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The Interaction of Spending Policies, Asset Allocation Strategies, and Investment Performance at University Endowment Funds

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  • Keith Brown
  • Cristian Tiu
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    Abstract

    Using data for more than 800 college and university endowment funds over 2003-2011, we provide a comprehensive analysis of the spending policies used in practice as well as how frequently and why those mandates are revised over time. Given the long-term and relatively static nature of the investment problem faced by the typical educational institution, existing theoretical models of endowment management predict that the permanent portion of the stated spending policy should be highly stable. However, we find that half of the endowments revised their rules at least once and, on average, about a quarter of the sample changed their spending policies each year, implying a retention rate far lower than expected. We show that larger endowments with lower historical portfolio returns and lower past payout levels are more likely to alter their future spending formulas, but that institutions having the ability to invoke special appropriations on a temporary basis are less likely to make adjustments to their permanent rules. Further, we document that both spending rule changes and asset allocation adjustments persist over time and that, consistent with hypothesized behavior, the former tends to lead the latter. Finally, while there is some evidence that endowment funds as a group produce superior returns relative to their policy benchmarks, we show that there is no difference in benchmark-adjusted performance between institutions that either did or did not change their spending rules.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19517.

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    Date of creation: Oct 2013
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    Publication status: Forthcoming: The Interaction of Spending Policies, Asset Allocation Strategies, and Investment Performance at University Endowment Funds , Keith C. Brown, Cristian Ioan Tiu. in How the Financial Crisis and Great Recession Affected Higher Education , Brown and Hoxby. 2014
    Handle: RePEc:nbr:nberwo:19517

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    1. Brown, Stephen J, et al, 1992. "Survivorship Bias in Performance Studies," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 553-80.
    2. Jeffrey R. Brown & Stephen G. Dimmock & Jun-Koo Kang & Scott J. Weisbenner, 2014. "How University Endowments Respond to Financial Market Shocks: Evidence and Implications," American Economic Review, American Economic Association, vol. 104(3), pages 931-62, March.
    3. Jeffrey R. Brown & Stephen G. Dimmock & Scott Weisbenner, 2012. "The Supply of and Demand for Charitable Donations to Higher Education," NBER Chapters, in: How the Financial Crisis and Great Recession Affected Higher Education National Bureau of Economic Research, Inc.
    4. Josh Lerner & Antoinette Schoar & Jialan Wang, 2008. "Secrets of the Academy: The Drivers of University Endowment Success," NBER Working Papers 14341, National Bureau of Economic Research, Inc.
    5. Josh Lerner & Antoinette Schoar & Wan Wongsunwai, 2007. "Smart Institutions, Foolish Choices: The Limited Partner Performance Puzzle," Journal of Finance, American Finance Association, vol. 62(2), pages 731-764, 04.
    6. Bodily, Samuel E. & White, Chelsea C., 1982. "Optimal Consumption and Portfolio Strategies in a Discrete-Time Model with Summary-Dependent Preferences," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(01), pages 1-14, March.
    7. Marshall Blume, 2010. "Endowment spending in volatile markets: what should fiduciaries do?," Review of Quantitative Finance and Accounting, Springer, vol. 35(2), pages 163-178, August.
    8. Hansen, Lars Peter & Jagannathan, Ravi, 1997. " Assessing Specification Errors in Stochastic Discount Factor Models," Journal of Finance, American Finance Association, vol. 52(2), pages 557-90, June.
    9. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
    10. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August.
    11. Litvack, James M & Malkiel, Burton G & Quandt, Richard E, 1974. "A Plan for the Definition of Endowment Income," American Economic Review, American Economic Association, vol. 64(2), pages 433-37, May.
    12. Hansmann, Henry, 1990. "Why Do Universities Have Endowments?," The Journal of Legal Studies, University of Chicago Press, vol. 19(1), pages 3-42, January.
    13. Tobin, James, 1974. "What Is Permanent Endowment Income?," American Economic Review, American Economic Association, vol. 64(2), pages 427-32, May.
    14. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
    15. Stephen G. Dimmock, 2012. "Background Risk and University Endowment Funds," The Review of Economics and Statistics, MIT Press, vol. 94(3), pages 789-799, August.
    16. Woglom, Geoffrey, 2003. "Endowment spending rates, intergenerational equity and the sources of capital gains," Economics of Education Review, Elsevier, vol. 22(6), pages 591-601, December.
    17. Brown, Keith C. & Garlappi, Lorenzo & Tiu, Cristian, 2010. "Asset allocation and portfolio performance: Evidence from university endowment funds," Journal of Financial Markets, Elsevier, vol. 13(2), pages 268-294, May.
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