What do you guys think about this statement? The risk tolerance of endowments is generally lower than foundations due to short-term budgetary needs (income and liquidity) of the sponsored organization, but can vary due to other factors such as the risk tolerance of the trustees/investment committee, the size of the principal, long-term return goals, etc. Foundation risk tolerance is critically linked to time horizon, but is also influenced by the risk tolerance of the board, principal size, etc. However, foundations are often more aggressive than endowments. Unique constraints may vary widely, but social investing is a typical concern of foundations and endowments. I can you really generalize that endowments are less risk tolerant then foundations, I think you have to determine it on a case by case basis. I would lean toward endowments since they do not have spending requriements and usually have an infinite time horizon. -Thanks.
This seems strange to me. Foundations and endowments generally have the highest risk tolerances of all organizations covered in the curriculum (they are usually perpetual, and generally have low cash flow needs in comparison to AUM, though there’s more variation on this one, and there are wasting endowments that are designed not to be perpetual). It is true that in the US, foundations have a 5% rule that says that they need to spend 5% of their assets to remain tax exempt, and so their spending rule is usually just to follow the 5% legal requirement. Endowments may have more unpredictable cash flows, such as when a university wants to build a new sports center so the undergrads can check each other out in lycra, or suddenly decide that all students now get scholarships (not that that sounds so bad), but the point is that it’s harder to predict. Given that it’s harder to predict, you might want higher risk to get a risk premium until such time as you actually know that you are going to be spending money, and then you set aside those cash flows by putting them in less risky assets. The thing that confuses me sometimes is when an endowment makes a big capital purchase (like the sports center) that costs, say $10MM to build, I saw Stalla’s example hitting the principal for that amount. Now I can see that a major purchase might want to hit the principal, because it might be unrealistic to expect to get that much from income and capital appreciation in a single year, but shouldn’t one try to increase the required return over the short term to replenish stuff over time, rather than making it a permanent hit. Maybe just extending the “replenishment period” infinitely is the same as increasing the required return off of the reduced base, as opposed to breaking it down into, say a required return of 10% for the next 5 years and only 8% thereafter.
Bchadwick, It’s the easiest to take it from principle to determine a long term required rate of return, however you COULD do a 2 stage return requirement, say +5% for the next year up until the $10M outflow, afterwards a +6% return requirement would be needed, something along those lines.