Endowments foundations and SWFs - Spending rules liquidity a...

Learning Outcomes

This article explains endowments, foundations, and sovereign wealth funds (SWFs) from a CFA Level III portfolio management perspective, including:

• how to distinguish their missions, funding models, and stakeholder structures and relate these to risk capacity and investment objectives;
• how different spending rules (hybrid formulas, statutory minimum payouts, stabilization transfers, and spend-down mandates) translate into required real and nominal returns, sustainability of capital, and intergenerational equity considerations;
• how to evaluate liquidity policies, cash-flow profiles, and the use of liquidity buckets, with emphasis on meeting recurring spending, capital calls, and stress-scenario outflows without forced selling;
• how time horizon—perpetual versus finite, savings versus stabilization—shapes tolerance for interim volatility, allocations to growth assets, and feasible exposure to illiquid alternatives;
• how to integrate spending, liquidity, and horizon when drafting or critiquing institutional investment policy statements (IPSs) and proposed strategic asset allocations;
• how to recognize typical exam traps, such as overstating the “long-term” nature of endowments while ignoring liquidity and payout constraints, or misaligning SWF portfolios with their stabilization or savings mandates;
• how to apply these concepts to exam-style vignettes, selecting the portfolio that best matches an institution’s objectives and constraints and justifying recommended changes in clear, curriculum-consistent language.

CFA Level 3 Syllabus

For the CFA Level 3 exam, you are required to understand institutional portfolio management for endowments, foundations, and SWFs, with a focus on the following syllabus points:

• Identifying core differences in the objectives, constraints, and stakeholders for endowments, foundations, and SWFs
• Describing the mechanics and implications of spending rules on portfolio policy
• Assessing factors influencing liquidity planning and requirements, including external spending, capital calls, and regulatory obligations
• Explaining how time horizon determines risk tolerance, asset allocation, and use of illiquid assets in institutional portfolios
• Evaluating the impact of spending rules and liquidity management on long-term sustainability and intergenerational equity

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. A university endowment uses a 4% spending rule based on a three-year moving average of market value. Which statement best describes the likely impact on asset allocation?
   1. It must hold mostly bonds to reduce volatility of the market value.
   2. It can hold more illiquid and growth assets because spending is relatively stable.
   3. It must hold mainly cash to match annual spending.
   4. It cannot invest in alternatives because the rule is based on market value.
2. A sovereign wealth fund has a stabilization mandate funded by volatile commodity revenues. Which liquidity profile is most consistent with this mandate?
   1. High allocation to private equity and real estate, limited cash.
   2. Predominantly long-dated equities, minimal bonds.
   3. Large holdings of cash and short-term government bonds.
   4. Concentrated domestic infrastructure investments with long lock-ups.
3. A private foundation must meet a statutory 5% annual payout calculated on prior year-end market value. Which liability characteristic most reduces its effective time horizon?
   1. The absence of a legal termination date.
   2. The combination of a high payout rate and limited new contributions.
   3. The ability to invest in hedge funds and private equity.
   4. The tax-exempt status of its portfolios.
4. Short-term liquidity needs generally limit the allocation to alternative assets in endowments. Is this statement most likely:
   1. True, because alternatives cannot be reconciled with any spending rule.
   2. True, when payout rates are high and backstops are weak.
   3. False, because long horizons always dominate liquidity needs.
   4. False, because alternative assets are always as liquid as listed equities.

Introduction

Institutional investors such as university endowments, private foundations, and sovereign wealth funds share a common objective: convert a pool of financial capital into a stable stream of real resources over time. Yet they do so under very different spending rules, liquidity needs, and time horizons. Level III questions frequently require you to infer these factors from a vignette and then evaluate whether a proposed asset allocation is consistent with the institution’s profile.

Spending rules determine how much cash must be distributed each year. Liquidity policies determine how that cash is raised without forced selling or undue transaction costs. The time horizon frames how much interim volatility can be tolerated in pursuit of long-term objectives. Together, these elements drive the institution’s risk capacity and feasible allocations to growth and illiquid assets.

