Foundation Performance and Private-Asset Allocation
A $220 million foundation's portfolio returned 9.6% last year, while its policy benchmark-60% global equity, 35% investment-grade bonds, 5% cash-returned 8.4%. The foundation's spending rule is 5% of a three-year average market value, and inflation is 2.5%. The portfolio holds 28% private equity and private credit, valued quarterly, and 12% in a single technology stock. Reported volatility is 11.2%, Sharpe ratio 0.62, tracking error 7.2%, information ratio 0.17, and maximum drawdown 14.8%. The board says the manager 'beat the benchmark by 120 basis points' and wants to increase the allocation to private assets. A consultant notes the policy benchmark has no private assets and uses monthly public-market returns.
1. Is the 120 bp excess return evidence of skill? Use the risk statistics and portfolio composition.
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Excess return is 9.6% - 8.4% = 1.2%, or 120 bp, but tracking error is 7.2%, so the information ratio is 0.17-only 0.17 units of excess return per unit of active risk. That is weak and statistically indistinguishable from noise over one year. Sharpe 0.62 versus 0.55 is similarly modest. More important, 28% of the portfolio is in private assets valued quarterly, which smooths reported volatility and can create artificial serial correlation; the 12% single technology stock adds idiosyncratic risk not captured by the policy benchmark. The 120 bp may reflect illiquidity and valuation lag rather than skill. The board should not extrapolate one year of excess return into a higher private-asset allocation.
2. Evaluate the benchmark and recommend changes.
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The policy benchmark has no private assets, so it is not a fair benchmark for a portfolio with 28% private equity and private credit. It also uses monthly public returns, while the portfolio's private values are quarterly and lag. A better benchmark is a custom blend using public-market proxies for private assets-for example, small-cap value plus a levered credit index-or the policy benchmark plus a stated illiquidity premium. Also report against the foundation's return objective: spending 5% + inflation 2.5% = 7.5%. The 9.6% return clears that, but the relevant question is whether it clears it after risk and fees. Add since-inception, rolling 3- and 5-year, and public-market-equivalent measures.
3. What additional metrics or controls would you require before increasing private assets?
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Before increasing private assets, add a liquidity coverage ratio showing cash plus undrawn credit versus expected capital calls and spending; stress tests for a 20-30% public equity decline and a denominator effect; public-market-equivalent returns and PME multiples; fee and carry sensitivity; and a single-stock risk limit. Separate the 12% technology position into a distinct risk budget and require a plan to reduce it. Use time-weighted returns for manager evaluation but money-weighted returns for the foundation's actual experience. Only then decide whether the private allocation is compensated for illiquidity.