Institutional BB12 (Foundation) - Risk Tolerance

Normally the Foundation’s risk tolerance is very high because of its perpetual nature. If not the perpetual, I can understand it will not be high risk tolerance. But how to know it’s average or below risk tolerance. My thought is it should be average risk tolerance given no contractually liability requirement?

Institutional BB12 - The Fund for Electoral Integrity

A group of major foundations has endowed a new organization, the Fund for Electoral Integrity, to supervise elections and political campaigns in countries undergoing a transition to democracy. The fund is headquartered in a developing country. It has received initial grants of $20 million, with $40 million expected to be received in further grants over the next three years. The fund’s charter expressly decrees that the fund should spend itself out of existence within 10 years of its founding rather than trying to become a permanent institution. Determine and justify appropriate investment policy objectives and constraints for the Fund for Electoral Integrity.

Solution for risk objective: Conservative or below-average risk profile

Q: How to know it’s average or below-average risk profile for the limited lifetime foundation? Below 10=> low?

  • Not being perputual is the first clue
  • Multi contribution years means multiple stages with the last stage being year 4-10, which is a relatively short end-stage time horizion
  • Spending itself out of existence implies they want to spend the money and not continue to grow it for some future spending goal. This implies they need the money now and wouldn’t likely want to take large risks that would result in capital loss that would be unlikely recoverable.

Thanks Galli. Understand three bullet points you mention will make them down from High risk tolerence. But they still have no contractually liability requirement.

Average risk tolerence is more fair?

Seems below average to me.

The 6-years of “spending” is similar to someone being in their late 70’s, if you only had 6-years to live would you aggresively invest or just enjoy spending your retirement?

Thanks. It makes sense!

Galli, I agree that their time horizon is more short-term and hence lower risk tolerence, but wouldnt they need a higher spending rate, and therefore higher risk return in order to make sure they have spent everything in 10 years? Assuming the default minimum 5% + inflation (lets say 2%) = ~7%, wouldnt they need a return higher than the 7% total spending rate to ensure that they have spent everything in 10 years?

Risk: Ability = Average determined by large asset base, no contractual liabilities, but lower risk tolerenca due to short time horizon. Willingness = should be above average? To make sure they have a higher spending rate to spend everything in 10 years, they need a higher risk/return relationship? Conclusion = Average

Return: 5% minimum + inflation. Possibly a higher return to make sure they spend everything?

Time: multistage: 1st stage involves foundation with 20mm assets , 2nd stage involves foundation with 40mm assets after 3 years. Shorter time period of 10 years reduces risk tolerance

Tax: must spend min. of 5% to enjoy tax-free status

Liquidity: no contractual liabilities, no major liquidity needs. 40mm coming in over 3 years = higher liquidity and higher risk tolerance

Legal: UMIFA/prudent investor

Unique: must spend everything over 10 years.

^ I think you’re over complicating it.

Their spending rate and their return are two seperate functions. They do not need a return to satify the spend which is how we commonly solve these problems.

They simply need a return that allows them to spend the foundation out of existence. This implies lower risk tolerance as their need to spend is high, their need for returns is non-exsistent.

they have a below average risk tolerance because of their high liquidity need over the next 10 yrs. if their need to end the fund is IN 10 yrs, that would be different, but the fact that they are spending it down OVER the next 10yrs limits their ability to take risk.

^ excellent point

Thanks Galli and Junior, you are right: they don’t need a return, they just need to make sure they can spend enough over the next 10 years.

Galli, you mentioned that the return and spending for a foundation are two separate functions - do you mean that they should be tackled separately like below or that they are just separate (which I am not sure I agree with):

Return Objective: To protect the real value of assets and to have enough for spending needs.

Return Requirement: Establishing a spending plan to ensure the foundation meets its spending needs appropriately. With 5% minimum spending rate + inflation + admin costs we derive a MINIMUM return requirement

Calling them seperate was probably a poor choice of words on my part.

I meant they related but they’re different Client “needs”. You can’t simply say the spend need is X without knowing what other factors are impacting the return requirement - or if it’s even needed in the first place.

Fair enough, and its a valid point. I certainly need more practice, especially in cases where we have to apply case-specific themes to the default themes we have learnt.