Key Term: spending rule
A formal policy that specifies how much an institution distributes from its portfolio each period, typically as a percentage of assets, a function of prior-year spending, or a hybrid of the two.

Key Term: liquidity
The ability to meet expected and unexpected cash outflows—such as operating spending, grants, capital calls, and margin requirements—without incurring unacceptable costs or losses.

Key Term: time horizon
The period over which an investor plans to achieve objectives. For institutions, this combines the legal or policy horizon (e.g., perpetual vs finite spend-down) with the effective horizon implied by spending, contributions, and risk tolerance.

Three cross-cutting ideas are especially important in exam settings:

• Spending rules are not just accounting devices; they imply a required return. If the rule plus inflation and costs exceeds the portfolio’s sustainable return, real capital will eventually erode.
• Liquidity is path-dependent. A portfolio that seems liquid in “normal times” can become effectively illiquid in crises as correlations spike and trading conditions deteriorate.
• Time horizon is partly endogenous. A legally perpetual fund can have a much shorter effective horizon if high payouts and weak funding backstops constrain risk-taking.

The sections that follow examine these issues in turn for endowments, foundations, and SWFs.

Key Term: intergenerational equity
The principle that current beneficiaries of an institutional fund should benefit without unfairly compromising the real value available to future beneficiaries.

Key Term: hybrid spending rule
A spending formula that blends a percentage of current market value with an inflation-adjusted prior-year spending level to smooth distributions over time.

Key Term: statutory minimum payout
A legally mandated minimum distribution, usually expressed as a percentage of assets (for example, many private foundations must distribute at least 5% of prior-year assets).

Key Term: stabilization fund
A type of SWF designed to stabilize government budgets or economies by funding shortfalls when revenues—often from commodities—are depressed.

Key Term: savings fund
A long-horizon SWF intended to transform temporary or exhaustible revenues into a lasting financial asset base for future generations.

Key Term: spend-down mandate
A formal decision that an institution will intentionally distribute and exhaust its capital over a specified horizon rather than maintain it in perpetuity.

Key Term: capital call
A contractual demand from a private market or alternative investment vehicle for committed but previously unfunded capital from an investor.

Key Term: liquidity bucket
A portion of the portfolio deliberately invested in assets of similar liquidity (for example, highly liquid, liquid, semi-liquid, illiquid) to manage cash-flow needs under normal and stress scenarios.

SPENDING RULES AND THEIR IMPACT

A core function for endowments and foundations is to provide ongoing funding via annual distributions governed by a spending rule. SWFs may also fund government budgets or intergenerational transfers, but their rules reflect national policy and macroeconomic objectives.

Spending rules influence:

• Required return: the portfolio must at least cover spending, inflation, and costs to maintain real capital.
• Risk tolerance: high or rigid spending can reduce risk capacity because drawdowns directly threaten mission.
• Portfolio composition: more predictable and flexible spending rules support greater allocations to risky and illiquid assets.

Endowments

University endowments typically aim for intergenerational equity: funding current operations while preserving purchasing power for future cohorts.

The most common approach is a hybrid spending rule, often based on a rolling-average asset value:

where:

• $w$ = weight on current market value (e.g., 30%–70%)
• $s$ = long-run spending rate (e.g., 4%–5%)
• $MV_{t-1}$ = prior-year market value
• $i$ = inflation adjustment, often CPI or a higher education cost index

This rule combines:

• A target spending rate (e.g., 4%–5% of assets) linked to long-run sustainability.
• Smoothing through the weight on prior-year spending to reduce year-to-year fluctuations.

Because distributions are relatively predictable and somewhat insulated from short-term market moves, endowments can:

• Hold high allocations to equities, private equity, real estate, and other alternatives.
• Tolerate interim volatility, provided long-run expected return comfortably exceeds spending plus inflation and costs.
• Accept some short-term erosion in real value after severe drawdowns, on the expectation of recovery over decades.

For IPS purposes, the required real return is approximately:

If the endowment targets flat real capital, the real required return is roughly equal to the spending rate (e.g., 4%–5%). The nominal required return then adds expected inflation plus investment and administrative costs.

