Think Like an Endowment

While many investors (and their advisers) still think about investment portfolios solely in terms of cash, stocks, and bonds, a growing number of investors and advisers have expanded their investment universe to include non-traditional investments, often called “alternatives”. The primary benefit of using non-traditional investments in a portfolio is to augment the risk-adjusted returns provided by a common stock-bond portfolio. This strategy is commonly referred to as taking an “endowment approach” because the endowments of large universities were early adopters of non-traditional investments.

As an example, as of June 30, 2016, Harvard University’s Endowment was valued at $35.7 billion, making it the single largest university endowment. The Table to the right outlines Harvard’s asset allocation shifts over the years[1]:

As can be seen, the percentage allocation to non-traditional investments increased from 13% in 1995 to almost 38% by 2016.

Harvard University Endowment’s annualized performance over the last 10- and 20-year periods ending June 30, 2015 was 7.6% and 11.8%, respectively, as compared to a standard 60% stock / 40% bond portfolio (using the S&P 500 Index and the Barclays Aggregate Bond Index), which provided 6.8% and 7.9% average annualized returns over those same time periods[2].

[1] Source: Harvard Management Company Annual Report 2016.

[2] Source: Harvard 2015 Annual Report.

Back-Tested Analysis

When performing back-testing analysis, a traditional 60/40 stock-bond portfolio declined 30.8% from peak-to-trough over the period January 2000 to December 2012. Conversely, a portfolio with equal allocations to the S&P 500 Index, the Barclays Aggregate Bond Index, and the Dow Jones Credit Suisse Hedge Fund Index only lost 23.2% during the same period. Moreover, the annualized volatility of the “endowment” portfolio was 6.5% as compared to the 60/40 portfolio at 9.2%[3].

J.P. Morgan Asset Management performed its own back-testing analysis comparing the return and volatility of portfolios with different allocations. As the chart to the right highlights, in every scenario, adding an allocation to non-traditional investments improved the portfolio’s return while reduced the average volatility[4].

[3] Data Source: Morningstar

​[4] Source: Barclays, Burgiss, Cambridge Associates. FactSet, HFR, NCREIF, Standard & Poor’s, Towers Watson, J.P. Morgan Asset Management. The portfolios that do not contain alternatives are a mix of S&P 500 and the Barclays U.S. Aggregate, in the amounts highlighted in the chart. The 20% allocation to alternatives shown in the other portfolios reflects the following: 10% in hedge funds, 5% in private equity, and 5% in private real estate. The volatility and returns are based on data from 1Q90 to 4Q14.

Implementing an Endowment-Styled Investment Portfolio

LINK Portfolio Alternatives offers the following five-step process on how financial advisers can adopt an endowment-style investment portfolio:

Step 1 – Define Investment Universe

The adviser's investment committee should begin by defining what investment types are suitable for its investors in general without regard to any specific investor. By evaluating regulatory, macroeconomic, and other market factors, certain asset classes or investment types may be eliminated either permanently or temporarily. LINK Portfolio Alternatives recommends that a universe of potential investments include the following:

Step 2 – Establish Client’s Investment Policy Statement

The adviser should help their client complete an Investment Policy Statement Questionnaire. Data gathered from the questionnaire ultimately helps create the client’s investment policy statement (“IPS”).

The purpose of an IPS is to establish a clear understanding between the client and the adviser as to the investment choices and policies applicable to their investable assets.  An IPS is not a financial plan, but is a component of financial goal setting. A financial plan can help clients gain a better understanding of their current financial situation and determine attainable financial goals. Within that context, an IPS helps outline a prudent investment philosophy and identifies appropriate investments and portfolio construction.

An IPS is also not a contract, but it does provide a framework within which an adviser may exercise investment discretion.  In addition, an IPS identifies any restrictions or prohibitions to a client’s portfolio or assets and outline both the client’s and the adviser’s duties and responsibilities.

Step 3 – Construct Portfolio

Using the current universe of available investments, a client’s IPS, and other inputs from the client, the adviser then creates a customized endowment portfolio that is comprised of both liquid and non-liquid investments. It is not uncommon for this step to require several passes as investment selections and allocations are refined.

Step 4 – Implement in Tranches

For better or worse, implementation does not happen quickly. It is critical that the client understand each new investment entering the portfolio. However, given that most investors are not familiar with non-traditional investments, this process takes time as only a few investments are introduced for each investment tranche.


Step 5 – Ongoing Monitoring


At mutually-agreed intervals, the client and the adviser should meet to discuss portfolio performance. While tactical allocation changes are typically happening all the time at the asset level, in particular for the liquid assets, strategic allocation changes never occur without a thorough discussion between the client and the adviser. Updates to a client’s strategic allocation are typically made only when there has been a significant change to global economies, market trends, or a client’s situation.

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Managing Direct Investments

Unlike liquid assets, which are typically managed per an asset allocation methodology, such as Modern Portfolio Theory (MPT), when managing direct investments, there is no investment theory on allocation or diversification that can be relied upon. Therefore, and advisory firm's approach to managing direct investments is commonly based on the collective wisdom of its team and its due diligence associates, thus making their experiences and connections all the more important.

