Question about liquidity constraint in generating IPS

This particular question is related to instituional IPS, but I suppose it could relate to individuals as well.

Let’s say I’m a foundation and have some type of 5% spending mandate, along with 2% in fees, and 2% in inflation. My return requirement is 1.05*1.02*1.02 = 9.24%

Since 5% are expenses I’m paying out next year, and another 2% are in fees. Is this something I mention within my liqudity constraints, or is this everythng else that could come up? I always get confused as whether to mention this or not. I typically do, and then it’s not included in the CFA or Schweser answer so I suspect I’m not supposed to.

Any input?

I guess foundations and endownemts are the exception here, since they have contingent contributions, so liquidity isn’t as much of a constraint in normal opertaions.

For individuals (and maybe insurance funds), the net outflow for the current year should be mentioned. I haven’t solved any AMs yet, so I can’t speak from experience.

well, I’d prefer to add the %, not accumulating them, your assumption is correct, those would be the variables you need to take into account to correctly calculate the liquidity need, this is ok for endowments.

In individuals it is not that simple, you nedd to calculate your “spending rate” with your expenses and income, also there is no management fee and you may need to add any special provision for taxes or expense.

Lets say in all cases you need to calculate the “Spending rate”, it is given for foundations, but for individuals and other institutional investors you may need to calculate the amount :slight_smile:


This wont be the case for a pension plan lets say.

Different rules apply as to how to answer the return objective.


This has been my understanding: If the money needed is covered by what is calculated in the return requirement, then it does not need to be listed as a Liquidity constrataint. This is the strategy I’ve taken with IPS’s, and I think it applies to both personal and institutions.

Liquidity constraints should be cash needed to set aside and not invested, therefore not included in assets used to obtain the target return. Usually it will be those needed in the first year.

For individuals at least, this wasn’t my experience. The net liquidity needs for the year need to be mentioned. If income covers expenses, but you have another annual obligation, that needs to be mentioned independant of return objectives.

This is more or less what I’ve been looking for. I’m thinking that if it’s a recurring expense that is covered in the return requirement, then it’s not explicitly listed in the liquidity constraints portion.

I disagree with this…if the annual spending requirement is 5% and the management fees are 2% then these should definitely be mentioned in the liquidity requirement. Just because they are accounted for in the return requirement, doesn’t mean they are not needed as a liquidity requirement.

Return requirement and liquidity requirement are two completely different things. Say you have accounted for the 7% return needed in the return requirement…fantastic…but if you also need to pay 7% out in spending and management fees then you MUST list that in the liquidity requirement. If the manager just reads the return requirement and investst in an illiquid private equity fund to get that 7% needed, then you’re gonna be stuffed when you need that return to pay out to cover your liquidity requirements.

The liquidity requirement is there to guide the manager as to what kinds of investments he can and can’t consider in the overall portfolio due to the fact that some of the assets need to be liquidated to cover outgoings. Again, a return requirement could in theory be met through a 100% private equity investment with a 10 year lock up period…but that in no way covers your liquidity requirements.

Beleive me, mention spending requirements and management fees in the liquidity requirement…you’ll thank me come results day.

I’ll look when I get home from work, but there was a particular AM mock I was taking, I think in Schweser, where the spending, inflation, and management fees came to just above 10%. None of which was mentioned in the liquidity requirement answer even though I included it in mine. I’ll try tracking it down so I can post it’s relevance here.

Can’t find the particular mock, but I’ll paraphrase some notes in Schweser:

Liqudiity issues can have multiple effects on the IPS. Here are some common liquidity constraints and how they’re treated in the IPS.

  1. Retired folks needing $110,000 per year growing with inflation to live on. You should list under return requirement and include in calculation of required return.

  2. The same couple wants to hold 8 months of living expenses as an emergency reserve. List this one under liqudiity constraints with the need to hold $50,000 as reserve and do so in SAA.

It goes on to list a couple more, but looking at point #1, it doesn’t seem to me like these expenses are liqudity constraints and instead they’re simply included in the return calculation and left out from the liquidity portion altogether…

This has been said many times before, and do this for the exam if you want full credit.

Liquidity constraints should be noted for all net cash outflows during the year. and specified if not indefinite.

Cash reserves should also be mentioned on your discretion, if you believe that shortfall and priorities demand such.