Investment Strategy for Sustainable Spending

Very Hard Institutional Portfolio Mgmt Foundations And Endowments

In reviewing its investment strategy, the board of trustees of a large university endowment notes that the overall spending rate has been declining relative to its target, which is set at 5% of the endowment's value annually. This reduction in spending could have negative implications for the university’s operations, particularly in funding scholarships and faculty positions. As such, discussions arise regarding potential adjustments to their asset allocation and portfolio management strategy.

The endowment currently has a mix of equities, fixed income, alternative investments, and cash, but the allocation to alternatives has been criticized for lacking sufficient diversification relative to its expected return profile. Trustees are also concerned about the rising expenses associated with managing the portfolios, particularly in light of the increased allocations to more complex asset classes.

Considering the circumstances, which of the following actions is likely to be the most effective approach for the foundation to achieve a sustainable spending level while managing risk?

Increase the target allocation to equities to capture greater capital appreciation, while simultaneously increasing the spending rate to 6% to fund immediate needs.

Diversify the portfolio further into a balanced mix of low-cost index funds and alternative investments to maintain a target spending rate of 5%.

Reduce the spending rate to 4% to align more closely with the long-term investment horizon and focus on harvesting returns from the current allocation.

Hint

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