ETFs Compass - Endowment Style Part I
This article will assess the merits of adopting an "endowment style" investment strategy. We will provide insight into the importance of strategic asset allocation as a driver of portfolio returns & risk. Furthermore, we will explore if smaller investors, by adopting the "endowment portfolio model" and implementing this strategy with accessible liquid ETFs and mutual funds, may obtain superior risk-adjusted returns compared to traditional bond/equity balanced portfolios. In particular, today, we will take a closer look at the endowment portfolio model presented by El Erian in his book " When Markets Collide ".
"The Endowment Model"
The US University Endowment Funds have been pioneers and leaders in diversified multi-asset class investing for almost three decades. The idea, behind their strategy, is to build a portfolio that yields better returns with less volatility than a standard stock and bond mix. The Endowment approach relies on heavy allocations to non-traditional asset classes for their return potential and diversifying power. Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities. Additionally, the Endowment's long time horizon is well suited to exploiting illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.
Below is a great chart that shows how the allocation mix for the Yale Endowment Fund - one of the absolute pioneers in the strategy - evolved over the last three decades to include a large part of non-traditional assets.
The US Endowment Funds are exceptionally well-resourced, they have access to the best fund managers and private equity programs. Their positional advantage significantly contributes to their investment success. However, this article will explore whether by adopting asset allocation principles, similar to the ones employed by the most successful endowment funds, it is possible for smaller investors to obtain high levels of risk-adjusted returns for their own portfolios, which are superior to those of traditional equity/ bond portfolios and to most balanced investment funds.
Why study the US Endowment Investment Srategy?
Examining the US Endowment Funds investment strategies may be relevant for the following reasons:
1. US Endowment Funds have achieved solid long-term investment returns. This is especially the case for the “Super Endowments” of Harvard and Yale. They have often, although certainly not always, achieved higher risk-adjusted returns than many traditional 60/40 global equity/ bond portfolios.
2. High diversification. US Endowment Funds have diverse portfolios with exposure to multiple asset classes, diverse risk/return and liquidity profiles.
3. Long-term orientation. US Endowment Funds typically have long-term investment horizons and stable, strategic asset allocations over time; asset allocations that rely less on market timing for generating returns with lower trading costs.
4. Focus on high-return assets. Liquidity often comes at a high price in the form of lower returns. To preserve the invested principal against inflation and secure better long-term returns, the strategy emphasizes investments in equities and long-term illiquid assets.
5. Importance of fund/manager selection. Performance varies widely between alternative investment managers. Selecting asset managers with proven track records and the right connections adds value to portfolios.
The endowment at Princeton University, for example – one that has performed admirably compared to other endowments – has seen annualized returns of 16.2% over five years, 12.7% over ten years, and 11.2% over twenty years, as of June 30, 2021 (Steyer, 2021). By comparison, the S&P 500 has seen annualized returns of 11.66%, 13.46%, and 9.01%, respectively (Mitchell, 2022). But let's be aware that dispersion in performance across endowments may be high and for a Princeton that may have performed very strongly, clearly, there are also cases of underperformance. Not all that shines is gold, but it may definitely be worth careful analysis.
This article will assess the merits of adopting an “endowment style” investment strategy, as well as provide insight into the importance of strategic asset allocation as a driver of portfolio returns and risk.
Endowments Target Returns
The typical endowment objective returns is about 7-8% and that is supposed to cover long-term inflation and a part of the yearly spending requirements. The investment horizon of the strategy is very long as it is supposed to serve the needs not only of the current but also the future generations.
This horizon may be probably impractical for most of our readers, but I think it is always a useful exercise to build a portfolio imaging not to be able to touch it for at least 3-4 years.
Oh, did I break your concentration? I did not mean to do that. So I will continue!
Historical Returns: Endowments vs. Balanced 60/40
Below you find a table from Hammond (2020), with the last four columns added by the CISDM Research Center:
Two important conclusions can be drawn by comparing historical returns:
I. The endowment portfolio outperforms the global 60/40 strategy combining a broad portfolio of U.S. and ex-U.S. bond and equity indices.
II. The U.S. 60/40 has performed very strongly over the last 30 years and only larger Endowments managed to perform slightly better, while the average endowment has often underperformed a classic U.S. balanced 60/40.
