The Endowment Model of Investing Return, Risk, and Diversification

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  • Edition: 1st
  • Format: Hardcover
  • Copyright: 2010-04-05
  • Publisher: Wiley
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A cutting-edge look at the endowment model of investingMany larger endowments and foundations have adopted a broadly diversified asset allocation strategy with only a small amount of traditional U.S. equities and bonds. This technique, known as the "endowment model of investing," has demonstrated consistent long-term performance and attracted the attention of numerous institutional and individual investors.With The Endowment Model of Investing Leibowitz, Bova, and Hammond take a closer look at the endowment model with customary research sophistication and attention to detail. Throughout the book, they examine how the model provides truly outstanding real returns, while keeping a close eye on the risks associated with this method of investing. Along the way, the authors offer practical advice on incorporating the endowment model into your own investment endeavors and reveal what it takes to make this method work in the real world. Details the growing debate about the endowment model of investing and discusses how to use it successfully Written by an authority on endowment investing and non-traditional asset allocation strategies Offers expert insights on understanding risk and return in non traditional asset allocationIf you want to gain a better grasp of one of the most successful forms of investing, then The Endowment Model of Investing is a book you need to read.

Author Biography

Martin L. Leibowitz is Managing Director in the U.S. Research Department at Morgan Stanley. Prior to working at Morgan Stanley, he was vice chairman and chief investment officer of TIAA-CREF. Leibowitz is a leading authority in the fields of security analysis and portfolio allocation. He is the author of four books, including Franchise Value, and 138 articles, eight of which have won the prestigious Graham and Dodd Award for excellence in financial writing.

Anthony Bova is a Vice President in the Morgan Stanley Research Department, focusing on institutional portfolio strategy. He recently won the ninth annual Bernstein Fabozzi/Jacobs Levy Award for coauthoring the article "Gathering Implicit Alphas in a Beta World," which ran in the Spring 2007 issue of the Journal of Portfolio Management.

P. Brett Hammond is a Managing Director and Chief Investment Strategist for TIAA-CREF Asset Management. His group is responsible for asset allocation modeling, institutional advising, economic and market commentary, and investment product and portfolio research. Within TIAA-CREF, Hammond has also published extensively on pension issues, developed new approaches to performance attribution, and played a key role in the creation of the company's life-cycle inflation-linked bond funds.

