Asset Allocation Rationales
A strong investment policy should explain why each asset class is included in the
portfolio and the specific role it is expected to play. Each type of equity investment
(domestic, international, emerging markets, private) has a particular purpose within the
investment portfolio. An investment portfolio may also include other asset groups regarded
as "hedging" assets. These types of investments include absolute-return strategies,
inflation hedges (real estate, timber, energy, and Treasury Inflation Protected Securities)
and deflation hedges such as intermediate and long-term U.S. Treasury bonds.
Each type of equity asset should have an expected performance objective in relation
to the institution's spending rate. For example, an investment policy may state that
equity asset classes have a long-term expected real return above the college's spending
rate. Furthermore, U.S. equities are intended to offer good liquidity and avoid currency
risk, while U.S. emerging markets equities are expected to generate higher returns than
other equities because of their smaller size and greater growth prospects.
"Hedging" assets are used to provide some protection against various risks facing the
endowment. For example, inflation hedges-such as inflation-linked bonds, energy, real
estate, commodities, timber, and natural resources funds-are intended to protect against
unexpected inflation and sustained periods of general price increases.
When an investment policy articulates the rationale for different types of assets,
there can be no doubt or confusion about why any particular asset class has been included
in the portfolio.
- Does your institution's investment policy explain the purpose of each asset class?
- Is the rationale for each class of equities explained in relationship to the
institution's spending rate?
- Are 'hedging' assets a part of your investment portfolio strategy and is their
rationale explained in the policy?