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Do Endowment Funds Select the Optimal Mix of Active and Passive Risks?

Journal of Investment Management (JOIM), First Quarter 2010

Posted: 13 Mar 2010 Last revised: 3 Jun 2010

Keith C. Brown

University of Texas at Austin - Department of Finance

Cristian Ioan Tiu

University at Buffalo; TIAA Institute

Date Written: March 10, 2010

Abstract

The investment decision confronting managers of multi-asset class portfolios can be characterized in terms of the passive (i.e., benchmark or policy) and active (i.e., market timing and security selection) strategies they adopt. In this paper, we investigate whether managers select the appropriate combination of active and passive allocations in their portfolios. Noting that this issue is ultimately a risk management question, we adapt a simple framework for establishing what constitutes the optimal level of active and passive risk exposures.We then examine the question empirically using a database consisting of the allocation decisions and investment performance of a large set of university endowment funds over the period from 1989 to 2005. Our findings show that (i) the average endowment had too little active risk exposure in its portfolio, (ii) endowment funds could have significantly increased their risk-adjusted performance by enhancing the scale of the alpha-generating strategies they were already employing, and (iii) this tendency to under-utilize active management skills was more pronounced for larger endowments than for smaller ones. We conclude that the typical endowment fund could have improved its performance by increasing the commitment to its active management skills.

Keywords: Risk budgeting, active-passive allocations, investment performance, endowment funds

JEL Classification: G00

Suggested Citation

Brown, Keith C. and Tiu, Cristian Ioan, Do Endowment Funds Select the Optimal Mix of Active and Passive Risks? (March 10, 2010). Journal of Investment Management (JOIM), First Quarter 2010. Available at SSRN: https://ssrn.com/abstract=1568446

Keith C. Brown (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-6520 (Phone)
512-471-5073 (Fax)

Cristian Ioan Tiu

University at Buffalo ( email )

238 Jacobs Management Center
Jacobs Hall, North Campus
Buffalo, NY NY 14260
United States
7166453299 (Phone)

TIAA Institute ( email )

8500 Andrew Carnegie Blvd
E3/S8
Charlotte, NC 28262
United States

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