Several discussion meetings have provided the following information about one of your firm’s new advisory clients, a charitable endowment fund recently created by means of a one-time $10 million gift:
Objectives
Return requirement. Planning is based on a minimum total return of 8% per year, including an initial current income component of $500,000 (5% on beginning capital). Realizing this current income target is the endowment fund’s primary return goal. (See “unique needs” below.)
Constraints
- Time horizon. Perpetuity, except for requirement to make an $8,500,000 cash distribu- tion on June 30, 2014. (See “unique needs.”)
- Liquidity needs. None of a day-to-day nature until 2014. Income is distributed annually after year-end. (See “unique needs.”)
- Tax considerations. None; this endowment fund is exempt from taxes.
- Legal and regulatory considerations. Minimal, but the prudent investor rule applies to all investment actions.
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Unique needs, circumstances, and preferences. The endowment fund must pay out to another tax-exempt entity the sum of $8,500,000 in cash on June 30, 2014. The assets remaining after this distribution will be retained by the fund in perpetuity. The endow- ment fund has adopted a “spending rule” requiring a first-year current income payout of $500,000; thereafter, the annual payout is to rise by 3% in real terms. Until 2014, annual income in excess of that required by the spending rule is to be reinvested. After 2014, the spending rate will be reset at 5% of the then-existing capital.
With this information and information found in this chapter, do the following:
- Formulate an appropriate investment policy statement for the endowment fund.
- Identify and briefly explain three major ways in which your firm’s initial asset alloca- tion decisions for the endowment fund will be affected by the circumstances of the account.