Table of Contents

Alpha/Beta Building Blocks of Portfolio Management
The Modern Endowment Allocation Model
Truly Long Term Orientation
Novel Asset Classes and Special Access
Remaking the Investment Manager Relationship
More Market-Sensitive Allocations
Asset Allocation
Beta-Based Risk and Return: The Sigma and Beta Lines
Structural Betas and Alphas
Finding the Beta in the Black Box
The Structural Beta
Return Components of Asset Classes
Risk Components of Asset Classes
Portfolio Beta Values
"Modern" Allocations with Alternatives
The Extreme Allocation
Return Components at the Portfolio Level
Comparison of Portfolios' Risks and Returns
Implications for Institutional Portfolios
Beta as the Key Risk Factor
Beta-Based Asset Allocation
Beyond Diversification: "Dragon Risk"
The Nature of Diversification
Dragon Risk
A Diversification Model
Diversification in Sources of Return
Potential Diversification "Costs"
Overdiversification versus Dragon Risk
Reverse Asset Allocation Using Alpha Cores
Simplifying the Portfolio Optimization Process
The Alpha Core
The Swing Assets
The Fixed Alpha Core Segment
Generality of the Alpha Core Representation
Varying the Core Parameters
The Cash Line Segment
The Bond Bridge
The Equity Extension Segment
The Three Segment Frontier
The Frontier Slope
The Uplifted Frontier
Channel Risk
Risk Mitigation and Asset Class Inclusion
The Efficient Frontier with Bonds as the Risk-Free Base
The Equity Risk Premium
Bond-Relative Alphas and Betas
Risk Analysis
Portfolio Level Analysis
The Alpha Core
Efficient Frontier Analysis
The Alpha Effect
Expanding the Alpha Core
Inherent Constraints on Alternative Assets
Building An Alpha Core
Maximum-Return Alpha Cores
The "Flower" Diagram
Expanding the Alpha Core
Moving Beyond Beta Domination
Dual Active/Allocation Alphas
Alpha-Driven Efficient Frontiers
The Efficient Frontier in Alpha Space
Increasing the Alpha Core Percentage
The Societal Efficient Frontier
Standard Efficient Frontiers
The Swing Asset Frontier
The Concept of a Societal Frontier
Total Betas and the Diversification Paradox
Dragon Risk Constraints and "Climbing the Alpha Wall"
A "Societal Frontier" of Quantum Risk States
Active Alphas and Other Return/Risk Tradeoffs
Societal Gaps and Opportunities
Beta Domination and Constrained Alternatives
Alpha Decay under Beta Domination
Realized Returns versus Going-Forward Alphas
Sharpe Ratio Decay
Sequential Alpha Erosion
Equilibration across the Societal Frontier
Shortfall Risks and Efficient Frontiers
Importance of Shortfall Risk in Portfolios
Efficient Frontiers Using Fixed Alpha Cores
Shortfall Probabilities
Shortfall Regions in Return/Risk Space
Shortfalls Relative to the Risk-Free Baseline
Shortfall Probabilities along the Efficient Frontier
Multiple Horizon Comparisons
Convergence of Risks
End-of-Period Shortfall Probabilities
Within-Period "Stop-Loss" Probabilities
High Watermark Shortfalls
Changing the Thresholds and Horizons
Shortfall Probabilities along the Efficient Frontier
Acceptable Return/Risk Regions
Active Alphas: Bound, Portable, and Integrated
Allocation Alphas
Active Alphas
Portable Alphas
Bound-Active Alphas
Integrated Alphas
Risk Budgets
Expanding the Active Universe
Shifting Policy Portfolios
Beta-Based Performance Analysis
Active versus Passive Alphas
Decomposition of Benchmark Return
Relative Return Analysis
Actives Alphas without Reweighting
Overweighting Active Alphas
Adding a New Asset Class
Beta Neutralization
Analyzing Historical Performance
Real Return "Tents" and Equity Durations
P/E Ratios and Nominal Interest Rates
P/E Ratios and Equity Duration
Inflation vs. Real Rate Effects
Spread-Driven DDM's
P/E Ratios vs. Inflation
P/E Ratios vs. Real Rates
Theoretical and Empirical Stress Betas
Stress Betas and Correlation Tightening
Portfolio Convexity Effects
Stress Correlations of One
Residual Volatility Constant
Varying Residual Volatilities
Stress Risks within Asset and Surplus Frameworks
Risk Life Cycles
Stress Times as Determinant of Risk Tolerance
Correlation Tightening Under Stress
Divergence under Stress
Short-Term Risk Reduction and Long-Term Returns
Normal Correlation-Based Betas
Beta Response Curves
Stress Betas
The Surplus Framework
Surplus Beta Curves
Partial Liability Hedge
Full Liability Hedge
De-Risking and Re-Risking
Maintaining a Fund's Return-Seeking Potential
Diversification Alphas
Active Alphas
Double Alphas and Portability
Stress Beta Pathways
An Empirical Example
A Minimum Residual Volatility Model
Implied Asset Volatility
Stress Betas at the Asset Level
Short-Term Vulnerability of Diversified Portfolios
Beta Pathways for Individual Asset Classes
The Endowment Model: Theory and Experience
Theoretical Beta-Based Risks
Historical Risk Characteristics
Alpha and Beta Returns
Diversification Performance: Under Stress (2008) and Over the Long Term (1993-2007)
A Semi-Diversified Portfolio
Volatilities and Volatility Ratios
Individual and Portfolio Correlations with US Equity
Historical Betas
Beta-Based and Alpha Returns
Stress Beta Theory
2008 Results and Stress Betas
Asset Allocation and Return Thresholds
Asset Allocation and Return Thresholds in a Beta World
Percentiles in Return/Beta Space
The Percentile Fan
Minimum and Maximum Betas for Return Targets
The "Characteristic Probability" of Exceeding the Risk-Free Rate
Multi-Year Horizons
Beta Regimes
Shortfall Lines
Alpha Cores and Stress Betas
Key Takeaways
About the Authors
Table of Contents provided by Publisher. All Rights Reserved.

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