I think, however that the global 60/40 is a more appropriate comparison for a global asset allocation strategy, as picking just US investments seems fairly arbitrary to me.
Endowment vs 60/40, 2022 the mother of all stress tests!
Let's take a glimpse to the performance of 46 U.S. Endowments over the fiscal year (FY) 2022. The performance data clearly shows that the highly diversified endowment investment style adds value when higher interest rates are a driver of risk-off markets.
You can find the FY 2022 performance data for the largest university endowment funds in the table just below.
The Alchemy of Asset Allocation
Anyone, who frequently sails the rough seas of the asset allocation routes, will tell you that the specification of appropriate asset allocations involves a mix of science and art. Anyone that gets into the details will realize that the balance has shifted significantly away from science and toward art over the last few years. This is due to a few factors: traditional boundaries between asset classes have become blurred and correlations may vary substantially over time and have been often increasing; when they not linked by fundamentals, asset classes get interconnected by technical factors, such as the “common ownership” across investors. So why has the industry been hanging to an approach that has become less robust over time? Probably for the lack of a better alternative.
The most promising ongoing work in this area goes one step upstream in the value generation chain. Rather than looking at asset classes, it is probably best to analyze the risk factors that give rise to investment returns over time. In other words, we need to look at the reason why investors are paid for allocating their capital to a certain risk factor. The ideal situation is to come up with a small set (three to five) of distinct (and ideally orthogonal) risk factors that command a risk premium.
How to implement asset allocation? Yale vs. Warren Buffet debate a.k.a. Active vs. Passive Solutions.
Warren Buffett’s favourite piece of advice is: stick to low-cost index funds. In their 2017 Annual Report, Yale felt to respond to W. Buffet by criticizing his low-cost index approach.
“[Low-cost passive index strategies] make sense for organizations lacking the resources and capabilities to pursue successful active management programs, a group that arguably includes a substantial majority of endowments and foundations,” Yale writes.
“However, Yale has demonstrated its ability to identify top-tier active managers that consistently generate better-than-market returns, after considering performance fees.”
Yale argues, by showing their actual results between 2006-2016 (see the table above) that investing simply based on its lowest-fee option would’ve led to significant underperformance relative to itself over the last several decades.
Personally, I see merits in both approaches. But, it all comes down to two key questions? The first question is do I directly invest in HFs and Private Equity? Second, do I have enough time and resources for a proper manager and fund selection? If the answers are a "no" to both questions, then probably a low-cost portfolio model, constructed around passive ETFs or Indexed Solutions, is probably the best choice.
In this paper, we will focus on a simple implementation of the Endowment Portfolio with liquid ETFs. The content we put forward does intend to be exclusively food for thought and we intentionally did not go through the process to try to select - what we think - may be the best products for each asset class (if that may ever exist). In a few cases, we also selected the ETFs with data available for the time periods we wanted to back-test in the following section. Bear also in mind, for example, that also most of the instruments used in the quantitative analysis that follows, are US domiciled and non-investable by European investors. Therefore, I strongly invite, whoever may wish to replicate an endowment portfolio, to do her/his own analysis or reach out to a professional financial advisor with knowledge of the specific circumstances.
Why is the long-run Strategic Asset Allocation (SAA) important? And is that so?
Quantifying the importance of SAA has been the subject of much academic debate over the years from Brinson, Hood and Beebower 1986 until more recently to the detailed paper from Xiong, Ibbotson, Idzorek and Chen 2010. Although we are bombarded with the message that “it’s all about asset allocation,” the fact is, it’s not. Active management plays an important role in explaining relative performance. But, while I don't consider myself an extremist of static asset allocations, I still recognize that - like it or not - the structural design of the portfolio explains a large part of portfolio returns. Active management can be an important differentiator superposed to the structural portfolio design.
However, also firm believers in highly dynamic portfolio management will have to recognize that there are always key performance drivers that are determined by how the strategy is conceived and designed: risk limits, investment universe, targeted risk premia, investment horizon, liquidity, investment jurisdictions, currencies etc. And the list can be obviously much longer. The strategy can be as dynamic as you like, but if there are original sins in the design, the road will become incredibly bumpy! So before becoming super hectic and steering the portfolio like crazy, I thought it may be a useful exercise, clearly also for me, to take a look at what could be possible long-term portfolio models.
