Institutional clients use a variety of benchmarks to measure their investment success relative to market indices. However, one of the most important benchmarks is not based on market returns, but rather on the real-world costs that organizations face now and in the future, and the ability of their investable asset pools to grow in line with the inflation of the organization’s cost structure.
The goal is simple; produce enough return to both meet current draw requirements funding present needs while growing the corpus at a rate equal to or faster than the rate of inflation, so that the assets will be able to meet the future needs of the institution to the same degree as in the present. The shorthand designation for the real-world performance goal is commonly called “CPI + 5%” – which assumes a 5% draw rate on asset values. Much attention is paid to the draw rate (the “5%” part of the term); less attention has been paid to the inflation measure used to quantify cost increases.
In this brief paper we hope to focus on the varied measures of inflation—including CPI, PCE, and GDP deflator—and how they can impact the evaluation of real returns in an institutional framework.