When Will I Be Loved? In Defense of the Endowment Model (Again)

Scott Welch, CIMA ®

Chief Investment Officer, Model Portfolios

05/26/2020

I’ve been cheated, been mistreated
When will I be loved

I’ve been put down, I’ve been pushed ’round
When will I be loved…

I’ve been made blue, I’ve been lied to
When will I be loved

(From “When Will I Be Loved,” written and performed by The Everly Brothers, 1960, covered by Linda Ronstadt, 1975)

Like asset classes and risk factors, the “endowment model” rotates in and out of favor. What do we mean by the “endowment model?” In the context of individual investors, we believe it means:

Broad and global diversification;

Intelligent use of active vs. passive investment strategies (i.e., a cost/benefit optimization of active management fees or, in WisdomTree’s phrase, “Modern Alpha^®”);

A prudent use of nontraditional or lower-correlation investments in an attempt to improve overall portfolio diversification;

A long-term time horizon; and

Investment discipline through full market cycles.

From the mid-1990s until the great financial crisis (GFC) of 2007–2009, the endowment model was all the rage, as university endowment funds like Yale and Harvard racked up impressive performance numbers due to their then cutting-edge approach to investing. The wealth management industry raced to democratize and incorporate some of these investment ideas into their own client portfolios.

Following the GFC, however, the endowment model fell out of favor, as many of those same universities faced liquidity squeezes that pushed performances down. If you were not as illiquid as an endowment, however, the approach still made sense for many investors.¹

But then the great central bank rally began in earnest, and from roughly 2013–2019, a new phrase came to be associated with the endowment model: deworsification. Essentially, investors who had anything in their portfolios except U.S. stocks and bonds saw reduced performance.

“Ride the beta wave” became the new investment mantra, and the endowment model for anyone beside the endowments essentially disappeared.²

Well, that regime may be ending. The dramatic market volatility over the past several months has many investors seeking, once again, to incorporate less-traditional or lower-correlation strategies into their portfolios.

At WisdomTree, we never lost faith in the potential benefits of an endowment model approach (for the right investor), and we have an asset allocation model portfolio called, explicitly, the “Endowment Model.” As of March 31, 2020, this model was allocated as follows:

Endowment Model Breakdown

We believe some aspects of this portfolio are worth highlighting:

The portfolio is globally diversified and, as with all WisdomTree model portfolios, it is “open architecture” and incorporates both proprietary and third-party investment strategies;

The portfolio consists of both cap-weighted and factor-tilted ETFs, as we seek to optimize the costs and benefits of both passive and active management strategies;

The portfolio incorporates WisdomTree’s 90/60 U.S. Balanced Fund (NTSX). This ETF uses the inherent leverage of futures contracts to gain a more capital-efficient exposure to a traditional “60%/40%” stock/bond allocation³; and

This increased capital efficiency leaves “room” in the portfolio to allocate to potential lower-correlation strategies. As of March 31, 2020, these “alternatives” included real assets such as gold, master limited partnerships and infrastructure, as well as nontraditional volatility management strategies designed to potentially lower the equity beta profile of the overall portfolio.

As we work our way through the coronavirus pandemic and then into eventual recovery (hopefully in the second half of the year), we believe that we will have entered a new market regime that will be marked by increased long-term volatility. Advisors who seek lower-correlated potential sources of returns, as well as broader diversification in their client portfolios, may want to give the WisdomTree Endowment Model a look.

This approach to disciplined, long-term investing may, once again, be loved.

¹In fact, in 2010, I wrote an article entitled, “In Defense of the Endowment Model,” which appeared in the May/June edition of the IMCA Investments & Wealth Monitor (pp. 32–36).
²For those who are interested, there is an annual survey of endowment performances conducted by the National Association of College and University Business Officers (NACUBO). The performances for the most recent fiscal year (July 1, 2018–June 30, 2019) are summarized here: https://www.nacubo.org/Press-Releases/2020/US-Educational-Endowments-Report-5-3-Percent-Average-Return-in-FY19.
³Investors often rely on the diversification potential of a 60% stock/40% bond portfolio in their asset allocation. NTSX incorporates this same logic to enhance the risk-return profile of a large-capitalization U.S. equity portfolio. Similarly, it can also be used as a 1.5x levered 60/40 strategy. NTSX seeks total return by investing 90% of its assets in the 500 largest U.S. stocks by market capitalization and 10% in short-term fixed income, and it targets a 60% notional exposure to U.S. Treasury futures.

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