The Endowment Model and Modern Portfolio Theory
We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze conditions under which the “Endowment Model,” used by some large institutional investors such as university endowments, does or does not work. The alternative asset has a lock-up, but can be voluntarily liquidated at any time at a cost. Quantitatively, our model's results match the average level and cross-sectional variation of university endowment funds' spending and asset allocation decisions. We show that asset allocations and spending crucially depend on the alternative asset's expected excess return, risk unspanned by public equity, and investors' preferences for inter-temporal spending smoothing.
For helpful comments, we thank Andrew Ang, Winston Dou, Thomas Gilbert, Steve Grenadier, Lars Peter Hansen, Bob Hodrick, Steve Kaplan, Monika Piazzesi, Jim Poterba, Mark Schroder, Tom Sargent, Stijn Van Nieuwerburgh, Luis Viceira, and Steve Zeldes; seminar participants at Columbia University; and participants at the European Finance Association and NBER New Developments in Long-Term Asset Management conferences. We thank Matt Hamill and Ken Redd of NACUBO and John Griswold and Bill Jarvis of Commonfund for assistance with data. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.