Advanced Endowment Model: The Right Building Blocks

For more than two decades, Partners Capital has been an investment partner for endowments, foundations, and families seeking to build resilient, long-term portfolios. Using our accumulated experience and learning, we have developed our own multi-asset class investment approach, applying the foundational principles of the endowment model and iterating it as capital markets have evolved over time. We call this the Advanced Endowment Approach (AEA). We use the word advanced with a large dose of humility and awareness that this approach can only be effective through continuous improvement in the face of an ever-changing investment landscape.  

In this Investor Perspectives article, we dive deeper into our Advanced Endowment Model, focusing on the first of five spokes – the Right Building Blocks to underpin a resilient, long-term investment portfolio.

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Building on solid foundations

The right building blocks aim to strike a balance between generating returns and providing resilience. To do this, you need to start with a solid foundation – determining the right risk level for the portfolio and sticking to it. This sets the ‘base speed’ of the portfolio, which can be enhanced with targeted active strategies and Private Markets exposure.

This needs to be balanced with portfolio elements which provide stability and liquidity across a range of market environments. Traditional Equity/Bond portfolios rely on Government Bonds to provide this stability. However, in our AEA approach, we advocate for diversifying your ‘safety net’ assets beyond just Government Bonds by adding Absolute Return Hedge Funds and Real Assets. A well-constructed Absolute Return program has generated higher returns with small drawdowns than Government Bonds, while Real Assets provide better protection in inflationary environments.

Set an appropriate risk level

Portfolios are exposed to a range of market risks such as Equity Risk, Interest Rates, Inflation, and Credit Risk. We find aggregate Equity-Equivalent Risk to be a useful measure for expressing a portfolio’s overall risk level. Asset Classes are not homogenous though, so a careful assessment of the market risks underpinning each investment is needed to truly understand the risks in a portfolio.

The right risk level will be contingent on the return requirements for the portfolio, as well as the ability for the investor to tolerate a market downturn. Our belief is that once set, investors need to stick to their risk level through market cycles as rigorous rebalancing adds value whereas varying the risk level is akin to market timing and will likely produce inconsistent results.

Targeted exposure to private markets

One of the key criticisms of the endowment model centres around whether investing in Private Markets is worth it, particularly in an environment which is likely to see higher interest rates for longer. We believe targeted exposure to Private Markets allows investors access to some of the best companies in the world, many of whom are choosing to stay private. These companies are often able to grow their earnings faster than their publicly listed peers – private companies have grown annual earnings 2-4% faster than similarly-sized public companies fairly consistently over the last 50 years.¹

Our focus in Private Equity is on the lower middle market to middle market sectors, which have more scope for earnings growth and are less reliant on IPO markets for exit opportunities. We focus on managers who are actively able to drive value in portfolio companies through operational improvements, rather than relying on expensive leverage or multiple expansion to deliver returns. This is supplemented by selective exposure to Venture Capital to gain access to innovation that will drive future market returns.

Notes

1. Through Q2 2024.

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Use hedge funds to diversify your ‘safety net’

A traditional 60/40 Equity-Bond portfolio relies on Government Bonds to provide the low-risk ‘safety net’ for the portfolio. While Government Bonds still have a place in a diversified portfolio, we believe that an effective way to further bolster portfolio resilience is through the use of Absolute Return Hedge Funds.

The increasing correlation of Government Bond and Equity returns means that Bonds don’t provide the same protection in times of market stress that investors require. In contrast, Absolute Return Hedge Funds have experienced lower drawdowns than Bonds and have been able to provide higher returns.

Notes

1. Last 10 years annual return to 30 June 2024.
2. Treasuries measured by iShares 7-10 Year Treasury ETF
3. Hedge fund performance shown as Harrier Fund C performance net of Partners Capital fees. Net performance is quoted net of 0.5% annual management fee and 5% performance fee. A client’s actual fees will vary based on the fee arrangement with Partners Capital. Past performance is not a reliable indicator and is no guarantee of future results.

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Add inflation protection

The post-COVID inflation spike brought inflation protection to the forefront of almost all investors’ minds. We expect inflation and the volatility of inflation to remain elevated as markets enter a new paradigm following an era of financial repression. Unfortunately, traditional “inflation hedges” such as Commodities and Gold are costly, in the sense that they deliver low long-term returns with higher volatility than Equities over the full cycle.

We believe Real Assets are higher-quality sources of inflation protection in a diversified portfolio. While Real Estate and Infrastructure provide slightly lower returns than Commodities and Gold in some inflationary environments, they deliver a far better long-term risk-adjusted return.

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Portfolios constructed using these building blocks should deliver both excess long-term returns and provide stability and protection across a range of economic environments.

Footnotes

1. Source: Cambridge Associates, US Private Equity Looking Back, Looking Forward: Ten Years of CA Operating Metrics, November 2022. Company sized based on enterprise value at acquisition: Lower Middle Market / Middle Market defined as assets acquired in years 2008 to 2020 with <$250M of EV.