The Endowment Model | Summary and Q&A

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March 13, 2021
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Ben Felix
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The Endowment Model

TL;DR

Large institutional investors' allocation to alternative asset classes as a sales tactic for high net worth individuals is flawed, as evidence shows the failure of the endowment model and the inability of alternatives to deliver expected returns and diversification benefits.

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Key Insights

  • 🔒 Large institutional investors' allocation to alternative asset classes, such as hedge funds, private equity, and private real estate, is often used as a sales tactic for high net worth individuals. However, the evidence suggests that this is a flawed approach.
  • 🚚 The failure of the endowment model, as observed in public pension funds and educational endowments, challenges the notion that alternative investments deliver superior returns and diversification benefits.
  • 📼 The increasing correlation between alternative assets and traditional assets eliminates any potential diversification benefits.
  • ✋ The high costs associated with alternative investments, estimated to be between two and four percent per year, further undermine their attractiveness.
  • 🏛️ The decreasing expected returns of illiquid asset classes, such as private equity, indicate that the historical advantage of these investments has largely diminished.
  • 🧑‍🏭 The success of large institutional investors should not be used as an argument for individual investors to replicate their strategies, as the factors contributing to their success may not be replicable for others.
  • 😘 The Norway Model, followed by the world's largest institutional investor, focuses on passive investing with exposure to systematic risk factors, low-cost index investing, and responsible investing practices.
  • ✋ High net worth individual investors may be better served by managing their funds passively at minimal costs, rather than pursuing exotic investments based on the appeal to authority argument.

Transcript

large institutional investors like pension funds university endowments and sovereign wealth funds are looked to as thought leaders in portfolio management and asset allocation their asset allocation strategies often have a taste for alternative asset classes like hedge funds private equity and private real estate the fact that institutional investo... Read More

Questions & Answers

Q: Why are large institutional investors often looked to as thought leaders in portfolio management and asset allocation?

Large institutional investors, such as pension funds and university endowments, are perceived as authoritative figures due to their extensive experience and resources in managing portfolios and allocating assets.

Q: How has Yale's endowment model performed over the years?

Yale's endowment model, pioneered by David Swenson, has delivered exceptional investment results since 1985. However, other institutions have struggled to replicate Yale's success, indicating that the endowment model may not be easily replicable.

Q: What is the correlation between alternative assets and traditional assets?

The correlation between alternative assets, such as hedge funds and private equity, and traditional assets like stocks and bonds has been increasing. This high correlation eliminates any potential diversification benefits that alternative assets may have provided in the past.

Q: What are the main reasons for the failure of the endowment model?

The failure of the endowment model can be attributed to several factors, including increasing correlation, high costs associated with alternative investments, and decreasing expected returns of illiquid asset classes. These factors have undermined the performance and diversification benefits of alternative assets.

Summary & Key Takeaways

  • Large institutional investors like pension funds and university endowments are often seen as thought leaders in asset allocation and portfolio management, with a preference for alternative assets like hedge funds, private equity, and private real estate.

  • However, the allocation to alternative assets has not been successful in delivering lower risk or higher returns, as observed in public pension funds and educational endowments.

  • The increasing correlation between traditional assets and alternatives, the high costs associated with alternative investments, and the decreasing expected returns of illiquid asset classes contribute to the failure of the endowment model.

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