Three lessons investors can learn from university endowments

These investment principles apply whether you’re saving for retirement or funding a college campus

Harvard University has the largest endowment of any college in the US — hitting $38 billion in fiscal year 2018 — and it’s built to be a permanent source of funding for teaching and research.1 That’s not the type of portfolio that individual investors can easily relate to. However, I believe investors may have more in common with endowment funds than they realize. Below, I outline three lessons that can be learned from taking an “endowment approach” to an individual portfolio.

1. The importance of a spending policy

Endowment funds typically have a spending policy that allows for a certain level of administrative expenses, as well as other projects designed to help the university attract and retain students and faculty.

For example, such a policy might allow a university to spend 1.5% of its endowment each year on administrative expenses, with additional expenditures of 4% for things like scholarships, endowed professorships, and building funds. There is also a number plugged in for inflation, such as 2%, for example. Adding these up, an endowment fund might hope to average around 7.5% per year to maintain its principal over the decades (not counting new donations). 

What could this mean for you? Similarly, many retirees are advised to keep their spending at or below a certain percentage of their balance each year (for example, 4.5%, with any necessary adjustments for inflation). This is designed to maintain their lifestyles without depleting the account during their lifetime.

2. The need for diversification

Even the most thoughtfully constructed spending policy might not be able to sustain itself without an investment policy that is designed to help target growth, manage volatility, and generate income from a variety of sources.  Endowment fund boards typically will have an Investment Policy Statement (IPS) that serves as the guide for what types of asset classes are allowed in the portfolio and in what percentages. 

It should be no surprise that endowment funds are typically heavily-weighted toward equities for growth potential. Fixed income, including preferred securities, typically has a prominent place in the mix, as well as “real assets” such as real estate and other investments that can help hedge against inflation.  Finally, “diversifying strategies,” such as “market neutral” funds or other strategies with low correlation to stocks and bonds, are often part of the overall investment policy and portfolio mix.

What could this mean for you? Individual investors can access similar investment choices through vehicles such as unit trusts, mutual funds and exchange-traded funds. What will the mix of investments look like if properly designed? That’s between you and your financial advisor, who will consider elements such as your risk tolerance, time horizon, and unique financial goals.

3. The role of rebalancing

Once your asset allocation is set, it’s important to check in on a regular basis to make sure that the market’s ups and downs haven’t shifted the allocation too far away from your plan. Endowment funds will rebalance on a regular basis, remove and replace certain investments that are underperforming, and in certain negative market years curtail its typical spending policy to conserve principal. They know that despite their annual performance reporting requirement, one good year or bad year won’t change the long-term policies they have in place to pursue their performance goals.

What could this mean for you? Likewise, you and your financial advisor can design a plan to regularly check in on your portfolio and rebalance your assets back to your long-term goal, as needed.

Endowments for ‘the rest of us’

Is your portfolio managed like an endowment fund?  Is your 401(k) or IRA designed to be sustainable, multi-generational, and to serve its purpose for you and your family, and possibly your heirs?  Even if you’re of a “die broke” mindset, with plans to spend down your portfolio completely during retirement, a long-term focus is essential as we are typically living longer, and no one wants to outlive their income or assets.  

Investors planning to take a typical drawdown of 4% to 5% per year for living needs in retirement should talk to their advisors about ways to target growth, manage volatility in all kinds of markets, and diversify their sources of retirement income.  A tall order for sure, but it is possible with the right asset allocation mix and account maintenance to increase your odds of success over long periods of time.

While many investors have reasonably adequate exposure to equity and fixed income, there may be opportunity to add additional asset classes for further diversification (which can help with managing volatility), as well as additional income generators. At Invesco Unit Trusts, we would highlight the following:

Dividend Sustainability Portfolio
Preferred Opportunity Portfolio
Defensive Equity & Income Portfolio
High Income Allocation Portfolio
Inflation Hedge Portfolio

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Important Information

Blog header image: Miquel Llonch / Stocky

Diversification does not guarantee a profit or eliminate the risk of loss.

Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money.

Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Preferred securities may include provisions that permit the issuer to defer or omit distributions for a certain period of time, and reporting the distribution for tax purposes may be required, even though the income may not have been received. Further, preferred securities may lose substantial value due to the omission or deferment of dividend payments.

The opinions referenced above are those of the authors as of Sept. 9, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

There is no assurance the trust will achieve its investment objective. An investment in this unit investment trust is subject to market risk, which is the possibility that the market values of securities owned by the trust will decline and that the value of trust units may therefore be less than what you paid for them. This trust is unmanaged and its portfolio is not intended to change during the trust’s life except in limited circumstances. Accordingly, you can lose money investing in this trust. The trust should be considered as part of a long-term investment strategy and you should consider your ability to pursue it by investing in successive trusts, if available. You will realize tax consequences associated with investing from one series to the next.

Jack Tierney

Head of UIT Investment Policy and Governance

Invesco Unit Trusts

Mr. Tierney joined Invesco in 2010. Prior to joining the firm, he was the head of product development, management and investment research for Van Kampen Unit Trusts since 2003. During his tenure with Van Kampen, he held positions within Van Kampen Consulting, business development, marketing services, mutual fund product management, and distribution, having started as a wholesaler with Van Kampen Merritt in 1984.

Prior to Van Kampen, Mr. Tierney spent four years with Merrill Lynch in Chicago as a financial advisor. He began his career as a high school business teacher and basketball coach in the Chicago suburbs. Mr. Tierney earned a Bachelor of Science degree in Marketing and a Master of Science degree in Business Education from Northern Illinois University.