Rebounding from the depths of the pandemic, markets provided institutions with one of the strongest fiscal-year period returns in history, with the median long-term endowment portfolio earning 30.1% for the year ending June 30, 2021.
While strong equity market returns have been a welcomed gift to investors, resulting valuations mean achieving future return objectives will likely be challenging. Abnormally high returns of the past fiscal year provide an opportunity for institutions to reduce spending rates without experiencing a decline in spending dollars, which lowers the long-term return need and increases the probability of maintaining intergenerational equity over the long term.
Higher portfolio values driven by recent market gains can potentially provide a growing stream of distributions to support operations in the near term, while also increasing the probability of maintaining intergenerational equity. In this paper, we discuss how this may impact your institution and how you can make the returns of the past fiscal year more impactful over the long-term.
Snap shot of the spending rules
Rolling three-year averageSpending amount is a set percentage (say 5%) of the average of the prior three years (12 quarters) ending market value.
Corridor (banded inflation) or snake in the tunnelSpending increases at an assumed rate of inflation, with a cap and floor on the effective spending rate (spending dollars divided by current market value). For example, increase spending by 2.5% each year as long as the effective spending rate is between 4% and 6%.
Hybrid method (elements of corridor and simple average)Spending is determined by taking the weighted average of the prior year’s spending amount, adjusted for inflation (70% weight), and the spending rate times the current market value (30% weight). Mathematically, the spending dollars would be equal to (0.7 x last year’s spending dollars x 2.5% assumed inflation) + (0.3 x spending rate x current market value).
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