The Endowment approach differs from the balanced bond/equity mix in a few important ways. First of all the balanced bond and equity mix in its various declinations 60/40 (equity/fixed income), 80/20, 30/70 etc. at its core is a barbell approach between risky and safe assets. The endowment approach can be thought of as a barbell between long and short investment horizons. On one side illiquid assets like private equity or real assets, from the other highly dynamic hedge fund strategies. This aspect of the endowment approach cannot be replicated through ETFs. The second aspect where the two approaches diverge is in the way they try to achieve diversification. The balanced strategy relies on the negative correlation between bonds and equities. The endowment approach seems to achieve diversification, at least ex-ante, in a slightly different way. It is trying to diversify across strategies with a diverse investor base to limit the correlation driven by common ownership of an asset. This may become particularly relevant in periods of liquidity crunches. The third differentiating element is about how the two strategies are seeking to achieve additional alpha. Balanced strategies, when they try to generate alpha, they are trying to achieve it through market timing. Endowment strategies, instead, are looking to add extra returns by investing in alternative risk premia and through the selection of either securities or managers. In the way of thinking of the original "Yale Model", investing in private equity or hedge fund strategies is the byproduct of trying to invest off the beaten track, in less crowded investment areas. When adopting the Yale or the El Erian model, it is not about a copycat of the output. It is about understanding where we are coming from.
This week, let's discuss...
M. El Erian Endowment Portfolio
In his book "When Markets Collide", M. El Erian has brilliantly presented a long-term portfolio allocation along the lines of classic university endowment funds. His actual action plan for investors is well summarized as follows:
The expected return is in line with an endowment allocation, with roughly a 1:1 ratio between expected return and volatility. The model portfolio looks fairly similar to the allocations of the Harvard Endowment, but the significant difference between the Yale or Harvard model to the portfolio construction presented here: is the absence of an allocation to hedge fund strategies. But, this makes it certainly easier to implement for the vast majority of investors. That's one of the reasons why we picked it as starting point in our series of posts on multi-asset portfolio construction with liquid ETFs.
But let's take a glance at the highlights of the approach.
The strategy is primarily a barbell of equity investment and real assets, while bonds play a role primarily for liquidity and diversification.
The role of the special situation sleeve is twofold: add potentially lowly correlated strategic themes and more short-term tactical trades. Some pundits have already observed that the asset allocation in the book does not add to 100%, but it sums up to 98%. I don't see it as an inconsistency. I think the philosophy is about having some margin for tactical portfolio shifts. Or at least, I believe that adding a tactical allocation touch to the strategic allocation brings additional diversification to the mix. But let's take a closer look at the key building blocks that the portfolio comprises.
Setting up a Liquid Endowment Portfolio.
AGG ETF / WEIGHT : 5%
The iShares Core U.S. Aggregate Bond ETF invests in U.S. dollars denominated, fixed-rate investment grade treasury bonds, government-related bonds, corporate bonds, mortgage-backed pass-through securities, commercial mortgage-backed securities and asset-backed securities that have a remaining maturity of at least one year. It seeks to track the performance of the Bloomberg U.S. Aggregate Bond Index, by using a representative sampling technique. As of Q1 2023, the fund will include 45% Treasuries, 29% Securitized, and 25% Corporates. A minimal part will be in municipals and cash.
BNDX ETF / WEIGHT : 9%
Vanguard Total International Bond ETF. The fund invests in the fixed-income markets of the global ex-US region. It primarily invests in investment-grade, fixed-rate debt markets, which include government, government agencies, corporate, and securitized non-U.S. investment-grade fixed-income investments with maturities of more than one year. The fund seeks to track the performance of the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged), by using a representative sampling methodology. This index provides a broad-based measure of the global, investment-grade, fixed-rate debt markets. Capped exposure (20%) to any particular bond issuer, including foreign governments. Hedged to offset currency exchange rate fluctuations. As of Q1 2023, the top 5 exposures by country are : Japan 15.5%, France 11.9%, Germany 10.7%, and Italy 7.5%.
Real Asset Sleeve
ICF ETF / WEIGHT : 3%
iShares Cohen & Steers REIT ETF. The fund invests in stocks of companies operating across mortgage real estate investment trusts (REITs), financials, diversified financials, and equity real estate investment trusts (REITs) sectors. It invests in growth and value stocks of companies across diversified market capitalization. The fund seeks to track the performance of the Cohen & Steers Realty Majors Index, by using a representative sampling technique. iShares Trust - iShares Cohen & Steers REIT ETF was formed on January 29, 2001, and is domiciled in the United States. The investment seeks to track the investment results of the Cohen & Steers Realty Majors Index, which consists of REITs.
