benchmark. For example, stock-picking fund managers might attempt to outperform the S&P 500 index. However, some funds do not attempt to compete against a benchmark. These funds seek positive returns irrespective of market conditions.
In many ways, they are like hedge funds, using exotic strategies like global macro, long/short and systematic trend following across a variety of asset classes to achieve a positive return regardless of how the market moves. During volatile times where stocks and bonds fall in tandem, such as this year, absolute return strategies shine. Notably, Yale’s endowment devotes around 22% of its asset allocation to an assortment of absolute return strategies. Investors can access absolute return strategies through various managed futures funds.
[READ: A Beginner’s Guide to Alternative Investments.]
Don’t Over-Allocate to Equities
Many retail investors, especially younger ones, hold a portfolio of 100% stocks. While this approach can maximize long-term returns, it does so with excessive risk.
With 100% stocks, high volatility and deep drawdowns are likely. In comparison, most endowments hold a small allocation to stocks, domestic and international.
For example, Yale’s endowment holds only around 4% in domestic equities and 14% in foreign equities. Instead, endowments seek returns via other assets, including real estate, commodities, venture capital and private equity. Retail investors can emulate this by buying shares of real estate investment trusts, or REITs, business development companies, or BDCs, and commodities funds.
Don’t Neglect International Stocks
Many retail investors allocate their portfolios heavily to domestic equities. This is called a home-country bias. While beneficial for tax efficiency and currency risk, it can lead to long-term underperformance.
College endowments realize this, and often allocate their equity holdings heavily toward international stocks. The goal is to offset the chance of the U.S. market performing poorly for an extended period, which can be disastrous for a school relying on its endowment returns to fund operations.
While U.S. stocks have outperformed over rolling 20-year periods, much of their returns came from various bull runs from 2009 to 2021. Prior to that, international stocks, particularly those from emerging markets, returned much higher. Markets are cyclical, and winners revert back to the mean. Thus, holding international stocks is sensible for long-term investors, whether for an endowment or as a retail investor.
Keep Contributions Consistent and High
Many college endowments rely on a generous stream of donor contributions to grow their AUM. While investment returns play a role in ensuring strong long-term returns, maximizing contributions can provide an equally large, if not greater, boost.
Having consistent cash inflows helps endowment portfolios compound faster and assists with portfolio rebalancing. Retail investors can apply this lesson by maximizing their own savings rate. This means investing money consistently, regardless of how the market is doing.
Most endowments do not keep a high cash allocation on hand, as they prefer to invest it as soon as possible while relying on their high diversification to lower risk. Retail investors can do the same by putting cash to work as soon as it hits their brokerage accounts.
Have an Investment Policy Statement
College endowment funds are governed rather effectively. This often consists of an investment committee, a chief investment officer and various advisors. There may also be a charter or investment policy statement that sets out the objectives of the endowment and puts constraints on asset selection and allocation.
Retail investors can do the same via a written investment policy statement, or IPS. This is a document that outlines the investor’s time horizon, risk tolerance and desired investment outcomes. It may also outline which assets the investor may or may not purchase, rebalancing time frames and contribution frequency. Having an IPS helps investors stay cool, rational and methodical when it comes to managing their portfolio, much like an endowment.
More from U.S. News
9 Highest Dividend-Paying Stocks in the S&P 500
9 Best Pharmaceutical Stocks to Buy for Income
7 Stocks That Outperform in a Recession
7 Lessons to Learn From College Endowment Investing originally appeared on usnews.com
