Question

Complete the objectives and constraint considerations for an Endowment:

- Return Objective:

- Risk Tolerance:

- Liquidity Constraint:

- Time Horizon:

- Tax Considerations:

- Legal and Regulatory:

- Unique Circumstances:

Answer 1

Since the question does not specify which kind of endowment this is, I am assuming it is endowment of not-for-profit organisation.

Considering that it is endowment, following are the objectives and constraint -

Return Objective - If it is a trust fund-run not-for-profit organisation, At the minimum, the return should counteract the inflation rate. So for example, if the inflation rate is 4%, the organisation would want the return to be minimum 4% so that in future if the organisation wants to purchase or make investments in the future, the value of the endowment fund should be enough to cover the inflation costs. So if a university decides to build a lecture hall of $1 million in another 5 years and has the endowment fund of also $1 million and if the inflation is 4%, the real cost of the lecture hall will be $1.21 in 5 years.

Risk Tolerance - If the organisation's/individual's risk tolerance is very low, they would want to invest the endowment funds in a relatively risk free investment such as Government Bonds to cover inflation. If the risk tolerance is moderately high, we can look forward to increasing the value of funds beyond inflation. The adequate risky security for a moderately high entity would be a "Mid-Cap" equity investment and corporate debutenture. If the risk tolerance is very high, which would be rare for an endowment funds, organisation can look for investmenet in startup seeding capital or opening up a fully-fledged venture capital fund.

Liquidity Constraint - A prudential policy for an endowment fund would be to keep some funds in liquid quick-to-convert-cash financial instruments so as to cover the short-term liabilities and obligations while at the same time investing the residual fund into securities such as G-Secs, government bonds, corporate debentures, oil funds, ETFs, etc. as per the risk appetite of the client. For liquidity, it would be beneficial to keep some proportion of the funds aside in recurring deposit schemes, municipal bonds, mutual funds, etc.

Time Horizon - The client should clearly state the time horizon of the investment funds. If the client wants a higher return and is comfortable with long gestation period, then it would make sense to invest in something like fixed income securities.

Tax Concern - The objective regarding taxation should be identified by the portfolio manager. If the tax saving is the primary concern of the fund, then investment into long term equity would make sense since dividend received is exempted from tax and the return from its sale would also not be taxable if held for a period of more than a year (depending on the tax rules of the goegraphical location).

Legal and Regulatory - Certain laws prevent investments into risky securities in case of pension funds and retirals. Also, insider trading is a concern if one of the heads of endowment funds knows non-public information about a publicly listed company.

Unique Circumstances - Many times, personal prefence and ethical dilemmas play a role in investment decisions. For example, despite a stock's low risk nature, client would not be comfortable in investment in the company if it is an oil trading outlet and the endowment fund belongs to a sustainable energy stakeholder.