VNQI / WEIGHT : 3%
Vanguard Global ex-U.S. Real Estate ETF is an exchange-traded fund launched and managed by The Vanguard Group. the fund invests in stocks of companies operating across real estate sectors. The fund invests in growth and value stocks of companies across diversified market capitalization. It seeks to track the performance of the S&P Global ex-U.S. Property Index, by using a full replication technique. The fund employs an indexing investment approach designed to track the performance of the S&P Global ex-U.S. Property Index, a float-adjusted, market-capitalization-weighted index that measures the equity market performance of international real estate stocks in both developed and emerging markets. This fund invests in stocks in the S&P Global ex-U.S. Property Index, representing real estate stocks in more than 30 countries. It provides a convenient way to get broad exposure across international REIT equity markets and achieve geographical diversification. This ETF closely tracks the index's return, which is considered a gauge of overall non-U.S. real estate investment trusts and operating companies' returns.
DBC ETF / WEIGHT : 11%
The fund uses futures contracts to invest in light sweet crude oil (WTI), heating oil, RBOB gasoline, natural gas, Brent crude, gold, silver, aluminium, zinc, copper grade A, corn, wheat, soybeans, and sugar. It seeks to replicate the performance of the DBIQ Optimum Yield Diversified Commodity Index Excess Return. DBC is a simple diversified commodity ETF, that performs quite well when commodity prices increase / inflation is high and rising and is a fantastic trading vehicle for commodity bulls. There are, however, many funds with broadly similar characteristics, including those focused on energy equities, miners, and more. DBC does have two important advantages relative to most of its peers. First of all, it is a pure commodity play, and second, it provides diversified exposure.
NFRA ETF / WEIGHT : 3%
The fund invests in the public equity markets of the global region. It invests in stocks of companies operating across energy, transportation, correctional facilities, hospitals, postal services, communication services and utility sectors. It invests in growth and value stocks of companies across diversified market capitalization. The fund seeks to track the performance of the STOXX Global Broad Infrastructure Index, by using a representative sampling technique. The investment seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the STOXX® Global Broad Infrastructure Index. The index reflects the performance of a selection of companies that, in the aggregate, offer broad exposure to publicly traded developed- and emerging-market infrastructure companies, including U.S. companies, as defined by STOXX Ltd. (the "index provider").
MUB / WEIGHT : 1%
MUB is the largest municipal bond ETF in the market. MUB is a municipal bond index ETF, tracking the ICE AMT-Free US National Municipal Index. It is a relatively simple, broad-based index, including all dollar-denominated, fixed-rate, investment-grade, tax-exempt bonds meeting a basic set of inclusion criteria. It is a market value-weighted fund, comparable to a market-cap weighting scheme but for bonds. MUB's underlying index is quite broad, resulting in a very well-diversified fund. MUB invests in over 5,000 securities from all relevant states and from all relevant market segments. As with most municipal bond funds, MUB is overweight state bonds, as well as bonds issued in New York and California.
SHYD / WEIGHT : 1%
The fund invests in fixed-income markets in the United States. It invests in municipal bonds that cover the U.S. dollar-denominated high-yield short-term tax-exempt bond market with a maturity of 1 to 12 years. It seeks to track the performance of the ICE 1-12 Year Broad High Yield Crossover Municipal Index, by using representative sampling technique.
Inflation Protected Bonds Sleeve
VTIP / WEIGHT : 5%
The Vanguard Short-Term Inflation-Protected Securities Index Fund invests in the fixed-income markets of the United States. It primarily invests in inflation-protected public obligations of the U.S. treasury with remaining maturities of less than five years. The fund seeks to track the performance of the Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index. The investment seeks to track the performance of the Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index. The key aspect of this piece of the puzzle is that short-dated TIPS have no credit risk, no inflation risk, and very little interest rate risk.