A key evaluation skill at Level III is to judge whether a proposed asset allocation offers a realistic chance of meeting this required return. For example, a portfolio heavily tilted to high-grade bonds in a low-yield environment might have too low an expected return to support a 5% spending rate plus inflation, even if it reduces volatility.

Foundations

Private foundations share many features with endowments but are often subject to statutory minimum payouts. In several jurisdictions, private foundations must distribute at least 5% of prior-year assets each year, including:

• Grants made to external organizations
• Certain administrative and investment costs

This has several implications:

• The statutory payout is a floor; actual economic outflow can exceed 5% after including fees.
• In a severe market downturn, the required payout is calculated on the prior-year higher market value, potentially forcing a draw on capital when it has just shrunk.
• With limited new contributions, a sustained payout rate above the portfolio’s sustainable real return eventually erodes capital.

Relative to endowments, key impacts on portfolio policy include:

• Lower risk tolerance when payout is high and inflexible. A 5% statutory payout plus inflation and fees may require a nominal return of 7%–8%. If the foundation cannot tolerate the volatility associated with high-growth portfolios, the long-term sustainability of real capital is at risk.
• Sharper focus on liquidity. Because the payout is calculated on prior-year assets and must be met regardless of current conditions, the foundation needs enough liquid assets to fund payouts in stressed markets without selling illiquid holdings at steep discounts.
• Sensitivity to policy changes. A move from a perpetual mission to a formal spend-down mandate (for example, liquidation over 20 years) sharply reduces the effective time horizon and risk capacity. The portfolio must shift toward more liquid and lower-volatility assets as the termination date approaches.

Community foundations and some public charities may have more flexibility, especially if they receive ongoing contributions or can adjust grant-making levels, but statutory rules still anchor minimum distributions.

Sovereign Wealth Funds

SWFs are government-owned investment funds with mandates that differ by type. Three archetypes are most relevant for exam questions:

• Stabilization funds: cushion the government budget and economy from revenue volatility, often linked to commodity prices.
• Savings funds: transform non-renewable or cyclical revenues into a diversified financial base for future generations (similar to very large endowments).
• Pension reserve or development funds: pre-fund future social security obligations or support strategic domestic projects.

Spending rules, whether explicit or implicit, reflect these mandates.

• Stabilization funds

  • Spending is driven by budget gaps or revenue shortfalls.
  • Withdrawals can be large, abrupt, and correlated with adverse market conditions (e.g., oil price collapses).
  • Formal rules might limit annual withdrawal to a percentage of recent GDP or specify triggers tied to commodity prices, but political demands can override these in crises.
  • Required return is less about intergenerational growth and more about preserving real value while keeping risk and drawdowns modest.

• Savings funds

  • Often apply a conservative, long-run spending rate (e.g., 3%–4% of fund value or expected long-run real return) to preserve capital for future generations.
  • New inflows from revenues may exceed outflows for extended periods, allowing an accumulation phase with high risk capacity.
  • The key objective is similar to an endowment: earn at least spending plus inflation over the very long term.

• Pension reserve/development funds

  • Spending rules may be tied to future benefit payments or project schedules.
  • If obligations are far in the future and prefunding is robust, risk capacity may be similar to savings funds.
  • If withdrawals are imminent or politically driven, risk capacity is much lower.

For SWFs, an important exam consideration is the gap between stated policy and political reality. Even a so-called perpetual savings fund with a low target payout may face opportunistic withdrawals during crises, which effectively shorten its time horizon and increase implied liquidity needs.

LIQUIDITY POLICIES AND PLANNING

Liquidity management is central to institutional investing. At Level III, you must move beyond simplistic labels (“endowments are long term, so liquidity is not a concern”) and consider:

• The pattern and predictability of outflows (spending, grants, budget transfers).
• Capital calls and reinvestment obligations from alternatives.
• Available backstops (credit lines, sponsor support, insurance, or government guarantees).
• The potential for liquidity to deteriorate in market stress.

