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Frontier Capital Management is delighted to be involved in the inaugural launch of the Investment Analysis of Charity Times.

We see this as an important offering to the sector that will enable a number of educational articles to be made widely available as well as offering insights into different approaches to managing charitable assets.

In this issue we would like to discuss the success of the US University Charitable Foundations and how their approach has differed from those in the UK – both in terms of diversification and also returns.

The university endowment funds of Harvard and Yale have been leaders in diversified multi asset class investing for over two decades.

Through this approach to investing and their exposure to alternative asset classes they have consistently achieved high double digit annual returns with low risk and only moderate draw downs.

The Endowment Funds are very well resourced and have access to the best institutional, private equity and hedge fund managers, and this adds to their investment success.

However, by adopting asset allocation principles similar to the Super Endowments it is possible for charity investors to also obtain high levels of risk adjusted returns that are superior to traditional equity/bond portfolios and most balanced investment funds. Examining the strategies of the US Endowment Funds is of relevance to charity investors for a number of reasons.

Firstly, the endowment funds have consistently achieved superior investment returns. The larger endowments – Harvard, Yale, Stanford, Texas and Princeton – have achieved on average 10 year annualized return of approximately 14.6 per cent.

This is roughly double the return for a traditional 50% equity and 50% bond portfolio while incurring a lower level of risk.

Secondly, the endowments have innovative portfolios with exposure to multiple asset classes that provide additional diversification benefits. Here the larger endowments tend to be leaders.They hold roughly 57 per cent of their portfolio in alternative asset classes.

In contrast the average US endowment still holds roughly 80 per cent in traditional assets.

The additional diversification in large endowment portfolios is one of the reasons for their superior long term investment performance.

Finally, endowment funds typically have long term investment horizons and stable asset allocations over time: allocations that rely less on market timing for generating returns and have lower trading costs.

Of the US Endowment Funds, Frontier places significant emphasis on the asset allocation methodology of Harvard and Yale.

They have been two of the best performing with annual returns consistently placing them in the top 10 of all US endowments. They have been pioneers in multi asset investing. Currently, 45% of their portfolios are in traditional assets– much less than the 80% of the average endowment.

Of their alternative assets, the majority is allocated to hedge funds. However their holdings of commodities and private equity are also much greater than the average endowment.

Like endowment funds in general the asset allocations have been very stable over time. Since 1999, the Super Endowment funds have only reallocated an average of approximately 8per cent of their portfolio annually.

This stability reflects their long term investment horizon and willingness to invest through economic cycles.

The superior returns make benchmarking to their asset allocations attractive. However most charities are not able to invest like the super endowments, particularly in asset classes such as private equity.

Nevertheless significant value can be created by following the multi asset approach within an index tracking portfolio.

Frontier have constructed an index tracking portfolio by using the annual asset allocation weights of the Super Endowments utilizing 7 global asset class indices. Returns are estimated from January 1999 to May 2008.

Private equity has been excluded as this asset class is not suitable for an index tracking portfolio (it has been pro rated half into listed equity and half into other alternative asset classes).

Cash has also been excluded so that the portfolio could be directly comparable to traditional equity/bond portfolios.

The resulting ‘adjusted’ Super Endowment asset allocation now places just 50% of funds in alternative asset classes – slightly less than the endowments exposure.

This index tracking portfolio generated annualised returns of 10.3% since 1999 relative to just 3.1% for US Equities and 4.1% for a US Equity/Bond portfolio.

The index tracking portfolio also had a much lower drawdown during the 2000-2002 equity bear market and has outperformed so far during the current sub prime crisis.The Super Endowments of Harvard and Yale have consistently achieved high investment returns and low volatility due to their multi asset approach to investing and exposure to alternative asset classes.

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