The university’s operating expenses are expected to grow at a rate of 2.5% annually, and the rate of inflation in the economy is expected to be 1% a year. Investment management expenses are estimated to be 0.65% of the endowment’s market value.
WHY they don’t add inflation rate to the total return expectation?
Which question is this? Inflation should be added, unless the 2.5% includes inflation (they sometimes frame the OpEx growth rate as inflation + x%).
It’s website test Andrei Zubov )in institutional topic) Q6. I haven’t found mention of the op. cost including inflation (though I recall seeing sth like that in a question but it cannot be a general rule I guess)
Is the expected growth rate of 2.5% a nominal projection? If so, you don’t need to worry about inflation. Would only need inflation added back if it said 'Expenses are expected to increase 2.5% in real terms".
It wasn’t specified.
I get it, I think. Makes sense, since costs will grow in nominal terms of course. So inflation is just given as a distractor here.
I get tricked with inflation in many cases and it makes me very nervous because calculations would normally be my strongest profile - but not with this stupid inflation figure appearing here and there.
On a related note:
when they want the endowment to preserve purchasing value we do add the inflation rate?
so if no mention about maintaining purchasing power, then:
spending rate + op. cost growth + asset man. fees
if they want to preserve real value, then:
spending rate + op. cost + asset man. fees + inflation
Is this correct as a general rule?
Inflation rate for US higher education expenses has generally been above regular GDP or CPI inflation rate. If education-specific inflation is given then, CPI inflation rate should not be used. I believe, in your example operating cost growth rate is nothing but the inflation rate for the education system. Hence you should use that and not the CPI or GDP inflation rate.
So as given in the book
Rate of return should be --> spending rate in % + rate of asset management fees in % + (general or specific) inflation rate in %
or you can use compounding approach for precise calculation.
Maybe I don’t understand the meaning of operating cost here? (Have never seen an endowment IRL).
In the questions we usually are given “operating costs will grow at a rate of…” and we are given inflation rate, and some of the questions ask to calculate the required return with a goal of preserving the real value of the endowment’s investment assets.
In my opinion, operating cost growth rate is nothing but the inflation rate of education and should preside the regular inflation rate. In that case ignore the general inflation rate (CPI price index or GDP deflator). It is just one of the components of requried rate of return
Yes, you must be correct - at least it makes much more sense this way.
As I have no idea how endowments work, I somehow figured it’s their own operating costs?