Key Term: liquidity bucket
A grouping of assets by expected time and cost to liquidate—such as highly liquid (T-bills), liquid (large-cap equities), semi-liquid (open-end funds with notice), and illiquid (private equity and direct real estate).

Endowments and Foundations

Endowments and perpetual foundations often have:

• Predictable annual spending based on a formal rule.
• Few hard liabilities beyond operating budgets and grants.
• Strong governance and investment committees accustomed to long horizons.

This profile supports a substantial allocation to illiquid assets, but only if liquidity risk is explicitly managed.

Key elements of liquidity policy include:

• Quantifying recurring cash needs.

  • Annual spending and operating costs.
  • Capital calls from private equity, real assets, and other drawdown structures.
  • Rebalancing needs, especially after market drawdowns.

• Segmenting the portfolio by liquidity bucket.
  For example, an endowment might classify its holdings as:

  • Highly liquid: cash, short-term government bills, developed-market large-cap equities.
  • Liquid: investment-grade bonds, broad equity index funds.
  • Semi-liquid: hedge funds with quarterly or annual liquidity and notice periods.
  • Illiquid: private equity, venture capital, direct real estate, infrastructure.

  Under normal conditions, an endowment may hold, say, 20% in highly liquid assets, 25% liquid, 25% semi-liquid, and 30% illiquid. Under stress (when equity prices fall and capital calls accelerate), effective illiquidity can increase significantly as the liquid portion shrinks faster than illiquid valuations are adjusted. Case studies in the curriculum show the illiquid share rising from roughly one-third to closer to 40% when stress scenarios are modeled.

• Stress testing liquidity.
  Sophisticated institutions run scenarios combining:

  • Market declines that reduce the value of liquid holdings.
  • Increased capital calls from private funds (the “J-curve” and opportunistic investment by managers).
  • Limited ability to redeem from semi-liquid vehicles because of gates, lock-ups, or extended notice periods.
  • Higher-than-normal spending needs, for example, from operating deficits.

  These tests reveal how quickly the highly liquid bucket could be exhausted and whether the institution would be forced to sell illiquid holdings in secondary markets at steep discounts.

• Maintaining buffers and backstops.
  Liquidity buffers can include:

  • A dedicated cash or short-term bond allocation sized to cover, for example, one to three years of spending and capital calls.
  • Committed lines of credit or the ability to issue short-term debt.
  • Access to sponsor support (for example, a university’s operating surplus) or government backstop in the case of some public institutions.

In exam vignettes, you may be asked whether a proposed increase in illiquid assets is appropriate. The correct evaluation typically weighs:

• The predictability and size of spending relative to assets.
• The robustness of liquidity stress testing and buffers.
• The quality of governance—whether the board will tolerate illiquidity during crises instead of forcing a fire sale.

Exam Warning

A common error is to ignore liquidity needs arising from capital calls in alternatives. A portfolio can appear liquid based on current holdings, yet uncalled commitments may greatly exceed the liquid bucket. When markets fall and managers accelerate calls to buy distressed assets, the institution can face forced selling of listed securities at depressed prices.

SWFs

Liquidity requirements for SWFs vary sharply by mandate:

• Stabilization funds

  • Must meet unpredictable, sometimes very large, budgetary shortfalls when revenues fall.
  • Liquidity policy favors cash, Treasury bills, and short-duration, high-quality sovereign bonds.
  • The fund must be able to convert a substantial fraction of assets to cash quickly without material price impact.
  • Allocations to private equity, real estate, and other illiquid assets are typically minimal or segregated in a separate vehicle.

• Savings and pension reserve funds

  • Have distant or policy-driven spending needs and typically experience net inflows for many years.
  • Can tolerate lower immediate liquidity and higher allocations to equities and alternatives.
  • Nevertheless, should still maintain a liquidity bucket for:
    • Gradual ramp-up of private markets (funding capital calls).
    • Tactical rebalancing during market dislocations.
    • Possible policy-driven withdrawals beyond modelled expectations.

