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Endowment asset allocation is the distribution of assets within an endowment to maximize returns and minimize risk. Universities and other large institutions use endowments to fund their activities, including providing financial assistance to students, investing in new facilities, and funding key faculty and staff members. These funds are critical to the welfare of the parent organization and should be managed with extreme care. Some institutions manage their own funds, while others turn them over to a skilled asset manager who can perform the necessary work.
The mixture of assets in an endowment tends to be highly diversified. This is a tactic that reduces risks by spreading investments across a broad number of categories. Even if investments in one sector perform poorly, the others may do well or hold steady, evening out the earnings for a given financial period. Patience can also be an aspect of endowment asset allocation, where managers are willing to wait for good returns rather than immediately moving funds out of unprofitable investments.
Managing an endowment can be complicated. Educational institutions are accountable to students and members of the public, and may need to release annual reports to discuss investments and earnings. When making decisions about endowment asset allocation, the management team needs to consider the interests of the institution, the draw on the endowment in recent months or years, and current financial issues. In poor markets, institutions may lean heavily on endowments as other sources of funding dry up, which means the principal may be depleted even as returns get lower.
A number of different asset classes can be represented in an endowment, including foreign and domestic investment in stocks, bonds, and other opportunities. Part of endowment asset allocation includes a precise balance between risk and returns. The highest returns come with the greatest risk, which can rule them out of the equation, because the manager doesn’t want to imperil the endowment. Stable returns are too low to meet the needs of the fund, however, so the investment mix needs to be calculated to have good, but safe, returns.
Research on endowment asset allocation shows that very large endowments can perform extremely well even in poor economic conditions. Having a large principal to start with can make it easier to diversify and take risks to get a chance at better returns. Conservative asset allocation strategies are common in small endowments, where there are concerns about risking the principal. This can backfire, however, as it may be difficult to build wealth if the manager doesn’t take some risks.