What investors can learn from endowment strategies

Many South Florida investors pay close attention to the daily changes in stock market averages and what the bond market is doing. But there’s another way to think about your investment portfolio: the endowment model.

Private colleges, universities and other institutions are often the beneficiaries of endowments from generous donors. These gifts — which may run into millions of dollars — provide a stream of income to support student scholarships, faculty positions, research laboratories or other academic needs.

As a general rule, these institutions try to use only the income from these gifts without touching the underlying funds. That would allow them to use these endowments indefinitely. Unlike an individual who worries about what might happen on Wall Street tomorrow, next week or next year, those short-term fluctuations make little difference to an institution’s endowment strategy.

Opportunities and risks

That long-term approach creates both opportunities and risks for individual investors. For instance, it can prompt consideration of different types of assets, such as alternative investments.

For investors who can afford to allocate a portion of their portfolios to less liquid investments, they can potentially boost their overall returns in the coming years.

These strategies can add a stabilizing component to a diversified portfolio because historically, they have a low to moderate correlation with market indices. This is an important consideration in an economic recession or in a period of high volatility in the financial markets.

However, alternative investments are not for everyone. They usually have high minimum levels of investments and may tie up those funds for 5, 10 or 15 years. That means an investor’s money would not be available in the event of a sudden need for cash, such as a medical emergency. These strategies are speculative, include a high degree of risk, and are suitable only for qualified, long-term investors.

Therefore, investors should retain a significant portion of their portfolios in liquid assets, such as a money market fund, as well as stocks, bonds, and other assets that can be sold, if necessary in the public markets.

Other strategies

For investors who don’t have the resources, patience or desire to pursue an endowment strategy, there are other ways to construct a diversified portfolio.

One example is the contrarian strategy, which focuses on assets that have been ignored or neglected by most investors. If strong demand has pushed up the prices stocks of a certain sector, for example, a contrarian investor would look at other sectors, seeking to find lower priced shares. Or a contrarian might partially turn away from the stock market and shift some funds to other types of assets.

A more traditional strategy involves building a portfolio of stocks and bonds based on a 60-40 model. A younger investor with many decades to go before retirement would put about 60 percent of the portfolio into stocks and 40 percent into bonds. For investors approaching retirement age, the percentage would be reversed. Of course, not all of the portfolio would be in stocks and bonds, since it’s important to include other types of assets.

While the 60-40 approach is easy to understand, it should be reviewed with your financial advisor on a regular basis. That’s because a run-up in the stock market might disrupt your target balance, leaving you with a 70-30 split, for instance. A significant imbalance could expose you to higher risk in the event of a downturn on Wall Street.

As with all types of investment strategies, it’s essential to consider your goals, your tolerance for risk and your time horizons when constructing your portfolio.

This story was originally published January 24, 2020 at 6:00 AM.