• Development funds

  • Often invested in strategic domestic projects that are intrinsically illiquid (infrastructure, state-owned enterprises).
  • Liquidity characteristics must be evaluated in the context of the broader sovereign balance sheet, including borrowing capacity and access to international capital markets.

For SWFs, exam questions often test your ability to match liquidity profile to mandate. Assigning a large allocation to illiquid alternatives in a stabilization fund is usually inconsistent with its need to respond quickly to fiscal shocks.

Liquidity Lessons from Crises

Historical crises—such as the Asian currency crisis, the 1998 Russian default and LTCM episode, and the 2008–2009 global financial crisis—illustrate that:

• Market-wide stress can turn assets that appeared liquid into illiquid holdings as bid–ask spreads widen and market participants retreat.
• Investors often sell what is most liquid first (public equities and bonds), leaving the portfolio increasingly dominated by illiquid holdings—the so-called denominator effect.
• Private fund managers may maintain capital call schedules even as public markets fall, further straining liquidity.

Endowments, foundations, and SWFs with large illiquid allocations must therefore design liquidity policies that remain robust under such stress, not just in base-case projections.

TIME HORIZON AND ASSET ALLOCATION

Time horizon is a critical constraint in asset allocation. It shapes both risk capacity and the institution’s tolerance for illiquid assets.

Endowments (Time Horizon)

Most university endowments are legally perpetual, and their missions (supporting teaching, research, and scholarships) are expected to persist indefinitely. This leads to:

• Very long formal horizon. The fund intends to exist forever, supporting multiple future generations.
• High capacity for interim volatility. Short-term drawdowns do not threaten the institution’s survival, provided spending can be temporarily adjusted or buffered.
• Strong rationale for growth assets. Over long horizons, equities and private markets have historically offered higher expected returns than bonds, improving the chance of meeting spending plus inflation.

However, the effective horizon can be shorter than “perpetual” if:

• The spending rule is aggressive (e.g., 6%–7%) relative to expected returns.
• The university relies heavily on the endowment (e.g., 40%–50% of operating budget) and has limited alternative funding sources.
• Governance is weak, and the board is prone to procyclical behavior (cutting risk after losses, increasing after gains).

Studies in the curriculum emphasize the trade-off between short-term volatility and the probability of meeting a long-term return target. For example, consider a perpetual endowment targeting a 5% spending rate with 2.1% inflation, implying a 7.1% nominal return objective:

• A portfolio of 70% equities and 30% government bonds may have lower volatility but an expected return below 7.1%, giving less than a 50% chance of meeting the target over long horizons.
• A portfolio of 70% public equities and 30% private equity may have higher volatility but an expected return slightly above 7.1%, giving a better-than-even chance of meeting the target.

This illustrates a key point: for a truly long-horizon investor, failing to achieve the required return can be more dangerous than experiencing short-term volatility. Asset allocation must balance these two dimensions of risk.

Foundations (Time Horizon)

Foundations can be either perpetual or spend-down:

• Perpetual foundations

  • Conceptually mirror endowments in time horizon and objectives.
  • However, high statutory payouts can shorten the effective horizon by eroding capital during adverse periods, especially when new contributions are minimal.
  • This can push the foundation toward more conservative allocations, even if that further reduces the chance of preserving real capital.

• Limited-life (spend-down) foundations

  • Have a specified termination date (for example, 15 or 20 years).
  • The time horizon shortens each year, and the portfolio must gradually de-risk and increase liquidity to ensure funds are available when needed.
  • Risk capacity is lower than for perpetual entities, particularly in the latter half of the life cycle, because capital losses cannot be compounded away over multiple decades.

Key Term: spend-down mandate
A formal decision by an institution to intentionally exhaust its capital over a specified time frame, shifting the portfolio objective from preserving capital to maximizing mission impact over that horizon.

A classic exam task is to compare the asset allocations of a perpetual foundation and a 20-year spend-down foundation:

• The perpetual foundation can justify higher equity and illiquid allocations, emphasizing long-run real return.
• The spend-down foundation must place greater weight on near- to medium-term volatility and liquidity, especially as the horizon shortens, even if this reduces expected return.

