Endowment spending in volatile markets: what should fiduciaries do?

Endowment spending in volatile markets: what should fiduciaries do? Spending rules often guide institutions in determining the annual expenditures from their endowments. A typical rule is five percent of some measure of the value of the endowment. That many institutions utilize the same type of spending rule suggests that these institutions set their spending rules independent of their investment strategy. This paper argues that for many institutions the spending rule and the investment strategy need to be determined simultaneously. The key to understanding this simultaneity is the institution’s willingness to reduce its endowment expenditures when the endowment drops in value. As an institution becomes more reluctant to reduce its expenditures in bad times, the need to set both its spending rule and investment strategy simultaneously increases. One practical implication is that even if an institution believes, for instance, that the returns of a particular class of assets, like equities, will be greater over the long run than the returns of other assets, that institution may still choose to hold some of these other assets if the resulting portfolio has smaller short-term volatility—despite the smaller long-run return. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Endowment spending in volatile markets: what should fiduciaries do?

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Publisher
Springer Journals
Copyright
Copyright © 2010 by Springer Science+Business Media, LLC
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-009-0156-5
Publisher site
See Article on Publisher Site

Abstract

Spending rules often guide institutions in determining the annual expenditures from their endowments. A typical rule is five percent of some measure of the value of the endowment. That many institutions utilize the same type of spending rule suggests that these institutions set their spending rules independent of their investment strategy. This paper argues that for many institutions the spending rule and the investment strategy need to be determined simultaneously. The key to understanding this simultaneity is the institution’s willingness to reduce its endowment expenditures when the endowment drops in value. As an institution becomes more reluctant to reduce its expenditures in bad times, the need to set both its spending rule and investment strategy simultaneously increases. One practical implication is that even if an institution believes, for instance, that the returns of a particular class of assets, like equities, will be greater over the long run than the returns of other assets, that institution may still choose to hold some of these other assets if the resulting portfolio has smaller short-term volatility—despite the smaller long-run return.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Feb 17, 2010

References

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