When an adviser is evaluating a potential Direct Investment Program (“DIP”), we at Link Portfolio Alternatives recommend numerous factors should be considered, such as sponsor experience and track record, deal structure, and general suitability. We also recommend an adviser look at how a sponsor would complement its organizational structure, distribution capabilities, and current portfolio offerings. The following outlines Link Portfolio Alternatives' recommend approach to managing DIPs:

Step 1 – Assemble a Due Diligence Team

Based on the guidance and direction from an advisory firm's investment committee, from time to time, prospective DIPs should be selected for potential inclusion onto the firm's investment platform. To complete due diligence on any candidate DIP, a Due Diligence Team should be organized that includes the following roles and responsibilities:

  • Chief Compliance Officer (CCO) – Manages firm-wide compliance, including approval of DIPs on the platform. The CCO maintains final approval / rejection authority.

  • Due Diligence Officer (DDO) – Manages one or more due diligence projects. The DDO reports makes approval / rejection recommendations to the CCO.

  • Due Diligence Analyst (DDA) – Responsible for detailed due diligence data gathering. DDAs do not make any recommendations.

Step 2 – Create an Initial Screening Process

To assist Atomi with determining whether a DIP is appropriate for inclusion, candidate sponsors are asked to complete an initial questionnaire. The purpose of the initial questionnaire is to determine if, based upon the sponsor’s representations, this is a sponsor Atomi should complete a formal due diligence review on. Data is not verified at this time as verification comes later in the process. Based upon the information collected, Atomi’s DDO makes a recommendation whether to proceed or decline with due diligence.

Step 3 – Formal Due Diligence and Review of Documents


Atomi’s DIP Due Diligence Checklist is used to assist the Due Diligence Analyst (DDA) in determining what documents and information should be considered for examination during the formal due diligence process. In addition, the DDA reviews the following documents:

  • Private Placement Memorandum or Offering Circular – All sponsor-related offering documents are reviewed to help the DDA identify areas of risk/concern and items for further clarification.

  • Third Party Due Diligence Reports – These reports may help the DDA identify additional areas of risk/concern and items for further clarification. Of course, the qualifications and competency of third party experts retained to perform the investigation on its behalf are also evaluated.

  • FINRA Notice 10-22 – FINRA’s memo on due diligence best practices is reviewed to help ensure the DDA work meets FINRA’s standards.

  • Due Diligence Internal Report Template – This document contains a list of questions developed by Atomi from our past experiences. This document is reviewed by the DDA to ensure that the documents we obtained are sufficient to complete the questions on this document.


During the review of sponsor and third party documents, the DDA documents any information encountered that should be reviewed in greater detail or requires additional verification. Special attention is paid to anything that may be considered a “red flag” that would alert a prudent person to conduct further inquiry. Red flags might arise from information that is publicly available or information that is discovered while completing due diligence. Either the DDA or the DDO follows up on any red flags as well as investigate any substantial adverse information about the issuer/sponsor.


All notes and observations are documented in the Due Diligence Internal Report.


Step 4 – Perform an On-Site Review

After substantial completion of Step 3, a visit to the offices/facilities of the issuer occurs to meet with the sponsor’s management team to discuss the issuer's business plan, knowledge of their industry, competitors, and any other relevant issues.

Step 5 – Complete an Internal Due Diligence Report

Upon completion of the due diligence process, the DDA completes the Due Diligence Internal Report by creating a summary memo that highlights the review process, significant findings, etc.

Step 6 – Complete a Final Review and Approve/Reject

Based on the research completed by the DDA, the DDO will make a recommendation whether to sign the sponsor onto the Atomi platform. Upon review of materials, the CCO may affirm or reject the DDO’s recommendation.

Step 7 – Conduct Periodic Reviews

At least annually, Atomi’s DDO conducts a review of each DIP sponsor to ensure that the DIP’s performance is within expectations and its business strategy is still aligned with investors’ interests. At any time, Atomi’s DDO may choose to cancel a DIP selling agreement.

Direct Investment Program Suitability Guidelines

When considering which investments are suitable for an investor, Atomi begins by considering the general suitability of the DIP itself, particularly considering the composition of the client’s total portfolio. Issues such as investment risk, stability of income, concentration risk, among others are considered. Ultimately, what may be appropriate for one client may not be prudent for another.

DIP Concentration Guidelines


As a general guideline, Atomi does not recommend more than 10% of a client’s investible net worth into any one DIP. If a client requests more than 10% of their net worth to be invested into a single DIP, Atomi will have the client sign Atomi’s Additional Risk Disclosure Form, highlighting the concentration risk.

In addition to the above program allocation limits, Atomi advises that no more than 20% of a client’s total portfolio should be allocated to a single sponsor. If a client requests more than 20% of their net worth to be invested into a single sponsor, Atomi will have the client sign Atomi’s Additional Risk Disclosure Form, highlighting the concentration risk.

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