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Endowment Management: Key Questions

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Cambridge Associates report, Endowment Management, summarizes our thoughts on best practices and the keys to success in endowment investing. In this abstract, we highlight the major questions outlined in Endowment Management, as a kind of checklist for investment committees. These questions focus on four attributes we regard as prerequisite to investment success: a strong governance structure, appropriate policies and objectives, adequate implementation capabilities, and a systematic approach to performance measurement and evaluation.

Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

INTRODUCTION

Effective endowment management requires the asking and answering of many key questions. The broadest of these are: Does our governance structure facilitate sound, disciplined decision-making? Do those individuals charged with responsibility for overseeing the assets have sufficient understanding of institutional investing and sufficient information at their disposal to make informed decisions? Are they spending enough time to do the job right? Do we have explicit, written policies that describe the endowments objectives and the means taken to achieve them? Do we have the knowledge, experience, and resources needed to implement those policies effectively? Are we monitoring and measuring the results of our decisions in ways that tell us whether we are succeeding in achieving our objectives?

ENDOWMENT MANAGEMENT: KEY QUESTIONS

CAMBRIDGE ASSOCIATES LLC

| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

GOVERNANCE

Good governance leads to good decisions and weak governance to poor decisions. By governance we mean the structure, size, and composition of the committee charged with responsibility for the endowment, and how that committee goes about organizing itself to discharge that responsibility.

Investment Consultants
What is the consultant hired for? What role is the consultant expected to play? Not only should the answer to these questions inform the choice of a consultant, but if the committee, the organizations staff, and the consultant are not entirely clear on this point after the consultant has been selected, disharmony and discontent will surely ensue. What knowledge, research, expertise, and resources can the consultant provide? What kind of questions should we be asking our consultant? How can we get the most value for our consulting fees?

ENDOWMENT MANAGEMENT: KEY QUESTIONS

The Investment Committee

What is the role of this committee? What kind of people should be asked to serve and should they have term limits? What are the characteristics and responsibilities of an effective chair? How often should the committee meet and what resources does it need to make good decisions? What distinguishes effective committees from dysfunctional, ineffective committees? Should the committee appoint subcommittees for specialized tasks?

Endowment Management Costs

Few endowments allocate sufficient time to evaluating what they spend to manage their assets and whether this money is well or badly deployed. As a result, the money is often deployed badly, thoughtlessly, in ways that do not yield valuebut no one realizes this because no one is keeping score. A high-cost structure can only be justified by superior performance, while a low-cost structure should also be scrutinized to determine whether the organization is in fact penny wise but pound foolish. The questions that should be asked about costs are: How much are we spending and on what? How does this compare to what similar organizations spend on endowment management? How can we determine whether we are spending too much in some areas and not enough in others? If we spent more or less in this or that area, how might this affect our net returns? Are we convinced we are getting value for money in all areas?

Meetings
How should meetings be managed? How long should they last? Who is responsible for the agenda? What differentiates a good meeting from a bad meeting? What should be the structure and content of the minutes? What happens when a committee member misses a meeting?

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| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

Should We Hire Professional Investment Staff?

Few institutions have the good fortune to be served by an investment committee whose members have sufficient time, knowledge, experience, and commitment to oversee the fund as effectively as capable professional staff could do. But whether an organization should hire professional investment staff is primarily a function of the incremental return expected from such an investment. The right questions to ask are: Can we expect to perform better if we hire full-time professional investment staff than if we do not? If yes, by how much? If we do not hire full-time professional investment staff, are we in danger of exercising inadequate oversight of our endowment fund? If the investment committee lacks the necessary expertise and/or time and resources to oversee the fund properly, are there viable alternatives to in-house professional staff?

Successful investing requires as much perspiration as inspiration, but investment committee members rarely spend enough time on endowment management to break a sweat.

ENDOWMENT MANAGEMENT: KEY QUESTIONS

CAMBRIDGE ASSOCIATES LLC

| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

POLICIES

Introduction
Endowment funds are not ends in themselves, but the means to an end, which is to provide financial support to their organization. Until the organization defines its financial objectives for the endowment fund, it cannot begin to construct investment objectives designed to realize those ends. Consequently, the trustees first responsibility is to define the funds financial objectives and their second is to articulate commensurate investment objectives.

