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Like absolute return strategies, property or real estate assets serve not only as a powerful diversifier, but they also protect the portfolio by generating returns that are not typically correlated with other traditional assets such as publicly traded equities. Colleges in Oxford and Cambridge historically owned significant property assets in their endowment portfolios. Their decision to maintain a relatively high proportion of property assets today is driven by the desire to diversify risk as well as to secure a steady source of income.

Colleges in Oxford and Cambridge have invested in property, bonds, and equity-like assets including private equity; they also own original works of art, rare books, vintage wine, and other such assets that would typically have been bequeathed to them. The range of assets may not have been significantly enlarged recently, but financial innovation has created more options whereby traditional assets can be accessed in a more efficient manner. This chapter examines issues that relate to overall asset allocation, primarily because it is this that shapes the individual portfolio.

This chapter begins by defining the strategic asset allocation decision and discussing how the strategic asset allocation should be set. It introduces the factors that should be considered in setting the defined benefit (DB) strategic asset allocation. Theoretical arguments favoring allocations to stocks and bonds are considered, followed by empirical evidence that shows what pension funds actually do. Finally, the allocation of DB assets over time is discussed.

This chapter analyzes the risks and rewards of moving from an unfunded defined benefit pension system to a funded plan for civil servants in Germany, allowing for alternative portfolio mixes using a Monte Carlo framework and a Conditional Value at Risk metric. The authors identify an investment strategy for plan assets that will minimize worst-case pension costs; this turns out to be 22 percent in equities, 47 percent in bonds, and 31 percent in real estate. The authors show that moving toward a funded pension system for German civil servants can be beneficial to both taxpayers and civil servants.

Oxford and Cambridge endowments comprise funds generally regarded as for the long term, and which fundamentally underpin and sustain the operation of the institutions at their desired level of activity. Oxbridge institutions have collectively embraced major change over the last few years by implementing total return investment strategies. They have simultaneously made the shift from spending policies that encouraged income generating investments towards establishing sensible spending rules that freed up asset allocation decisions. Such changes in investment approaches have consequences in terms of determining appropriate governance, choice of assets, identifying skilled managers, monitoring their performance, understanding the sources of value-addition and cost analysis, and setting many other aspects of endowment policy. As such transitions take a long time to implement, many of the institutions are in the process of managing that change.

In the world of endowment management, where the investment horizon may extend over centuries, investment decisions to support the objectives of endowed institutions pose a unique set of challenges. This chapter addresses the issues surrounding the definition of the investment objective. The establishment of a benchmark or policy portfolio for some endowments is a way of defining the investment objective, with the benchmark asset allocation reflecting that objective. Thus, the benchmark allocation of assets is responsible for providing resources for current operations while preserving purchasing power of assets in the long term. The benchmark therefore reflects the institution's approach to various aspects of managing the endowment, including risk.

Experienced investors recognize that understanding the risk profile of the overall portfolio lies at the heart of any assessment of investment alternatives. Attempting to identify the risks to college endowment portfolios (on a scale of 1 to 5 with 1 being not very important and 5 very important), with reference to various aspects of portfolio risk (such as market risk, risk relative to benchmark, liquidity risk, fiduciary risk, and ‘other’ risk factors), provides clues to the risk framework within which colleges in Oxford and Cambridge invest. A majority (85%) of colleges consider their investment committees as being responsible for risk management of endowment assets, with about half reporting that the job is done internally without the assistance of any expert external guidance. The involvement of investment consultants in managing portfolio risk, is minimal. Even in Oxford, where more institutions reported using the services of investment consultants, only 15% of Colleges used a consultant in risk management.

The use of external investment advisers among institutions in Oxford and Cambridge is low. This may be due to the high level of professional expertise available internally, including alumni and others within the investment committee who are willing to offer their independent advice. Lack of any regulatory requirement for external expert advice and the historical asset mix of the endowment may have also contributed to the lack of professional employment of investment consultants in managing the endowment. About two-thirds of surveyed colleges in Oxford and Cambridge, for example, did not use any external investment consultants in the management of their endowment portfolios. And among those colleges that did, several registered dissatisfaction with the consultant's ability to deliver a value-added service. Less than 10% of bursars reported plans to appoint a consultant for the sake of strategic asset allocation or risk assessment.

Institutions have spending and investment policies to support their endowments. Spending policies help in determining issues in long-term asset allocation. The governing bodies of colleges face the challenge of balancing the conflicting goals of supporting current operations and preserving endowment assets. Donors also expect their gifts to provide permanent support towards a specific activity, though colleges usually prefer undesignated or general donations. Spending policies act as referees in the perpetual game between current and future players. A clearly defined spending policy also frees up the asset allocation decisions and enables the fund manager to focus on investment issues.

