Investment and the governance and ethical dimensions

Charity governance rules are set out in a myriad of statutes and regulations, from the Charities Acts 2011 and 2016, to the Charity Commission guidance (CC14) Charities and Investment matters.

Whilst all set out what trustees must do, they say little on how good governance with respect to investment policy can be implemented on a practical basis. What constitutes “regularly” for example or what are the appropriate questions trustees should be asking?

From a governance perspective trustees need to realise that they have to act in good faith and ensure that they are properly briefed on how their investments are managed, how they are performing and how risks are being controlled. Having an investment committee or trustee responsible for investment does not absolve the rest of the trustee board of responsibility.

CC14 is clear on the requirement for trustees to set the charity’s objectives and decide what to invest in, as well as the need to incorporate this in a formal investment policy. However, arriving at these decisions will take some consideration and a degree of information gathering.

Return is only one component of this decision. risk, volatility and cost will also be considerations, as will maintaining the charity’s position on all matters relating to any ethical investment restrictions, or environmental, social and governance (ESG) requirements . All of this should be captured in your investment policy.

No official restrictions

Interestingly, despite a growing range of restrictions and ESG considerations, there is actually no formal requirement, in the Charity Commission guidance CC14, to have any restrictions at all.

Conversely, trustees are required to implement, maintain and review an investment policy. Trustees need to ensure it is “regularly” reviewed and is still fit for purpose. The trustees’ clear duty is effective stewardship of their reserves, so good governance requires close monitoring of the requirements set out in the investment policy.

At the very least, monitoring means both meeting with your investment manager(s) at least twice a year but also a regular, I would suggest annual, attendance at any events they run to communicate strategy. This will provide broader understanding as to who is running your money, not simply the decisions that take place at your investment reviews.

You are expected as part of good governance to “manage your manager” effectively. This means proactively contacting your investment manager during periods of uncertainty to establish exactly what the impact is on your charity’s investments. Waiting for them to call you is not the right approach. It is not just the value of the investments at risk, but it could be the charity’s reputation as well.

Regular reviewing in practice

“Regularly” reviewing your investment policy should mean looking at it annually and reviewing performance, barring any interim prolonged poor performance, every five years. The crucial point being one should also include these important requirements in the investment policy so trustees are committed to being active in discharging their duties and ensuring that the charity’s goals are met.

Your investment policy is the place to set out your requirements and how they will be measured and over what period. Your target should be your investment manager’s target and vice versa.

The ability to protect your charity’s reserves from the ravages of inflation is an increasingly popular and relevant investment target. If you want “Inflation Plus 3%” for example, that is how your portfolio should be managed and the investment selection within the portfolio should reflect this. Therefore, unless it is your goal to beat a certain benchmark, index or peer group these should not be included in your investment policy.

However, complying with CC14 is not the end of the matter. In a recent speech on the “Future of Charities: Why doing good is not enough”, Baroness Stowell, the new chair of the Charity Commission, reminded charity trustees that charities’ current privileged treatment depends, to an extent, on public trust.

An important element of this trust is that the public expect charities to behave like charities, and not like corporations. This means they expect consistent ethical behaviour and maintained high standards. If charities fail to meet those expectations, people may question why particular charities deserve their charitable status and the tax exemptions they enjoy.

Leading nicely onto governance, this must include trustees taking into account their charity’s fundamental principles and mission, and whether these need to be incorporated into their investment policy.

Starting point with principles

The starting point is setting out what principles or ethics the trustees want to incorporate into their policy and as such, underlying investments. Any decision on this must be taken in the best interests of the charity and not as a reflection of any personal views.

Any ethical investment restrictions, or ESG (environmental, social and governance) requirements should be a clear read across from the charity’s mission and purpose. Trustees can incorporate these sorts of requirements into their investment policy if they have reasonable grounds for believing that not having the certain constraints or requirements may alienate donors. As indeed would investments which are counter to the principle purpose of the charity.

