Investment Philosophy
The university's endowment is comprised of general, unrestricted funds as well as funds dedicated to specific priorities, such as financial aid or faculty chairs or the maintenance of the Sarah P. Duke Gardens. These resources are pooled together much the way individual investors pool their assets in a mutual fund.
To support an annual spending stream and to preserve the purchasing power of the endowment in perpetuity, Duke seeks to achieve an average annual return on its endowment assets of at least 5.5 percent after inflation. This goal requires aggressive endowment management.
Diversification
Diversification is central to generating strong investment returns while moderating portfolio risk and volatility. For each asset class, DUMAC has a long-term targeted weight of investment as well as a range of permissible levels of investment. In periodic reviews, the professional staff reexamines asset allocation policies, suggesting realignments or modifications, which must be approved by the DUMAC Board of Directors as well as the Duke University Board of Trustees.
Each asset class plays an individual role, but all work in concert to achieve overall portfolio objectives:
- GLOBAL EQUITY comprises domestic, international, and emerging markets equity. Domestic and international equity have similar expected real returns, but they are not perfectly correlated and therefore provide some diversification benefits to the portfolio. Emerging markets equity provides similar diversification benefits, but with even higher expected returns and significantly higher volatility. Many non-U.S. markets, and especially emerging markets, are less efficient than U.S. markets, giving active managers a greater opportunity to add value.
- HEDGED STRATEGIES, made up of non-directional and directional hedge funds, are expected to generate "cash plus" returns and capture some positive exposure to the systematic risks of Global Equity while minimizing volatility, downside risk, and correlation to other asset classes. Non-directional hedge funds use arbitrage-like strategies and have very low correlations with all other asset classes, providing excellent diversification and an additional hedge against bear markets. This sub-asset class includes event-driven strategies, relative value strategies, and some market-neutral long/short strategies. Directional hedge funds are comprised primarily of long/short equity hedge funds with some degree of market directionality or net exposure. This net exposure, which shifts over time, allows directional funds to capture some systematic market risk.
- PRIVATE CAPITAL consists primarily of buyout and venture capital partnerships. Private Capital is expected to generate high real returns over time due to its higher risk and lower liquidity characteristics. Risk is partially mitigated by maintaining a portfolio that is well diversified by both fund vintage year and investment stage. The disparity between the best and worst performing funds is dramatic, which makes manager selection particularly critical.
- REAL ASSETS are mainly private real estate, energy, power, infrastructure, timber, and illiquid commodities. The portfolio is designed to provide some diversification to other asset classes through exposure to assets that exhibit returns which are not correlated with those asset classes. It also provides a limited hedge against inflation.
- INFLATION SENSITIVE ASSETS are often inflation-linked bonds and commodities, but may include the common stock of public companies with meaningful underlying exposure to commodities, energy, or timber. The primary function of these assets is to protect against inflation by providing positive returns in inflationary environments.
- FIXED INCOME generally provides moderate returns and dampens volatility by serving as a hedge against negative equity markets. During a period of decreased equity returns, high-quality fixed income securities represent a counterbalance, producing a reliable income stream and capital appreciation potential. Furthermore, opportunistic fixed income investments can offer higher, equity-like returns while providing portfolio diversification benefits. Examples of such opportunistic investments are emerging markets debt and high yield bonds.
Managing Risk
An investment strategy that focuses upon high investment returns alone is dangerous. DUMAC pays particular attention to managing risk within the portfolio, controlling excessive volatility through diversification among different asset and sub-asset classes.
Because individual asset groups respond differently to similar economic or market stimuli, they often reflect among themselves a counter-cyclicality of investment return behavior. Knowledge of this differential behavior helps DUMAC select and arrange investment opportunities, which, although individually risky, dampen risk or volatility when aggregated within the overall portfolio.
DUMAC measures risk in several ways, but the most common measure used by institutional investors is the standard deviation of returns: the extent to which actual returns over a period are likely to differ from average historical returns. A higher standard deviation indicates higher risk or volatility.
The table below compares the results of DUMAC's strategy to the results of a blend of 70 percent Russell 3000 Index* and 30 percent LB Aggregate Bond Index. The DUMAC strategy of controlling risk within the portfolio has worked well to reduce volatility of returns by lowering the standard deviation. Also measured below is the incremental return per unit of risk, a calculation called the Sharpe Ratio. As indicated by Duke's higher Sharpe Ratio, Duke's return was generated with significantly less risk.
| Duke | 70% Russell 3000/ 30% BC Aggregate |
|
| Nominal Annualized Return | 12.9% | 7.6% |
| Standard Deviation | 8.6% | 10.8% |
| Sharpe Ratio (5%) | 0.9 | 0.3 |
* Prior to 7/1/03, this measure used the S&P 500 Index rather than the Russell 3000 Index.