2007 cfai old essay question 5 b. states that the endowment has had weak performance over the last five years and this REDUCES their ability to take risk. It would appear to me that if performance is not doing enough to cover the required rate of return (spending requirement and inflation target and management fees) that it should allow for a great ability to take risk.
can someone help provide better logic. Its not a huge point but I feel like it could def come up again on the exam in some form.
The endowment has been losing money, would they make riskier bets just to make up for the shortfall? No…
Look at it this way: all else equal, the only thing that’s changed in the last 5 years is the asset base is lower. It decreases their ability to take risks --> hence, a lower risk tolerance
The primary return requirement for foundations or endowments is to at least preserve the purchasing power of the portfolio, so if portfolio have been hurt for 5 years now that should definitely tell them to target less riskier investments (less risk tolerance) that can achieve minimum required return with greater probability.
When you already are in a difficult financial position, and cannot afford losing more and want to preserve the real value of your portfolio why would you try to earn a higher return which would involve a greater risk and you could get into even deeper financial troubles, further worsening your condition.