Is tax-exempt status a contributing factor to higher Risk Tol?

[Gersonides]

In the 2013 AM exam, there is a question about a particular foundation which is described as tax-exempt. One of the questions is to ID reasons why the foundation has a higher RT.
I could swear in an earlier mock, I saw that as a reason in the guideline response to a similar question. So I used that as one of my supporting reasons.
But i’s not listed in the guideline answers on this one. Anyone have insight on whether this would or would not be a factor in determining RT?

 

[MrSmart]

I think tax status would be more of a return objective approach, rather than tolerance for risk.

 

[IHateMyLIFO]

I wouldn’t think being tax-exempt would increase risk tolerance. If anything, being taxable should increase risk tolerance, as after-tax risk is lower than before tax risk: Std. Dev. (AT) = Std. Dev. (PT) * (1-T). At least, this is the case for individual investors.

 

[S2000magician]

Bearing in mind that the efficient frontier is curved – marginal risk/marginal return increases as return increases – consider two taxpayers: Mary and Bob.
Mary is tax-exempt and needs a 7% after-tax return; on the efficient frontier she can get 7% expected return with 8% standard deviation of returns.
Bob is not tax-exempt; he needs a 7% after tax return and pays 30% in taxes, so he needs a 10% before-tax return. Ten percent returns come with13% standard deviation of returns. So Bob’s after-tax return is 10%(1 − 0.3) = 7% and his after-tax volatility is 13%(1 − 0.3) = 9.51%.
Mary can tolerate 7% after taxes more easily than Bob can, ceteris paribus.

 

[Gersonides]

S2000magician wrote:
Bearing in mind that the efficient frontier is curved – marginal risk/marginal return increases as return increases – consider two taxpayers: Mary and Bob.
Mary is tax-exempt and needs a 7% after-tax return; on the efficient frontier she can get 7% expected return with 8% standard deviation of returns.
Bob is not tax-exempt; he needs a 7% after tax return and pays 30% in taxes, so he needs a 10% before-tax return. Ten percent returns come with13% standard deviation of returns. So Bob’s after-tax return is 10%(1 − 0.3) = 7% and his after-tax volatility is 13%(1 − 0.3) = 9.51%.
Mary can tolerate 7% after taxes more easily than Bob can, ceteris paribus.

If I’m understanding correctly, then, taxable status is not a direct function of risk tolerance. Rather, a non-tax exempt entity would potentially require taking more risk, regardless of risk tolerance.
I was initially thinking that being tax-exempt meant that higher turnover was more acceptable, hence a higher ability to take risk.
I guess the bottom line is that for exam purposes, it’s not a reason for a higher risk tolerance.

 

[gad4]

Im thinking that if an organiztion is tax exempt, then they get to keep all the profits, therefore they can take greater risk.
However im open to clarificaiton.

 

[MrSmart]

Risk should be independent of return.
Your risk tolerance won’t improve if you can suddenly make 50% on your risk free assets.
Except if you consider risk here a function of itself, or in others, a multi-period simulation.

 

[Third_Time_is_t]

I believe the “tax-exempt” status is not a risk tolerance item, but a item to clarify “unique circumstances” because foundations, pensions, endowments are subject to “Unrelated Business Income” tax if they stray from their sole objective(s). However, I haven’t come across any questions that specifically ask for “Unique Circumstances” in the written exams; usually the questions ask about liquidity and time horizon.
I would try to find other case-specific items that are specific to risk tolerance….for example, Pensions (average age of workforce, percentage of retired vs active lives, health of a sponsor based on debt-to-equity or net income/sales ratios); Foundations (percent spent per year and whether that is a “goal” or a “mandatory” amount, recent returns on plan assets, perpetual or finite time period); and Endowments (impact to operating budget for the school, current size of the portfolio, ability to receive additional donations, size of the endowment and whether it can bear additional due-diligence costs for investing in alternative assets).