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


Keith C. Brown

Cristian Tiu



Journal of Investment Management 8, 2010, pp. 62-86





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 and extend a simple framework for establishing what constitutes the optimal level of active and passive risk exposure.  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.


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