Private Equity Sleeve
PSP / WEIGHT : 4%
The Invesco Global Listed Private Equity Portfolio ETF (NYSEARCA:PSP) is a private equity index ETF. PSP is an index ETF, tracking the Red Rocks Global Listed Private Equity Index, a private equity index. The index focuses on traditional private equity companies, which make direct equity investments in private companies. PSP's index also includes smaller investments in companies making loans to private companies, generally referred to as business development companies or BDCs, and companies providing services to private equity companies. PSP's holdings consist of 31 private equity companies, which provide investors with indirect exposure to over 1000 private companies. Indirectly, the fund is as diversified as most broad-based equity index funds,
PEX / WEIGHT : 3%
The ProShares Global Listed Private Equity ETF invests in private equity companies and BDCs. These are two fairly uncommon asset classes and investments, and missing from the portfolios of many investors. Including them in your portfolio is likely to boost diversification, reducing risk and volatility. PEX's index also includes companies which invest in debt securities issued by private equity companies, or do direct lending to the same. These companies are generally classified as business development companies, or BDCs, and have very different business models to more traditional private equity companies. As an example, Ares Management Corporation (ARES) is the fund's second-largest holding. Ares focuses on direct lending to mid-size private equity companies, with smaller investments in other financial activities. Although there are some similarities between traditional private equity companies and BDCs, I believe these to be two distinct asset classes/business models. Due to this, I think PEX is more appropriately described as a private equity/BDC index ETF, in spite of its name. These are high-yielding investments and allow the fund to pay a significant dividend yield.
Public Equity Sleeve
VTI / WEIGHT : 15%
The Vanguard Total Stock Market ETF invests based on the CRSP US Total Market Index. CRSP Market Indexes capture broad U.S. equity market coverage and include securities traded on NYSE, NYSE American, NYSE ARCA, NASDAQ, Bats Global Markets, and the Investors Exchange. Nearly 4,000 constituents across mega, large, small and micro capitalizations, representing nearly 100 per cent of the U.S. investable equity market, comprise the CRSP US Total Market Index. Reconstitution occurs quarterly after the market close on the third Friday of March, June, September, and December. With over 3900 stocks, the Top 20 still represent almost 30% of the portfolio; compared to the bottom 3000 stocks of the portfolio being only 8%! Translation: while VTI provides total market coverage, most of the results come from a small percentage of the larger stocks held.
HFXI/ WEIGHT : 15%
Index IQ ETF Trust - IQ FTSE International Equity Currency Neutral ETF is an exchange-traded fund launched by New York Life Investment Management LLC. It is managed by Index IQ Advisors LLC. It invests in public equity markets of the global ex-US region. It invests directly and through derivatives in stocks of companies operating across diversified sectors. It uses derivatives such as futures and forwards to create its portfolio. It invests in growth and value stocks of companies across diversified market capitalization. The fund seeks to track the performance of the FTSE Developed ex North America 50% Hedged to USD Index. The underlying index is an equity benchmark of international stocks from developed markets, with approximately half of the currency exposure of the securities included in the underlying index "hedged" against the U.S. dollar on a monthly basis.
VWO/ WEIGHT : 12%
Vanguard FTSE Emerging Markets ETF invests in public equity markets of the global emerging region.
VWO tracks the FTSE Emerging Markets All Cap China A Inclusion Index, an index of these same securities. It is a relatively simple index, investing in all emerging market equities which meet a basic set of liquidity, trading, and size criteria. The fund includes investments in Chinese A-shares, which are sometimes off-limits to foreign investors. It is a float-adjusted market-capitalization index. VWO's underlying index is remarkably broad, which results in an incredibly well-diversified fund. VWO invests 5250 securities and has exposure to the most relevant industry segments and emerging market countries. The fund is somewhat overweight in China, due to the size of the country's economy and corporate sector. The fund is also somewhat overweight financials, a particularly large, important corporate sector in most emerging markets.
CSD ETF / WEIGHT : 1%
For investors, the appeal of spin-offs lies in their long history of outperforming the broader market, particularly in the years immediately following separation from a corporate parent. CSD was formerly known as the Guggenheim S&P Spin-Off ETF, but after the take-over of the Guggenheim ETF business by Invesco, the fund was renamed to Invesco S&P Spin-Off ETF. The investment seeks to track the investment results (before fees and expenses) of the S&P U.S. Spin-Off Index.
