The Effects of Spending Rules and Asset Allocation on Non-Profit Endowments2022
The long-run impact and implications of an endowment’s spending policy and asset allocation decisions are examined. Using a dynamic model, the authors explore how different endowment spending rules influence the dynamics of an endowment’s size and future spending. They find that different parameters within each spending rule have significant long-term impact on wealth accumulation and spending capacity. Using Merton's (1993) endowment model and compiled asset allocation data, they estimate the intertemporal preferences and risk aversion of several major endowments and find significant variation across endowments in their propensity to increase portfolio risk in response to increased spending needs.
Measuring and Optimizing the Risk and Reward of Green Portfolios2022
We study the performance of green portfolios in both the US and Chinese markets, constructed using a broad range of climate-related environmental metrics, including carbon emissions, water consumption, waste disposal, land and water pollutants, air pollutants, and natural resource use. We compare several popular long-only and long–short green portfolio construction methodologies and find that a method based on Treynor–Black weights offers the most robust performance, thanks to its ability to quantify alphas for individual assets using only a small number of parameters. In the United States, green portfolios (e.g., low-carbon portfolios) have realized positive alphas in excess of Fama–French factors, a significant portion of which can be explained by an unexpected increase in climate concerns over the past decade, rather than positive expected returns. In contrast, Chinese investors have borne a cost for holding green assets instead of brown assets over the past seven years, implying a positive carbon premium, the opposite of US markets.
Optimal Impact Portfolios with General Dependence and Marginals (Working Paper)2022
Impact investing typically involves ranking and selecting assets based on a non-financial impact factor, such as the environmental, social, and governance (ESG) score and the prospect of developing a disease-curing drug. We develop a framework for constructing optimal impact portfolios and quantifying their financial performances. Under general bivariate distributions of the impact factor and residual returns from a multi-factor asset-pricing model, the construction and performance of optimal impact portfolios depend critically on the dependence structure (copula) between the two, which reduces to a correlation under normality assumptions. More generally, we explicitly derive the optimal portfolio weights under two widely-used copulas---the Gaussian copula and the Archimedean copula family, and find that the optimal weights depend on the tail characteristics of the copula. In addition, when the marginal distribution of residual returns is skewed or heavy-tailed, assets with the most extreme impact factors have lower weights than non-extreme assets due to their high risk. Our framework requires the estimation of only a constant number of parameters as the number of assets grow, an advantage over traditional Markowitz portfolios. Overall, these results provide a recipe for constructing and quantifying the performance of optimal impact portfolios with arbitrary dependence structures and return distributions.
Disease-focused foundations have used venture philanthropy (VP) for decades to develop interventions that have patient impact and generate revenue to support their mission. We articulate the distinguishing motives and features of VP funds and their distinct role in the life sciences innovation ecosystem. In particular, we focus on how entrepreneurs and VP funds can work together to help patients and generate economic value. We recommend that entrepreneurs seeking VP support understand a fund’s mission and objectives, and position themselves to fit the fund’s strategic and financial portfolio needs. Finally, we provide case studies of three specific initiatives — the JDRF T1D Fund, targeting type 1 (juvenile) diabetes; MPM Capital’s Oncology Impact Fund; and the American Heart Association’s Cardeation Capital — to showcase these efforts and benefits in practice.
The Risk, Reward, and Asset Allocation of Nonprofit Endowment Funds (Working Paper)2021
We collect tax return data from all 311,222 public NPOs in the United States over the 2009-2017 period to study the asset allocation choices and investment returns of their endowment funds. One in nine public NPOs have endowment funds. The majority of funds allocate their assets conservatively to low-risk assets, and as a result, earn an average annual return of 5.3%. There is substantial heterogeneity in investment returns across funds. Large funds significantly outperform small funds across all return measures and nonprofit sectors. Endowments in NPO sectors devoted to public and societal benefit, the environment, and the arts are among the top performers. High returns among higher education endowments are explained by size, while hospital endowments significantly underperform. Higher investment returns are associated with better governance, more highly paid management, lower discretionary spending, and lower investment management fees. Lastly, when faced with volatile contributions, endowment funds hold more cash and invest more conservatively.