The next step is that an ethical and or ESG requirement needs to be incorporated into the charity’s investment policy. This is for two reasons: firstly, it provides a criterion for reviewing the content of the investment portfolio, and secondly it also provides a prompt to trustees of what they agreed their key ethical principles to be.

Incorporating specific requirements

There are several ways in which a charity can incorporate specific requirements into their investment policy. The most common are:

EXCLUSION. An approach to exclude specific industries or companies, often known as negative screening. Tobacco is the most popular exclusion and a more contemporary exclusion is to “divest” from carbon based energy industries.

SELECTION. This involves having a policy aimed at selecting companies or themes which align with a charity’s aims or wider social goals, or which rate well in terms of environmental, social and governance (ESG) factors.

ENGAGEMENT. An approach to influence companies’ behaviour by engagement and/or using share voting rights to influence company policy in line with best practice.

MIXED MOTIVE. Some charities have decided to use their assets to deliver tangible outcomes that directly contribute to a charity’s mission while at the same time achieving a financial return through social investment. This is also referred to as impact investing and can sometimes be complex.

Ultimately, trustees need to decide the level of their investment policy’s ethical commitment. Some insist on a criteria being met only by their direct investments whilst others want to look through any investment vehicles and have their policy implemented at all levels.

Trustees of charities, which have looked to exclude investments in areas in conflict with their mission, have excluded direct investment in sectors such as tobacco, armaments, alcohol, pornography, gambling and birth control among others.

However, trustees are also increasingly looking to take into account factors such as the way the companies they invest in manage issues such as climate change, equal of opportunity, race, gender, sustainability, human rights, community impact, executive compensation and board accountability.

Using an investment code

Some frame their ethical policy as support for a code of investing. This can range from those recommended by the Church of England’s Ethical Advisory Group to the United Nations Principles for Responsible Investment (UNPRI).

Whatever trustees decide, they need to have this discussion. If they decide to implement restrictions, they also have to be clear that once they have set such criteria they need to take responsibility for ensuring their restrictions are complied with and they can still meet their investment target.

This means not only ensuring their investment manager takes the necessary action to ensure compliance with their instructions, but also that he/she has the necessary systems in place to monitor the portfolio and ensure ongoing compliance. This doesn’t absolve trustees of the need to continue asking sensible questions about the portfolio themselves. This is a process of continuous engagement and monitoring to ensure their policy is being complied with.

As described, some trustees may want to implement ESG constraints in the underlying funds. This can be difficult when investments are often made via fund structures such as OEICS or other aggregated vehicles.

Trustees should feel happy questioning the investment manager’s knowledge of the underlying investments, and ascertain how frequently that knowledge is updated. Ensuring there are sufficient levels of transparency should at the very least give trustees and their advisers an early warning of any difficulties complying with any restrictions, and allow any which do arise to be resolved quickly and effectively.

Dialogue with investment managers

Maintaining clear and regular dialogue is especially important in picking up any issues such as a breach of the investment policy. Breaching ethical restrictions not only goes against the trustees’ investment policy, it can cause a reputational issue and have an impact on donor support. Charity supporters will expect the charities they support to practice what they preach. Therefore, trustees will need to demonstrate they have taken appropriate action and are suitably contrite when issues arise. This is true of all the requirements and targets in an investment policy.

Finally, the fact that there is not a current problem with an investment portfolio does not mean it does not need looking at or that trustees don’t need to ask searching questions of their investment manager. Market crashes are events that test investment skills and they are rarely announced in advance. How your investment manager protects your assets in a downturn is as important as how they grow them - and assessing them in good markets in an important way for trustees to ensure their portfolio is fit for purpose should markets become volatile.

So what does good governance look like? In the end, eternal vigilance is the defining characteristic of a successful trustee body and a fundamental element in ensuring good governance. Incorporating the right behaviours of monitoring and engagement into your trustee body and into its investment policy is vital. This is because good governance does not just consist of complying with the law and CC14; it requires trustees to be proactive.

Trustees not only need to review their investment policy regularly but also need to manage their investment managers to achieve the right results. This means questioning and understanding what their investment manager is doing and ensuring that their investment policy is complied with.

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