Trustee Investment Strategy for Endowments and Foundations

Foreword ix

Preface xi

Acknowledgments xvii

1 Introduction 1

1.1 Endowment fund characteristics 2

1.2 Constraints on endowments 4

1.3 History rhymes 6

1.4 The US endowment experience 8

1.5 Structure of the book 12

2 Language of Return 17

2.1 Economic return 17

2.2 Investment return 18

2.3 ‘Other income’ not return 20

2.4 Income, capital and ‘total return’ 21

2.5 Real and nominal return 23

2.6 Absolute and relative return 26

2.7 Arithmetic and geometric return 28

2.8 Time-weighted return and money-weighted return 31

3 Elements of Return 35

3.1 Deriving return 35

3.2 Risk-free return 37

3.3 Premium for risk 38

3.4 Equity risk premium 41

3.5 The eighth wonder of the world 43

3.6 Valuation change 44

3.7 Drivers of return 48

3.8 Scenario analysis 49

4 Understanding Risk 53

4.1 Description of risk 53

4.2 Pascal’s Wager 54

4.3 Chance 56

4.4 Co-movement and common factors 58

4.5 The Greek alphabet 62

4.6 Confidence 63

4.7 Consequences 64

4.8 Endowment fund risk 65

5 Spending Rules 69

5.1 The endowment dilemma 69

5.2 Micawber’s rule 71

5.3 Pattern of flows 73

5.4 More scenario analysis 75

5.5 Determining an operating rule 76

6 Assets for Strategy 79

6.1 Back to the future 79

6.2 Investment approach 81

6.3 Classification of assets 82

6.3.1 Operational assets 84

6.3.2 Intergenerational assets 85

6.4 Asset categories 86

6.4.1 Cash 87

6.4.2 Short-dated and intermediate-term bonds 88

6.4.3 Long-dated bonds 89

6.4.4 High-yield bonds 90

6.4.5 Inflation-indexed bonds 91

6.4.6 Convertible bonds 92

6.5 Equities 93

6.6 Private equity 95

6.7 Real estate 96

6.8 Commodities 98

6.9 Hedge funds 99

7 Legal, Social and Ethical 103

7.1 Quis custodiet ipses custodies? 103

7.2 Tax matters 106

7.3 Extra-financial issues 106

7.4 Corporate governance 107

7.5 Corporate social responsibility 109

7.6 Socially responsible investment 111

7.7 Program-related investment 113

7.8 Global view 114

7.9 Reality check 115

8 Understanding Strategy 117

8.1 Resource assessment 118

8.2 Defining needs 119

8.3 Quantifying needs 122

8.4 Spending rule 123

8.5 Operational assets 124

8.6 Intergenerational assets 126

8.7 Review 134

9 Implementing Strategy 137

9.1 Investment policy statement 137

9.2 Trustees of an endowment 139

9.3 Investment committee 141

9.4 Investment staff 144

9.5 Risk tolerance and control 146

9.6 Operational asset management 147

9.7 Intergenerational asset allocation 148

9.8 Benchmarks and performance 150

9.9 Consultants 152

9.10 Selection of asset managers 153

9.11 Costs 156

9.12 Custody 159

10 Synopsis 161

References and Reading Matter 165

Glossary 171

Index 221