SWFs (Time Horizon)

Time horizon for SWFs is closely tied to their type:

• Stabilization funds

  • Have a short effective horizon aligned with the fiscal cycle.
  • They may exist in perpetuity but must be positioned to meet shocks over a horizon of quarters to a few years.
  • Asset allocation is therefore conservative, with low duration and low credit risk.

• Savings and pension reserve funds

  • Have long or intergenerational horizons. For example, a fund may be designed to support citizens after natural resources are depleted or to pre-fund an aging population’s pensions.
  • These funds can tolerate high allocations to equities and alternatives, similar to (or even more aggressive than) large endowments, as long as withdrawals remain predictable and modest.

• Development funds

  • Time horizon is often long but may be constrained by specific project timelines and political cycles.
  • Investments may be illiquid and domestic, raising concentration and governance risks that must be weighed against developmental objectives.

A recurring exam consideration: political risk can shorten the effective time horizon of an SWF, even if the legal mandate is long-term. Frequent policy changes or pressure for short-term budget relief may force more liquid and lower-risk allocations than the formal mandate would suggest.

Worked Example 1.1

A university endowment has a 4% annual spending rule (based on a hybrid formula) and a target total return of 7% (net of inflation). It maintains a 25% allocation to illiquid alternatives. The board is considering increasing the spending rule to 7% to support a large expansion in financial aid. How would this likely affect the endowment’s asset allocation and risk tolerance?

Answer:
Raising the spending rule from 4% to 7% sharply increases the required real return. The endowment would now need to earn roughly 7% real (plus inflation and fees) to maintain purchasing power, which may be unrealistic without assuming much higher volatility. At the same time, higher annual cash outflows increase liquidity needs and reduce risk capacity:

• The endowment would need more liquid assets to fund the larger, recurring payouts, particularly in down markets.
• The tolerance for interim drawdowns declines because a large, fixed spending amount compounds the effect of market losses.
• Maintaining a 25% allocation to illiquid alternatives could create liquidity stress when markets fall and spending must still be met.

In practice, the portfolio would likely have to:

• Increase the allocation to liquid growth assets only if governance can tolerate much higher volatility, or
• Acknowledge that preserving real capital is no longer feasible and accept gradual erosion of the endowment.

Most boards would instead reduce illiquid exposures, temper equity risk, or reconsider the proposed spending increase to maintain sustainability.

Worked Example 1.2

A sovereign wealth fund has a stabilization mandate funded by oil revenues. The government faces unpredictable calls on the fund to cover budget deficits during commodity downturns. What portfolio characteristics are suitable for this fund?

Answer:
The fund’s primary role is to provide liquidity and capital preservation when oil revenues fall. Appropriate portfolio characteristics include:

• High allocation to cash, Treasury bills, and short-duration, high-quality sovereign bonds to ensure rapid access to funds.
• Limited credit risk and low duration to avoid large mark-to-market losses that could impair its ability to support the budget in crises.
• Minimal exposure to illiquid assets, such as private equity or infrastructure, because these cannot be easily sold when needed.
• Potentially a modest allocation to liquid, diversified equities to improve long-run return, but only to the extent that this does not materially jeopardize near-term liquidity.

Even if the fund technically has a long life, its effective time horizon for risk-taking is short due to its stabilization mandate.

Worked Example 1.3

A private foundation has $500 million in assets, a statutory 5% payout (based on prior year-end market value), and no expectation of new contributions. It has historically targeted a 60% equity / 40% bond allocation. The board is considering increasing private equity to 20% of assets funded from public equities. How should you evaluate this proposal?

Answer:
Analysis should consider spending, liquidity, and time horizon together:

• Spending and required return:
  • The 5% statutory payout plus 2% expected inflation and roughly 1% in fees implies a nominal required return of around 8% to preserve real capital.
  • Increasing private equity may raise expected return, helping close this gap if the foundation can tolerate additional volatility.
• Liquidity:
  • The 5% payout ($25 million annually) must be met regardless of market conditions.
  • Private equity introduces capital calls and long lock-up periods. If liquid public assets fall in a downturn, the foundation may be forced to sell at depressed prices to meet both payouts and capital calls.
  • Without a dedicated liquidity buffer or strong ability to cut spending in downturns, a 20% allocation to private equity may be too high.
• Time horizon:
  • While the foundation is legally perpetual, the combination of high payout and no new contributions effectively shortens the horizon. Repeated drawdowns can permanently impair the asset base.

