Economist James Tobin of Yale famously wrote in 1974 that "The Trustees of an endowed institution are the guardians of the future against the claims of the present", thus creating the concept of intergenerational equity. To achieve perfect symmetry, an endowment would spend its real investment returns, thus preserving the purchasing power of the principal indefinitely.

Although a great deal of time and energy is spent managing the investment side of this equation, curiously, the spending side appears comparatively unmanaged. Surveys portend a possible herd mentality for spending formulas, with a majority falling within a tight range. And anecdotal evidence suggests that ad hoc overrides to the spending formula are common, particularly after periods of underperformance.

SimMetric takes spending policy management to the next level. It allows you to model alternative spending policies and compare how they perform relative to the current policy. The approach is to forecast fund levels into the future and measure how the alternative formulas perform against objectives. It facilitates the development of a spending policy that is in harmony with the investment policy at the structural level, breaking the dependency on overrides.

Control your own destiny or something else will.

For a spending policy to satisfy all constituents under all market conditions, its basic structure is critical. The most common spending formulas express the annual spend as some percentage of assets, usually averaged over 24- to 36-months. Although this makes intuitive sense, it can backfire at the worst possible times.

For example, consider a fund which has suffered a sharp decline of 20% during a single quarter. If the subsequent spending calculation is based on mostly pre-decline asset values, the result can be a spending amount that is inappropriately high compared to current market value - in this case, it might approach 10% of the fund value. This overspend extends and amplifies the negative effect of the bad performance and possibly inflicts permanent harm on the fund.

Another structural issue with spending formulas is their year to year volatility, which can make annual budgeting more difficult. Ideally, a spending policy would be stable and predictable to facilitate longer range planning and budgeting, yet still retain a link to the real returns to share any incremental wealth created to the current generation.

SimMetric allows you to build and model a wide variety of spending formulas that address these structural problems. You can incorporate lagging, minimums and asset averaging and other types of formulas.

Making it all look easy.

SimMetric's intuitive user interface, analytical power and rich graphical display of data allow users of varying skill levels to operate the tools. Call us for a demonstration.