This chapter begins by discussing the trend towards defined contribution (DC) plans over the last 25 to 30 years. This trend has placed more and more sponsors in a situation where the employees are responsible for choosing the asset allocation that will determine their retirement pension income. Employer responsibilities in this setting are discussed. The second section discusses investment policy for DC plans, which includes the choice of investment alternatives and the approach to employee financial education. The third section discusses asset allocation for DC plans. It includes an analytical framework that demonstrates the effect of the asset allocation decision on expected risk and return.

This chapter discusses six important points about the asset-management industry: The industry is likely to grow substantially in the years ahead. Despite the prospects for rapid growth, the structure of the asset-management industry is likely to reflect a high degree of contestability. The rapid evolution of the institutional asset-management industry will have a major effect on financial markets. Cross-border asset allocation will grow disproportionately as a product of institutional investors’ search for efficient portfolios through international diversification. The development of deeper and broader global capital markets will fundamentally change the market for corporate control into a much more fluid one focused on financial performance and shareholder value. Developments in institutional asset management will pose strategic challenges for the management of banks and other traditional financial institutions.

One important area for periodic review for all investors is the overall cost incurred in investment management. At first glance, costs associated with endowment management for Oxford and Cambridge institutions appear to be broadly aligned with that of industry globally, with Oxford reporting greater efficiency in managing such expenditures. Average costs, however, do not reflect asset allocation decisions, the nature of strategies implemented, the level of risk, Sharpe (i.e., reward-to-risk) ratios achieved, or other services delivered to the client. Taking into account the more traditional approaches to investing within Oxford and Cambridge institutions, a higher level of pooling and/or indexing could reduce costs further; or a higher level of investment service could be secured at the same expense.

Explores optimal investment strategies when both riskless interest rates and risk premia change over time in ways that can be described by a vector autoregressive (VAR) model. In this situation, a long‐term investor with constant risk aversion should both exploit and hedge against variations in investment opportunities. As in Ch. 3, a conservative long‐term investor should hedge real interest rate risk by holding long‐term inflation‐indexed bonds, or nominal bonds if inflation risk is low. In addition, the investor should respond to mean‐reverting stock returns by increasing the average allocation to equities. The strategic equity allocation also involves gradual changes in asset allocation over time, since the state variables that predict excess returns are generally slow‐moving.

This chapter uses a life‐cycle model calibrated to microeconomic US data to examine financial asset allocation strategies of working households saving for retirement. For typical US households with relatively safe labour income streams, risky investments should be extremely attractive when they are young, have modest savings and have many years until retirement; but risky assets should be less attractive later in life, as human wealth declines and financial assets accumulate. Households whose income comes from private businesses, which are exposed to many of the same risks as publicly traded companies, should find risky investments in stocks less attractive at all ages. Households with high‐risk aversion should be cautious investors both because of their high‐risk aversion and their tendency to accumulate greater precautionary savings. Impatient households, on the other hand, accumulate relatively little savings; financial risks are relatively unimportant for them compared to income risks, and thus they can afford to invest more aggressively.

Actively managing a portfolio involves three main activities: asset allocation (designing and maintaining the relative asset class weights), asset selection (selecting assets to match the allocation), and market timing (deciding when and how much to invest). This chapter looks at asset allocation models—theoretical and practical templates that active asset managers use to make the asset allocation decision. Asset allocation models examined include the Markowitz model and alternative (skewness, stochastic dominance, and ad hoc) models. The chapter also discusses the models actually used in practice and portfolio rebalancing. Many observers, influenced by a continuum of research, believe that asset allocation is by far the most influential factor explaining the variability in portfolio performance. Only recently does research support the roughly equal importance of asset selection and asset allocation with market timing a distant third. Regardless of the precise influence accorded to any of three activities of active management, asset allocation is sensibly an essential ingredient in portfolio design and performance.

A pension plan’s investment policy is put in place by allocating plan assets among available investment asset classes. This chapter discusses asset allocation in general, and presents aggregate data on how pension funds actually allocate assets. It then discusses the primary asset classes and their investment characteristics.

This chapter discusses liquidity management theories such as the commercial loan theory, shiftable theory, and anticipated income theory. It assesses the reasons for most liquidity problems of banks, highlights the need for liquidity planning, and presents a liquidity model for banks. It shows that liquidity management in a bank is closely linked with its assets-liabilities strategy. A fully matched position is ideal — a self-liquidating balance sheet — but this is not observable in real life, because of the conflicting objectives of a bank and its borrowers, nor is it desirable due to its negative impact on profitability; a reasonable level of mismatch enhances profitability.

This chapter begins with a description of financial sector reforms in India and their impact on banks and financial institutions. It then discusses changes in savings and investment behaviour, and the concepts of securitization, strategic planning, and capital planning. This is followed by the development of a mathematical model to establish relationships between profits, dividend payouts, and growth with a given capital adequacy norm. The model shows that the future growth of a bank ultimately depends on the return on assets (ROA). ROA, in turn, depends upon the quality of loan assets under the appropriate risk-return parameters and their funding operations. The case study of a real-life commercial bank in the public sector is presented to illustrate these banking strategies.