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To test an endowment spending rule, calculate the cash draw from its stated asset base, then measure the fund left after return, costs and spending in inflation-adjusted terms. A smooth budget does not by itself protect future beneficiaries: after a market fall, an average of earlier, higher values can authorise a larger draw than a rule based on the latest value. Intergenerational equity asks whether the remaining purchasing power is being preserved while the current mission is funded.
Why the base of the rule matters
A current-value rule applies a spending rate to the most recent valuation. A smoothing rule applies it to an average of earlier valuations. The second gives a steadier operating budget, but reacts more slowly when the corpus falls. The candidate therefore has to separate budget stability from capital preservation. CAIA Association lists Foundations and the Endowment Model in its Level II curriculum outline, and its endowment stress analysis notes that a prolonged shock interacts with spending policy and liquidity planning.
Use the curriculum edition for the exam year you are taking: CAIA Association says on its curriculum and study tools page that an edition applies to the calendar year of its exam. The example below is a calculation aid, not an institutional policy recommendation.
An illustrative spending and purchasing-power check
All figures in this example are invented. An endowment has three prior year-end corpus values of £100 million, £110 million and £90 million, in that order. Its policy rate is 4% of either the latest value or the simple average of the three values. For the current year, assume the opening corpus is £90 million, the gross portfolio return is 8%, costs are 1% of opening corpus, and inflation is 3%. Spending and costs are paid at year-end.
The latest-value base is £90 million, giving a £3.6 million draw. The three-value average is £100 million, giving a £4 million draw. The gross investment gain is £7.2 million and costs are £0.9 million under both rules. Subtract each draw from the corpus after that gain and those costs, then divide the result by the inflation factor to express it in opening-year pounds.
| Latest year-end value | £3.6 million | £92.7 million | £90.00 million |
| Three-year average | £4.0 million | £92.3 million | £89.61 million |
The latest-value rule exactly preserves the opening £90 million of purchasing power in this one-year example; the smoothing rule leaves about £0.39 million less. The difference is the extra £0.4 million paid to current beneficiaries, adjusted for inflation. One year cannot prove a rule sustainable. The proper longer-run test repeats the calculation under different returns, inflation and costs, and checks whether a stable budget is masking gradual real erosion.
The mistake to avoid
Do not compare the nominal 8% return with the 4% policy rate and conclude that future purchasing power is safe. That ignores the 1% cost and 3% inflation assumptions, and under smoothing the effective draw is measured against a different base from the latest corpus. In this example, the £4 million smoothed draw is more than 4% of the £90 million opening corpus. Read the base, timing and units before deciding whether present and future beneficiaries are treated consistently.
The CAIA programme page places the topic in the wider course, and the Omni study methodology explains how to practise a calculation and its interpretation together.
Sources
- Explore the Curriculum - Chartered Alternative Investment Analyst Association · caia.org · Retrieved
- Stress Test Scenarios and Endowment Portfolio Impacts - Chartered Alternative Investment Analyst Association · caia.org · Retrieved
- Curriculum and Study Tools - Chartered Alternative Investment Analyst Association · caia.org · Retrieved
