Alternative investments are frequently misunderstood. They are blamed for starting financial panics by some and branded as way too aggressive by others.  However, the term alternative investment is really a misnomer. There are only four asset classes; equities, bonds, cash and commodities. 

All money managers invest in one of more of these asset classes, the only difference is whether they have the flexibility to go long and short, whether they use leverage, and what their ownership structure is. 

Alternative investments, generally defined as hedge funds and/or private equity, have ownership structures that permit more flexibility in how they invest and a fee structure that rewards the manager based on performance. 

University endowments provide an interesting case study for family offices and the exceptionally wealthy. By rule, endowments cannot invade their principal; they can only spend their real returns (earnings in excess of inflation) so that the endowment will continue to grow for future generations. 

Because of these mandates, the number one rule in endowment investing is not to lose any money. In order to comply with this rule, endowments look to mitigate risk and preserve capital first and look to build wealth second. They do this by large investments in hedge funds and private equity.

This provides an important lesson for family offices and the exceptionally wealthy, who usually seek to preserve the wealth they have built and keep their money growing over an unlimited time horizon.  

University endowments, especially the larger ones, have been able to successfully use alternative investments to produce returns that have handily beaten the market over time, with less risk.

Below is a study of the performance of large endowments vs. small endowments and the market. It is interesting to note that large endowments have outperformed small endowments and the market over every time period.