Constructing Investment Portfolios for Endowments

May 11, 2021 |
3 minute read

There are fundamental principles of effective endowment management that we have organized into what we call “the 6 Ps of Investment Stewardship” –  Purpose, Policy, Process, Portfolio, People and Perspective. In this next blog in our Investment Stewardship series, we will begin to dive into the principle “Portfolio.”

Constructing and overseeing an investment portfolio is at the heart of endowment management — the nucleus around which everything revolves. Being that the investment portfolio is the core component to effective endowment management, this will be the first of two parts outlining the critical considerations within portfolios. (Read about Purpose, Policy and Process.)

If the strategic document behind the portfolio is the investment policy statement, the most fundamental tenet underpinning a wide range of decisions is asset allocation. Fundamentally, asset allocation is apportioning investment funds among categories of assets. Broadly, those categories are stocks, bonds, cash and real assets.

Today, however, these categories are divided and subdivided to optimize returns while managing risk. A traditional stock portfolio, for example, may include allocations to growth and value styles; small, mid- and large cap stocks; international (non-U.S. developed markets); and emerging markets. For many nonprofits today, the largest single allocation is to alternative investment strategies. These include private capital (venture capital, private equity and international private equity), real estate, natural resources, commodities, distressed debt and marketable alternative investments, (hedge funds, absolute return, market neutral, long/short, 130/30, event-driven and derivatives).

Looking Beyond Traditional Asset Classes

Historically, asset allocation decisions have been based on the asset classes and strategies identified in the previous paragraph. Today, however, there are other ways of looking at portfolio diversification.

Many endowments employ a functional classification in combination with traditional asset allocation. This approach diversifies across asset classes/strategies based on their role in the portfolio: growth, risk reduction, inflation protection, liquidity, opportunistic investments and duration.

Another approach is factor-based asset allocation, factors being the attributes that can explain differences in returns. Most factors fall into two broad categories: macroeconomic factors (a focus on broad risks across asset classes, e.g., inflation, credit and economic growth) and style factors (a focus on risks and returns within asset classes, e.g., growth, value and momentum). A factor-based strategy involves tilting equity allocations toward or away from specific factors.

What about Liquidity?

Investors are also mindful of the liquidity position of their portfolios in order to meet short-term cash needs. Typically, there are three liquidity categories:

  • liquid, or the ability to convert an asset into cash in one month or less;
  • semi-liquid, or being able to convert to cash in one month to one year; and
  • illiquid, or an asset requiring more than one year to be converted to cash.

Asset allocation and spending policy are closely linked and must be compatible...right?

A critical challenge is choosing a strategic asset mix that will generate the returns necessary to support the agreed-upon spending policy at an acceptable level of risk. When experienced investors make asset allocation decisions, they do not seek to maximize returns, but instead focus on risk-adjusted returns, or maximizing returns for a given level of risk.

What investors seek to do by diversifying their portfolios is to combine assets that are relatively uncorrelated. Investing in asset classes that can be expected to move together produces little diversification benefit. However, adding asset classes that on their own might be considered risky can lower an endowment’s overall risk profile if these classes have a low correlation with each other. The Investment Policy Statement (IPS) may be reviewed once every two or three years, unless extenuating circumstances intervene.

Asset allocation, however, should be reviewed at every meeting of the investment committee—not necessarily with the idea of making changes, but to review how the portfolio is currently allocated versus the policy allocation and to rebalance, if necessary.

How often should you rebalance?

A decision to rebalance should be made when the agreed-upon asset allocation (the policy portfolio) has become distorted by the relative performance of one or more allocations. Outperformance by one or two allocations and/or underperformance by others will alter the risk/return profile of the portfolio.

Traditionally, endowment managers have rebalanced annually, or even less frequently. Rebalancing too often can be disruptive and costly, while rebalancing every two or three years may incur excessive portfolio risks.

To continue learning about the ins and outs of the role of portfolios in endowment management, download our complete guide, Principles of Investment Stewardship for Nonprofit Organizations.

download now


Commonfund Institute


Commonfund Institute

Stay connected with the Insights Blog

Popular Blog Posts

Market Commentary | Insights Blog

Chart of the Month | The Surprising Relationship Between Money Supply and Inflation

The potential for rising inflation is becoming a top concern for many investors and consumers. Many believe that inflation is already here as evidenced by price increases in commodities, homes,...
Perspectives | Insights Blog

The Case for Using the Higher Education Price Index® (HEPI) to Define Inflation for Colleges

When calculating return targets for an endowment portfolio, a conventional piece of the equation is often the Consumer Price Index (CPI). CPI plus 5% is the common short-hand formula for institutions...
Governance And Policy | Insights Blog

Endowment Management and the Three Primary Responsibilities of a Board

The fourth blog in the “Six Ps of Investment Stewardship” series addresses People, specifically how boards function within an organization. To learn more about the first four principles in the series...


Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.