ANGL ETF / WEIGHT : 2%
ANGL tracks an index of fallen angel bonds: bonds that were investment grade at issuance but have been downgraded to junk status. Fallen angels tend to outperform both investment grade and junk bonds overall due to forced selling as they are downgraded. The ANGL fund tracks the ICE US Fallen Angel High Yield 10% Constrained Index ("Index"). The index is comprised of non-investment grade corporate bonds denominated in U.S. dollars that were rated investment grade at the time of issuance. The index contains domestic U.S. issuers as well as non-U.S. issuers, although qualifying securities must be issued in the U.S. market. Non-U.S. issuers may be from the E.U., Australia, Canada, Japan, New Zealand, Norway, Sweden, Switzerland, and the United Kingdom. Single issuer weight is capped at 10% of the index.
A 'fallen angel', as the name suggests, is a bond that was rated investment grade at issuance, but has since been downgraded to junk status by one or more of the rating agencies (S&P, Moody's and Fitch). Bond downgrades typically occur when an issuer experiences financial difficulties such as declining revenues or industry disruptions.
An article from the Chartered Alternative Investment Analyst Association ("CAIA") claims 'fallen angels are the last free lunch'. The fundamental reason fallen angels tend to outperform is that when a bond issuer falls on hard times and is downgraded below investment grade, investment-grade fund managers are forced to remove the securities from their portfolios. This forced selling causes the affected securities to be massively dislocated relative to their underlying business risks as they enter the fallen angel indices. Over time, the business risk is normalized, allowing the fallen angel to outperform similarly rated junk bonds.
BOSS / WEIGHT : 1%
Three studies, dating back to 1999, postulate that founder-led companies outperform based on the prevalence of an owner's mentality, and its attributes. Mr. Chris Zook, Bain and Company, published in the Harvard Business Review in 2016 a review of the performance of companies led by their original founders. Zook's review is a follow-up of a Purdue Krannert School of Management study titled, Founder CEOs and Innovation: Evidence from S&P 500 Firms that looked at the performance of companies managed by founders between 1993 and 2003 and a similar 1999 study published in the Journal of Financial and Quantitative Analysis. All three studies support the same thesis: companies led by their original entrepreneurs outperformed management teams that eventually replace them.
ICLN / WEIGHT : 1%
Clean energy has progressed significantly in the last few years, but decarbonization and net-zero emission goals are unrealistic, expensive, and time-consuming. The top sectors in ICLN are Semiconductor Equipment, Renewable Electricity, and Electric Utilities, constituting more than 55% of the total ETF. Overall, the ETF is well diversified with exposure to growth-oriented technology stocks and more stable utilities, which can mitigate risk and volatility. From a geographic standpoint, the U.S. has the highest allocation weight of 42.9%, while the combined allocation for European and Asia is 17.9% and 17.2%, respectively. The fund seeks to track the performance of the S&P Global Clean Energy Index,
VEGI / WEIGHT : 1%
It invests in stocks of companies operating across materials, chemicals, fertilizers and agricultural chemicals, industrials, capital goods, machinery, consumer staples, food, beverage and tobacco, beverages, food products, agricultural products, packaged foods and meats, and agricultural and farm machinery sectors. It invests in growth and value stocks of companies across diversified market capitalization. The fund seeks to track the performance of the MSCI ACWI Select Agriculture Producers Investable Market Index (IMI). The holdings of the fund consist of mainly agricultural equipment producers as well as seeds, fertilizers and chemicals producers.
EMFM / WEIGHT : 1%
Most emerging markets funds are dominated by more advanced economies like Brazil, China, India, Russia, and Taiwan. The Global X Next Emerging & Frontier ETF (NYSEARCA: EMFM) is the more recent arrival and it invests in companies from emerging and frontier markets but excludes investments in Brazil, Russia, India, China, Taiwan, and South Korea. Like its competitor, it maintains a ratio of roughly 75% emerging markets and 25% frontier markets. Allocation to frontier EM would make an excellent supplement to traditional emerging markets exposure.
PIE / WEIGHT : 1%
PIE screens potential components based on relative strength factors, selecting approximately 100 securities. For investors who buy into the investment thesis behind the relative strength strategy, PIE might make for a better way to access emerging economies. What is crucial to remember with PIE is that the Dorsey Wright Emerging Markets Technical Leaders Index, PIE's underlying index, is built on price momentum, which can apply to a plethora of countries and stocks. As a momentum strategy, the ETF is not always invested in high beta names, on the contrary at times the strategy can have clear defensive credentials, depending on relative price momentum.