Until the organization denes its nancial objectives for the endowment fund, it cannot begin to construct investment objectives designed to realize those ends.
Asset Allocation Modeling
The sloppy approach to asset allocation is to run a model designed to optimize the trade-off between risk (defined as volatility) and return, and allocate accordingly. Although model enthusiasts often present themselves as rigorous statisticians, model inputswhich determine the outputsare in fact no better than educated guesstimates. Consequently, although models are extremely useful to inform ones thinking about risk and return, they should never be used as the sole determinant of an asset allocation.

ENDOWMENT MANAGEMENT: KEY QUESTIONS

Spending
The answer to How much can we spend? is contingent on answers to four other questions: Do we want to grow, maintain, or liquidate the endowment fund? If we decide to maintain the fund, how much risk of failing to realize that objective will we tolerate? What average annual real rate of return can we expect to earn over the life of the fund? How much variability in the level of spending can we stand?

Asset Allocation
A funds strategic asset allocation should be articulated in the form of a long-term policy portfolio, reflecting the asset mix best suited to realize the funds investment objectives over the long term. The investment committee must also decide whether the endowment should engage in tactical asset allocation, which is the attempt to add value by tactical deviations from the strategic asset mix. Such deviations should be deliberate and purposeful, rather than accidental and random, and the results of such decisions should be closely evaluated.

CAMBRIDGE ASSOCIATES LLC

| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

I M P L E M E N TAT I O N

Introduction
Many endowmentsparticularly smaller funds managed by investment committeessquander the value of carefully designed policies by careless implementation.

Indexing and Active Management

In asset classes where index funds are available, active managers should be considered only when a compelling case can be made that they are likely to add value, net of their higher fees and greater risk of underperforming the asset class in question. In general, the dos and donts of active manager selection in traditional asset classes are relatively straightforwardand consistently ignored. The simplest of these are: Dont hire managers on the basis of good recent performance. Do hire managers with coherent, disciplined philosophies and processes that have generated good long-term results, when they have recently suffered a period of relatively weak performance solely as a result of sticking to their knitting. Dont fire managers solely on the basis of poor recent performance.

ENDOWMENT MANAGEMENT: KEY QUESTIONS

Resources
Here, the first question to ask is not, What do we want to do? but, What can we do, given available resources and expertise? In particular, investors intending to diversify their portfolios into alternative investments should first assess the resources required to do so successfully.

The Role of Each Asset Class

The second step is to match the form of the investment with the role it is designed to play in the portfolio. For example, a bond allocation designed as an anchor to windward in times of economic stress should not be implemented by investing in low-quality credits.

Alternative Assets
In so-called alternative investmentsparticularly hedge funds, private markets, and private real estatethe dispersion of returns among managers is so broad that the consequences of poor manager selection can be severe. Consequently, investors should not heed the siren song of alternative assets until and unless they have answered four key questions: Do we understand the risk and return characteristics, and the underlying source of return of these prospective investments? Do we know what additional resources are required to invest successfully in these areas? Are we prepared to pay what is needed to succeed? What are our implementation options and how should we evaluate them?

CAMBRIDGE ASSOCIATES LLC

| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

E V A L U AT I O N

Endowment funds should not only measure performance, but also evaluate the risks incurred to attain the returns. Few do so with any rigor, but since returns are essentially the payments investors receive for incurring various kinds of risks, this fundamental component of performance should not be ignored. Too often, trustees ask only the impossibly broad question, How did we do? They should ask: How did we do relative to our long-term objective? our policy portfolio? other organizations like ours? What is the purpose for which we are asking, How did we do? To determine whether we are maintaining the real value of the assets? To see if we are beating our policy portfolio benchmark? To assess whether our tactical bets have paid off? To judge how staff have performed?

ENDOWMENT MANAGEMENT: KEY QUESTIONS

CAMBRIDGE ASSOCIATES LLC

| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com

O F F I C E L O C AT I O N S

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ENDOWMENT MANAGEMENT: KEY QUESTIONS

CAMBRIDGE ASSOCIATES LLC

| Copyright 2008 by Cambridge Associates LLC. All rights reserved. | www.cambridgeassociates.com