The below is from the online CFAI question bank. My 2 questions are similar to what many have asked on the CFAI website but there’s no consensus.
-Does the return objective have to include the 1% liquidity need for the pension plan? Or is that already accounted for in the discount rate?
-For the endowment, is 1% inflation already a part of the operating expenses growth rate of 2.5%? Or do we have to add inflation on top of the expense growth rate when calculating our return objective?
SELECTED PENSION PLAN INFORMATION FOR CGI PRODUCTS
Funded status, excess or (deficit) $25 million Liability discount rate 5.00% Annual liquidity need as percentage of plan assets 1.00%
Zola asks Zubov, “Based on the information provided, could you give us some preliminary guidance on an appropriate return objective?” Zubov responds, “In this instance, a return objective of up to 100 bps higher than the liability discount rate would be appropriate. This return objective could potentially minimize future pension contributions and maintain or increase future pension income.
Hoven University (HU) has asked Greenhill to manage the university’s endowment. The endowment’s spending rule dictates that it make an annual contribution of 4% of its year-end portfolio market value to support HU’s operating budget. The annual endowment contribution represents 25% of HU’s annual operating budget. The university’s operating expenses are expected to grow at a rate of 2.5% annually, and the rate of inflation in the economy is expected to be 1% a year. Investment management expenses are estimated to be 0.65% of the endowment’s market value. The investment committee has asked Zubov to present his views on the risk and return objectives and liquidity constraints for the endowment. Zubov responds with the following statements: