Blog: Amplify

Preserving Equity among Generations: CPI + 5%

Editor's note: This post is one in a series highlighting sessions for the upcoming Endowments and Finance Summit, held in Washington, DC, on September 6-7. The Summit is where foundation leaders – such as CEOs, CIOs, CFOs, Senior Investment Officers and board and investment committee members – converge to dialogue on trends, issues, best practices and innovations dealing with endowments, financial management, business and other professional challenges.

The term intergenerational equity has been in the nonprofit vernacular since former Fed Governor and Yale professor James Tobin, suggested that, “The trustees of an endowed institution are the guardians of the future against the claims of the present. Their task is to preserve equity among generations.” 

Tobin’s observation was made in the mid-1970s and reminded the caretakers of foundations and universities that the path to maintaining intergenerational equity (i.e. purchasing power) is to earn a return from the investment portfolio that at least matches the rate of spending (i.e. distributions) plus the rate of inflation. For many foundations, in particular private foundations where the minimum spending rate is mandated, that goal translates to achieving CPI (inflation) + 5%.

In the three decades following Tobin’s assertion, maintaining intergenerational equity was relatively easy. However, the past decade has been wrought with challenges that started with the global credit crisis and evolved into the current low fixed income return environment, leaving many foundations falling short of achieving investment goals. With many economists expecting tempered returns from the global capital markets going forward, we’re seeing an increase in the number of foundations that are revisiting their approach to managing their long-term investment pool.

The questions, "Can Foundations Still Achieve CPI + 5%?" and, if so, "‘What are the Key Considerations in Getting There?" are the central themes that will be explored during a moderated panel discussion at the upcoming Endowments and Finance Summit. Generally, there are three policy levers available to fiduciaries of long-term investment pools that have the greatest influence in determining success: asset allocation, spending rate/methodology, and new gift flows.  Strategic asset allocation (the long-term policy target allocation) is the most critical determinant of success among the three levers. A 1986 study conducted by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower suggested that up to 90% of portfolio returns can be determined by asset allocation. 

For some foundations that do not have control over spending rates or expect additional outside contributions to the investment pool, strategic asset allocation may be the only influential lever available to them. It’s not surprising that foundations and their Investment Committees spend so much time on this policy-level decision. These discussions can be complex and need to account for the considerations that help shape asset allocation, such as the amount of liquidity needed by the institution, its appetite for risk assets and alternatives, preferences for active versus passive implementation, and specific return objectives, among others. For institutions that do have influence over spending and new contributions to the investment pool, it is important not to ignore these levers in policy formulation as they can often compensate for shortfalls when policies and objectives are in conflict.

The path to CPI + 5% is becoming more challenging and requires a greater focus on alignment of policy decisions with long-term goals and objectives.  We hope that you’ll consider joining us as we explore the critical investment portfolio policy levers and how they can be applied for foundations at our session, "Knowledge is Power: Insights from the Commonfund Benchmark Studies" on Friday, September 7, 2018 at 8:30 AM during the Endowments & Finance Summit in Washington, DC.


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