The Endowment Model of Investing: Return, Risk, and Diversification

by Martin L. Leibowitz ( ); Anthony Bova; P. Brett Hammond

• ISBN13: 9780470608449
• ISBN10: 0470608447
• Format: eBook
• Copyright: 2010-03-01
• Publisher: Wiley

Summary

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.

Table of Contents

Preface

Acknowledgments

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

Notes

References

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

Notes

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

Conclusion

Appendix

References

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

Appendix

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

Conclusion

Alpha-Driven Efficient Frontiers

The Efficient Frontier in Alpha Space

Increasing the Alpha Core Percentage

Conclusion

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 Risk-and-Return Tradeoffs

Societal Gaps and Opportunities

References

Equilibration

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

References

Shortfall Risks and Efficient Frontiers

Importance of Shortfall Risk in Portfolios

Efficient Frontiers Using Fixed Alpha Cores

Shortfall Probabilities

Shortfall Regions in Risk-and-Return Space

Shortfalls Relative to the Risk-Free Baseline

Shortfall Probabilities along the Efficient Frontier

Multiple Horizon Comparisons

Appendix

References

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 Risk-and-Return Regions

Conclusion

References

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

Conclusion

References

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

Conclusion

Real Return Tents and Equity Durations

P/E Ratios and Nominal Interest Rates

P/E Ratios and Equity Duration

Inflation versus Real Rate Effects

Spread-Driven DDM's

P/E Ratios versus Inflation

P/E Ratios versus Real Rates

Conclusion

References

Theoretical and Empirical Stress Betas

Stress Betas and Correlation Tightening

Portfolio Convexity Effects

Stress Correlations of 1

Residual Volatility Constant

Varying Residual Volatilities

Conclusion

Appendix

References

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

References

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

Appendix

The Endowment Model: Theory and Experience

Theoretical Beta-Based Risks

Historical Risk Characteristics

Alpha and Beta Returns

Conclusion

Diversification Performance: Under Stress (2008) and over the Long Term (1993 through 2007)

A Semi-Diversified Portfolio

Volatilities and Volatility Ratios

Individual and Portfolio Correlations with U.S. Equity

Historical Betas

Beta-Based and Alpha Returns

Stress Beta Theory

2008 Results and Stress Betas

Conclusion

Asset Allocation and Return Thresholds

Asset Allocation and Return Thresholds in a Beta World

Percentiles in Return and Beta Space

The Percentile Fan

Minimum and Maximum Betas for Return Targets

The Characteristic Probability of Exceeding the Risk-Free Rate

Multiyear Horizons

Beta Regimes

Shortfall Lines

Alpha Cores and Stress Betas

Conclusion

Appendix

References

Key Takeaways

About the Authors

Index

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