What does the allocation look like now?
Same recap in table format:
Portfolio rebalancing is a contrarian strategy. When is it time then to rebalance? Swensen suggested people should rebalance their retirement accounts at least quarterly. He says the technique is a disciplined way to buy low and sell high over time. It also keeps your risk profile where you want it to be.
Saying investors should have a rebalancing strategy is one thing, but saying what that strategy should be is another. A variety of rebalancing rules of thumb have been suggested and debated by investment professionals.
The portfolio is reset to its target allocations on a fixed schedule—such as annually, quarterly or monthly. This rule has the virtue of simplicity but can lead to frequent, relatively minor changes.
The portfolio is adjusted if an asset class moves from its target by more than a certain amount—say plus or minus 5%. While this is a more flexible rule, in volatile markets it can also trigger a lot of buying and selling.
Range limits for each asset class are based on their expected volatility. So the rebalancing thresholds for, say, small-cap stocks would be wider than for, say, short-term bonds.
Portfolios are rebalanced as needed, based on an analysis of market conditions. This is similar to “tactical” asset allocation, which seeks to exploit shorter-term changes in market values.
In theory, at least, rebalancing should allow investors to earn higher returns at lower risk. In part, this is because the rebalancing process is contrarian—it involves selling assets that have been appreciated and buying assets that are temporarily out of favour.
Do the portfolio of institutional funds investors include hedge funds and private equity investments?
Sovereign Wealth Funds vs. Public Pension Funds
The most commonly adopted categories are fixed income and treasuries (“FIT”), public equities (“Eq”), real estate (“RE”), infrastructure (“Infra”), private equity (“PE”), and hedge funds (“HF”).
And what about the U.S. Pension Plans?
Let's take a look at an Overview of the 2020 Asset Allocation Study of Fortune 1000 Pension Plans.
Aggregate asset class distribution, 2020
Aggregate asset allocations by plan size, 2020
Let's also take a closer look at the asset allocation mix for Canadian pension funds. The survey covers all DB plans and represents total plan assets of $2,786B. Below you will find a table and box & whisker charts that provide the range of actual exposures to total and sub-asset classes for all DB plans for the year ending December 31, 2021.
What about more detailed exposures for each asset class.
Fixed income first:
Now it's the turn of equity:
Last, but not least, alternatives :
In the report below, we measure various performance metrics, we visualize performance, drawdowns and rolling statistics for the portfolio presented in this article. For the portfolio profiling, we employed the Python library #QUANTSTATS, written by Ran Aroussi, who we thank for the great contribution, which we found comprehensive and easy to use.
Below is the Tearsheet with the performance analysis of the El Erian Endowment portfolio presented in this article over the last 10 years.
Our Conclusions on this Model Portfolio. Pros & Cons.
The advantages of this implementation of El Erian's Endowment Model are relevant. First, the strategy is more diversified than traditional portfolios. Second, It has a proven track record at many large institutions and universities. Third, this portfolio construction model can effectively defend against correlation changes between bonds and equities. Fourth, It can achieve strong risk-adjusted returns. And last, by employing alternative assets instead of HFs, the strategy is accessible to a broad audience of investors.
What are the CONs instead?
First, high volatility in periods of market stress, as the strategy has a high exposure to high-return markets, given its long tem orientation. Second, It may still be hard to be implemented for smaller investors, given there are many strategies to be monitored and reviewed. Third, this approach requires greater due diligence than traditional portfolios. Fourth, It may be hard to duplicate historical success, especially for the special situation bucket, as that sleeve has a strong discretionary component. Last but not least, the Private Equity sleeve is a very indirect way to invest in private markets. Investing in equities of firms investing in venture capital or leveraged buyouts is very different from investing in private equity deals. First of all the mark-to-market is daily as it is still an investment in public markets and secondly, equities of firms active in private equity or private debt, may already discount expectations on the alpha generated by these firms.
What do we think overall? This combination of ETFs is certainly a rough approximation of an endowment strategy, and it certainly lacks some of the strengths that a portfolio run at a top University Endowment, Pension Fund or SWF may certainly have. However, it is good food for thought and certainly a valid starting point for further discussion and analysis.
Hoping you enjoyed the read!
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