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Optimal Investment Strategies for University Endowment Funds

46 Pages Posted: 19 Jun 2004  

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit

Date Written: August 1991

Abstract

A common approach to the management of endowment is to treat it as if it were the only asset of the university. This approach leads to prescriptions for optimal investment and expenditure policies that are essentially the same across universities. Indeed, the resulting optimal portfolio strategies are focused almost exclusively on providing an efficient tradeoff between risk and expected return, a generic objective that is just as applicable to individuals and non-academic institutions as it is to universities. In contrast, the model developed here provides intertemporally optimal investment and expenditure rules for endowment that take account of the university's overall objectives and total resources. The explicit inclusion of other university assets in addition to endowment leads to optimal endowment portfolios that are not efficient in the sense of the risk-return tradeoff. Moreover, two universities with similar objectives and endowments can have very different optimal portfolios and expenditure patterns if their non-endowment sources of cash flow are different. The model also takes account of the uncertainty surrounding the costs of the various activities such as education, research, and knowledge storage that define the purpose of the university. As a result, the analysis reveals a perhaps somewhat latent role for endowment: namely, hedging against unanticipated changes in those costs.

Suggested Citation

Merton, Robert C., Optimal Investment Strategies for University Endowment Funds (August 1991). NBER Working Paper No. w3820. Available at SSRN: https://ssrn.com/abstract=226740

Robert C. Merton (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Avenue
E62-634
Cambridge, MA 02139-4307
United States
617 715 4866 (Phone)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6678 (Phone)

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