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It's fecundity that matters.
Endowment funds and long-duration personal trust funds are different from other institutional funds such as pension funds. Trustees of endowments and long-duration trusts expect to preserve their capital for a very long time; trustees of pension funds expect their capital to be consumed. Trustees of endowments and trusts seek reliable streams of spendable cash; trustees of pension funds (whose spending needs typically lie in the future) seek healthy short- to mediumterm total returns.
I explain why endowment and trust fund trustees should evaluate their funds differently from the way that pension fund trustees evaluate theirs-and introduce a new technique for evaluating endowments and trusts.
To some, capital is an asset whose utility lies in its ability to be converted into cash to pay for (say) college educations or a new home. To others, the utility of capital lies in its ability to generate streams of spendable cash on a sustained basis. For the first group, the utility of capital is a function of its price. For the second, it is primarily a function of its ability to provide predictable long-term spendable cash.
The same asset-financial capital-can be employed to satisfy different objectives. As a result, the same asset should be subject to different evaluation standards. To be useful, these standards should relate to the funds' objectives.
OBJECTIVE OF ENDOWMENTS AND TRUSTS
The primary objective of most endowment funds, and of many long-duration trust funds, is to provide spendable cash for their owners and beneficiaries for a very long time. Given this objective, the most important point to consider in evaluating the health of endowments and trusts is their fecundity. Fecund means "fruitful or fertile," and cash withdrawals from a portfolio are effectively its fruit. Fecundity is a measure of the spendable cash that a fund can provide today without unduly threatening its ability to provide similar amounts-adjusted for inflationin the future.
Consider a simple case: a tax-exempt institution whose need for cash will grow with inflation and whose endowment is invested solely in long-term inflation-indexed Treasury bonds (TIPS) purchased at par and paying a real coupon of C. The fecundity of this endowment is C times the inflation-adjusted par value of the bonds. In the more common case, when capital...