Therefore, increasing private equity might be appropriate only if:

• A robust liquidity policy is established (for example, maintaining one to two years of payouts in cash and short-term bonds), and
• The board explicitly accepts higher interim volatility and possible short-term erosion of real capital to improve long-run sustainability.

Otherwise, the proposal should be scaled back or rejected.

Worked Example 1.4

A savings-type SWF has a current allocation of 20% global equities, 70% government bonds, and 10% cash. It is intended to support future generations once oil reserves decline in 25–30 years, and net inflows are expected for at least the next 10 years. The government has no history of drawing on the fund for short-term budget support. Is the current allocation appropriate?

Answer:
Given the long horizon and expected net inflows, the current allocation is likely too conservative:

• Time horizon: The fund’s primary objective is to build real wealth over multiple decades, not to stabilize current budgets. This supports a higher allocation to growth assets (global equities and possibly alternatives).
• Spending profile: With no near-term withdrawals and strong net inflows, the fund can tolerate more interim volatility. Cash and high-grade bonds are still needed, but a 10% cash and 70% bond allocation is excessive relative to objectives.
• Required return: To transform finite oil wealth into a perpetually sustainable financial asset, the fund must earn a healthy real return over time. A 70% bond / 10% cash allocation in a low-yield environment may not provide sufficient expected return.

A more appropriate allocation might involve:

• Increasing global equities to perhaps 50%–60%.
• Adding a measured allocation to illiquid alternatives such as private equity and real assets, subject to governance capacity.
• Reducing bonds and cash to a level sufficient to meet operating expenses and tactical needs.

Such a shift must, however, be balanced against political tolerance for volatility and the risk that future governments might change the fund’s role.

Summary

Spending rules, liquidity needs, and time horizons are tightly interconnected for endowments, foundations, and SWFs:

• Spending rules determine cash outflows and implied required returns. Hybrid rules and smoothing can stabilize payouts and increase risk capacity, while statutory minimums and high payouts can compress effective horizons and reduce risk tolerance.
• Liquidity policies must cover recurring spending, capital calls, and stress scenarios. Liquidity buckets, stress testing, and buffers (cash, short-term bonds, credit lines) are essential, especially for institutions with large illiquid allocations.
• Time horizon shapes the trade-off between volatility and the probability of meeting long-term objectives. Perpetual or intergenerational funds can hold more growth and illiquid assets, but only if spending and liquidity policies are aligned and governance can withstand interim drawdowns.

In Level III IPS questions, you are expected to integrate these dimensions—evaluating whether a proposed asset allocation, spending policy, or shift in mandate is consistent with the institution’s objectives, constraints, and long-run sustainability.

Key Point Checklist

This article has covered the following key knowledge points:

• Differentiate spending rules for endowments, foundations, and SWFs, and relate them to required returns and risk tolerance.
• Explain how smoothing mechanisms in hybrid spending rules affect volatility of distributions and capacity for illiquid assets.
• Analyze statutory minimum payouts and spend-down mandates and their impact on sustainability and effective time horizon.
• Describe liquidity planning for institutional investors, including liquidity buckets, capital call management, and stress testing.
• Evaluate how stabilization, savings, and development mandates for SWFs shape liquidity needs and asset allocation.
• Assess how time horizon (perpetual vs finite) interacts with spending and liquidity to determine feasible allocations to growth and alternative assets.
• Apply these concepts in worked examples and exam-style questions to justify changes to institutional portfolios.

Key Terms and Concepts

• spending rule
• liquidity
• time horizon
• intergenerational equity
• hybrid spending rule
• statutory minimum payout
• stabilization fund
• savings fund
• spend-down mandate
• capital call
• liquidity bucket