CAP Investment Management & Endowments 2 — Questions and Answers
Question 1: What is the 'total return' approach to endowment spending?
- Spending only dividend and interest income generated by the portfolio
- Spending a predetermined percentage of total portfolio value, including both income and capital appreciation (Correct answer)
- Returning all investment gains to the original donors
- Allocating 100% of annual returns to grantmaking activities
Correct answer: Spending a predetermined percentage of total portfolio value, including both income and capital appreciation
The total return approach bases spending on a percentage of total portfolio value rather than limiting distributions to income alone, providing more consistent and predictable grantmaking.
Question 2: Program-related investments (PRIs) differ from mission-related investments (MRIs) primarily because PRIs:
- Require above-market financial returns to compensate for philanthropic risk
- Must be structured exclusively as equity investments in for-profit companies
- Count toward the private foundation's mandatory 5% annual distribution requirement (Correct answer)
- Are restricted to investments within the foundation's home state
Correct answer: Count toward the private foundation's mandatory 5% annual distribution requirement
PRIs count toward a private foundation's 5% distribution requirement because their primary purpose is furthering the foundation's exempt charitable purposes, not generating financial return.
Question 3: What does 'rebalancing' an endowment portfolio mean?
- Adding new donors to the foundation's beneficiary and distribution list
- Restoring the portfolio to its target asset allocation after market movements shift the actual mix (Correct answer)
- Transferring investment assets between multiple affiliated foundations
- Converting all investment holdings to cash in preparation for a major grant cycle
Correct answer: Restoring the portfolio to its target asset allocation after market movements shift the actual mix
Rebalancing corrects drift from the target asset allocation by selling outperforming assets and purchasing underperforming ones, maintaining the intended risk/return profile over time.
Question 4: Which type of endowment fund permanently restricts the principal by donor intent, allowing only investment returns to be spent?
- Quasi-endowment (board-designated fund)
- Term endowment with a fixed expiration date
- True (permanent) endowment (Correct answer)
- Unrestricted operating reserve fund
Correct answer: True (permanent) endowment
A true or permanent endowment permanently restricts the original gift principal per donor intent, with only investment income and returns available for spending.
Question 5: What is 'liquidity risk' in the context of endowment management?
- The risk of investing in foreign currency-denominated assets
- The risk that the endowment becomes unable to meet short-term cash needs due to excessive illiquid holdings (Correct answer)
- The risk of holding too much cash and missing investment returns
- The risk that donor restrictions will be changed after the gift is accepted
Correct answer: The risk that the endowment becomes unable to meet short-term cash needs due to excessive illiquid holdings
Liquidity risk is the danger that too high a concentration in illiquid assets (private equity, real estate) prevents the foundation from meeting spending obligations or emergency cash needs.
Question 6: When advising a client on a donor-advised fund (DAF) investment strategy, a key consideration is:
- DAF investments must exactly mirror the sponsoring organization's own portfolio
- The donor retains full legal ownership and control over the invested assets
- DAF assets must be fully distributed within five years of contribution
- The investment timeline should align with the donor's philanthropic goals and anticipated grant distribution horizon (Correct answer)
Correct answer: The investment timeline should align with the donor's philanthropic goals and anticipated grant distribution horizon
Matching the DAF investment horizon to the donor's grant distribution timeline optimizes both growth potential and asset availability for charitable giving when needed.
Question 7: What does 'investment due diligence' mean in the context of foundation endowment management?
- Filing required annual tax and financial returns with the IRS
- Investigating and evaluating investment managers and strategies before committing foundation assets (Correct answer)
- Auditing grant recipients for proper use of distributed funds
- Verifying the charitable intent of prospective major donors
Correct answer: Investigating and evaluating investment managers and strategies before committing foundation assets
Investment due diligence involves thoroughly researching and evaluating potential managers, funds, and strategies—reviewing track records, fees, risk controls, and mission alignment—before making investment commitments.
CAP Investment Management & Endowments 2
What is the 'total return' approach to endowment spending?