An endowment model is a type of investment inspired by university endowment investment styles, particularly the Yale University fund. It consists of a blend of typical investments including stocks and bonds in addition to less traditional offerings such as hedge funds and private equity. The balance tends to be heavy on equities and light on low-yield investments such as bonds. This kind of investment style focuses on maintaining low liquidity, the risk of which can be managed by committing to long-term investments. The concept is also known as modern portfolio theory.
Though it became known because of its success with university funds, the endowment model can be used in a variety of ways. In addition to being an option for other organizations, it can also be used by individual investors. It tends to be more common among larger organizations that can handle having a high percentage of cash tied up in long term investments.
One of the primary strategies of the endowment model is that by varying investment vehicles returns are supposedly higher. An investor using this style would first get an idea of the history of a particular option and determine its pattern of success in the market. Then the investor would pick investment options that are different but not quite opposite to each other.
The idea behind the endowment model is that the risk of investment increases if the funds chosen are too much alike or exactly opposite. If there are too many similarities between two funds, then losses, in addition to gains, could be too volatile. When investment vehicles are exactly opposite each other, then there is less of a chance of making a profit, because there is a strong chance that when one investment is performing well, the other will be in decline. By understanding the past patterns of available investment options, an investor using the endowment model can pick funds that vary but are not so different that gains and losses will cancel each other out.
There has been some skepticism about the endowment model. Though it gained popularity by increasing the fortunes of some Ivy League universities, when the investments made by multiple endowments began to plummet in the market, some claimed that this was the fault of the model. Others have argued that it is not the model that is at fault, but the allocation of assets. It has been claimed that the model still works as long as the investor ensures that sufficient cash is free for regular operations. In essence, if low-liquidity is not taken too far, the model is arguably still viable.