Endowment funds are the investment portfolios that are established for foundations such as universities, churches and charitable organizations. Some of the largest endowments in the world are established by universities, such as Harvard and Yale, which combined for over $60 billion in assets under management, as of January 2016. Each endowment has an investment policy statement, which is designed to outline the purpose and guidelines of the endowment fund and how its funds are to be invested by the portfolio manager.
The beginning of an investment policy statement is designed to introduce the institution or entity for which the endowment was created. This portion also outlines the roles of the individuals, such as the investment management committee members or board of trustees, who are responsible for carrying out the statement’s guidelines.
The beginning of the investment policy statement also contains the mission statement or objectives of the endowment. For example, the University of California, Los Angeles’ (UCLA) endowment statement has two missions; maintain the endowment’s purchasing power in perpetuity and achieve sufficient investment returns to sustain the level of spending necessary to support university operations.
The spending policy portion of the statement provides the details of the target distribution rate for the endowment fund on an annual basis. This target rate is established by the board of trustees and can be calculated as a percentage of total fund assets or a fixed rate each year. This amount can change on an annual basis, depending upon the budget needs for the university and the overall investment performance of the endowment fund.
The investment objective section quantifies the mission statement goals and objectives. For instance, the UCLA investment policy states that sustainable investment returns over the long term should be kept. The investment objectives portion of the statement dictates that the goal is to achieve an average annual real return of 5% per year over the long term. This section also dictates important requirements for the fund’s investments, such as to maintain diversification, reasonable risk levels, liquidity and social responsibility. Many investment policy statements provide the appropriate benchmarks and the corresponding expected returns for each asset class as a comparison measure for the fund’s performance.
Asset Allocation Policy
This portion of the investment policy statement requires the most detail. The asset allocation policy establishes the type of investments that the endowment investment manager can use. Many institutions have been using a wide variety of asset classes to make up the asset allocation of the endowment funds. The Harvard Endowment uses traditional asset classes such as U.S. equity, foreign equity, emerging equity, domestic bonds, foreign bonds and high yield. However, it also has exposure to other asset classes such as private equity, absolute return, natural resources and real estate. The Harvard Management Company (HMC), which runs the endowment, believes that the exposure to multiple asset classes increases overall performance while decreasing risk.
The asset allocation policy also dictates the acceptable allocation target range that each asset class can have. This helps the endowment fund maintain the long-term goals of the investment policy statement, while giving the investment manager flexibility to make tactical decisions within the ranges. For example, the Harvard endowment has a range of 6 to 16% for U.S. equities, 6 to 11% for foreign equities and 4 to 17% for emerging market equities. The largest allocation is for private equity, with a range from 13 to 23%. The smallest allocation is to high yield, with a range of 0 to 3%.
Endowment Portfolio Reporting and Maintenance
This section of the investment policy statement clarifies the monitoring and reporting policy for the endowment fund. This will include the auditing of the fund performance by a reputable third-party accounting or auditing firm. The section will also provide statements of the asset allocation, performance, activity and market value of the fund to the board of trustees and members of the foundation.
This portion of the statement also reviews the asset allocation rebalancing policy. If a certain asset class falls above or below the intended target range, the investment manager would make the correct trading adjustments. These portfolio rebalances can be made on a quarterly, semi-annual or annual basis.