Friday, August 2, 2019

Endowment management - Market power, private information and liquidity as drivers of asset allocation

What are causes for portfolio differences between large and small endowments? All portfolio allocation information is readily available from a number of sources. Endowments know the allocation and performance of their peers. There have been books written on the so-called "endowment model", so there is no secrecy with what Yale or other Ivy League schools do, yet there are significant differences in allocations based on endowment size. 

It cannot be said that small endowments are driven by ignorance of their peers. It does not seem likely that there will be significant differences between the risk preferences of endowments based on size. There have to be other reasons for allocation differences.

Differences in portfolio management are likely to be driven by market structure and not financial knowledge. I suggest that asset allocation differences based on size across endowments are driven by three factors:
  • Market power and costs 
  • Private information 
  • Liquidity 
Market power - Small endowments do not get access to the best private equity, venture cap, and real estate deals. They also do not have the size and staff to dictate terms in a deal. Big and more successful managers want to deal with big and successful endowments. Size receives attention and commands attention. Size has benefits that allow these endowments to increase allocations to less liquid and less well-known investments. 

Private information - Large endowments that receive more attention also receive more information about new opportunities. Large endowment also have the staff to create private information through their due diligence analysis. There are able to find hidden value in less public deals.

Liquidity - Large endowments may have less of an immediate need for cash and also have more budget flexibility. These endowments can invest in more long-term illiquid projects. Hence, this lower need for liquidity will be seen in their allocations.

The activities of large endowments cannot be replicated by small endowment. This difference impacts allocation decisions and create a barrier to entry to replicate the Yale endowment. Market structure and organization matters. 

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