Why Does Increased Inflation=Higher Risk Tolerance?

[rellison]

2011 CFA Test, Question 3B:
One would think that increased inflation would lead an endowment to decreased risk tolerance because it would erode the value of real returns, and require more liquidity to cover the higher nominal expenses, thus lowering risk tolerance. But Schweser says:
Answer says that an increase in expected inflation “Increases risk tolerance: An increase in expected inflation may cause the endowment to demand a higher real return on investments to compensate for a perceived increase in risk. This can lead to an increase in expected long-term real returns for the portfolio. As expected real returns increase, with the nominal spending rule held constant, the risk tolerance of the endowment increases.”
What up with that?

 

[luftwaffle]

When I answered this question, my understanding was the same as what CFA wrote. Basically higher inflation means they will be demanding a higher rate of return to compensate, which means that they will have to take more risk.

 

[rellison]

It doesn’t say they will have to take more risk though; it says their tolerance for risk goes up. Meaning, because they were forced to work work work to preserve real value of assets in the face of rising inflation, they overcompensated with their work ethic (?) and so now their real returns are such that they can kick back and relax or take more risk.
Is that an accurate summary of their explanation?

 

[AlmostDoneIII]

Endowments and foundations try to preserve assets (including inflation match) unless specified. So with that in mind I understand it as inflation goes up your nominal return goes up (the foundations return target). So if that’s increasing they “think/percieve” the risk is going up to achieve these returns. So now the endowments think well shizzle I want more real return. Now because they want real return to go up their risk tolerance has to go up.
All because of a inflation triggering this “percieved” increase in risk.