Endowment Liquidity What if

CFA Level III
#1

Two hypotheticals.

Background:

Question 3 from 2011 is an endowment where its spending rule is the same as the university’s requirement. The university needed like 37,500,000 and that was the same as the 5% spending rule times assets.

So in calculating liquidity, or even retutn requirement for that matter, lets assume that thee university needs:

  1. university spending needs are higher than spending rule

Im assuming we calculate liquidity as the masimum in spending and just don’t give the university what they need.

Correct?

  1. This is a trickier situation:

What if the university needs say 3% of assets, but the spending rule is 5%,

Waht do we calculate for liquidity? University spending need or spending rule?

What about the return requirement? Its always based on spendind rule, right?

#2

If Spending Needs > Spending Rule need --> this Spending Rule need is just sth. set up by the IRS to ensure that funds are not hoarded.

The part about calculating per the spending rule for liquidity but not giving univ what it needs - I think would be not the right approach. Remember you are the advisor to the endowment / foundation and the need is coming from a 3rd party. In this case - I guess more risks should be taken within limits to ensure you try to meet the needs.

Look for donations / other means to match up the requirement with what is being generated.

Periodic shortfall should be met from the investment portfolio till such time that a solution is found to cut down on the shortfall.

2nd Case:) this is easier I feel. Spending Rule for Return Requirement (5% per the IRS).

Liquidity - will be 3% (per needs of Univ).

You have a periodic excess earning - which goes into the portfolio and is kind of saving up for a rainy day.

Also allows the endowment to take more risk on their investments.

#3

Lets hope they don’t try to give us grief like this. or god forbid, throw in a bank.

#4

If Spending Needs > Spending Rule need –> this Spending Rule need is just set up by the IRS to ensure that funds are not hoarded.

Just to be explicit, this means to use the spending requirement not the spending need for return calc, correct?

#5

basically - I was talking about the 5% minimum requirement. If they do not spend that much at least - there will be consequences in terms of tax payments (and this might be retrospective …) hence their liquidity needs may increase.

If the higher educational institution has a need of 8% e.g. - use the 8% - and calculate the need.

This is how much the corpus of the endowment must grow - in order to continue into perpetuity.