Pursuing a responsible investment policy
Responsible investments have been surging over the past couple of years, with 22% of investors saying that all or most of their portfolio incorporates ESG (environmental, social and governance) according to the ESG Global Survey 2021.
However, at a time when many charities are still recouping losses following two years affected by the Covid-19 pandemic, it is important for trustees to find the delicate balance between caution and bold risk-taking, to try and ensure that investments are in the right place at the right time.
As a result, now is an even more crucial time for trustees to ensure that their charities’ best interests are safeguarded and the funds they invest are in responsible businesses.
Responsible investments
Everyone has their own definition of what they consider to be ethical and responsible meaning that there is no hard and fast rule when you are applying these to a decision about investing. But, with millions of investors beginning to consider the responsible impact of a business, it is important for trustees to look at how they can ensure that the investment means more than just a monetary return.
One way charities can do this is by having a screening process in place – either negative or positive. This ensures that the companies the charities are investing in are not harming the people they are wanting to protect and look after.
The negative screening process can be direct and identify businesses the charity should not have contact with. For example, a charity which focuses on health issues may not want to invest in a company that profits from tobacco, or a charity which focuses on the environment may not want to invest in a fossil fuel company.
Meanwhile, positive screening can be put in place to find companies that match the impact and goals of the charity. This type of screening is likely to become more prevalent due to the increasing importance being put on ESG criteria (environmental, social and governance).
For example, fund managers and their clients are wanting to know a lot more about the individual companies they’re investing in, in terms of their green credentials, what are they doing to cut their carbon footprint, how are they becoming energy efficient, and how they treat their staff.
A lot of investors now factor ESG into their portfolio choices and pick companies with better ESG credentials over companies with lower ones, regardless of the profit that business makes.
The UK and Europe are leading the way in terms of ESG investment and regulation with several new forms of legislation having been recently introduced such as The European Union’s Sustainable Finance Disclosure Regulation (SFDR), EU Taxonomy, and UK Sustainability Disclosure Requirements (SDR). These all ask important questions of investors that help to identify whether they are making responsible investment decisions.
This can also be seen in the UK High Court, which clarified the law on responsible investing by charity trustees. The judgment of Butler-Sloss & Others v Charity Commission in late April 2022 outlined that trustees may decide to exclude investments which conflict with the charity’s objectives – provided that they have taken relevant factors into account, for example, the seriousness of potential conflict as against the risk of financial detriment, and frame their investment policy accordingly.
Although the aim of ESG is to make companies be more socially conscious, as it makes businesses and individuals more aware of the impact they’re having and how they can reduce their impact, there are also some concerns.
For example, the impact of Russia’s invasion of Ukraine is forcing companies and investors to wrestle the E, the S and the G against each other. Governments in Europe are now having to go back on their environmental pledges by turning back to fossil fuels in order to reduce dependence on Russian gas and fulfil ethical goals.
As well as this, the British defence minister Ben Wallace has recently encouraged the UK to continue to increase investment on defence in order “to tackle threats not only from Russia, but from China and other countries”, posing new considerations for ESG investors.
Comprehensive policy statement
So for charity investors are now beginning to think about the impact of their investments for the first time, with ESG for example, many are realising it is not at all straightforward.
The most effective way for charities to ensure they are investing responsibly is to set out a comprehensive investment policy statement that sets out the parameters for how the trustees can invest, what they are prepared to invest in and why, and provides a clear strategy that the trustees can follow. Ultimately, it is there to help charities make responsible investments and to try and protect them from making poorer financial decisions.
An investment policy statement can also help ensure that charities remain compliant during the investment process, as well as following the Charity Commission Guidance. Chapter four of the guidance focuses on holding, moving and receiving funds safely in the UK and internationally, and provides advice to trustees about what elements they need to consider if they are to remain compliant.
Trustees should stick to the principles of the Charity Commission’s Guidance, as well as its investment policy statement, in order to protect themselves against accusations of not being compliant. If the guidance and policies are adhered to, there will be evidence and processes in place that can be shown to prove that any accusations are incorrect.
Think long term but be reactive
With an investment policy statement, there is a clear plan in place for the charity’s investments, but there are many potential difficulties that could arise which are hard to factor into policies.
There are different types of risks for charities such as capital, inflation and interest rate risks. Therefore, it is important for charities to understand the different types of risk and what this means, as well as consider what level of risk they are willing to take in order to be reactive in investments.
Charities can put parameters in place to identify what they’d be willing to accept and what would be too much in terms of risk taking. It is crucial for them to try and stay within these parameters and have a structure in place, such as the investment policy statement, so that, if it doesn’t go according to plan, the charities can say that these parameters were set but at the current time and in the current set of conditions it was nearly impossible for them to be met.
The secret when these risks do appear is to remain calm and not panic. It is important to have a long term strategy in place and to also be able to react tactically to what is happening in the short term. For example, with inflation and interest rates rising, trustees have to be aware of what is going on and adjust accordingly.
The actual real value of charities’ funds are being eroded due to the fact that the cost of living is going up faster than the return being generated so, although the capital is safe, it’s not actually protecting investment against the rises in costs of living.
If charities are trying to protect against inflation and get higher growth on their money, then obviously they can consider taking the route of investing money into the stock market as so many now do. But this can then risk the capital due to the volatile nature of markets. For long term investments, charities might be best to protect capital by at least leaving some money in an interest paying bank account, particularly as interest rates appear to be on an upward path..
Having a diversified portfolio can also protect investment when risks are in place, such as when the economy or a sector isn’t doing well, and can be a vital way for charities to ensure they maximise return.
Ultimately, there is no right or wrong way for charities to best manage funds and protect their money during uncertain times as each has its own unique set of circumstances. A lot of risks to charities are short term, so it is more important for charities to understand and document why investments are performing in certain ways during periods of economic stress than it is to drastically deviate away from the investment policy statement.
The future
There are numerous factors that charities and trustees have to consider when they invest, including remaining compliant, factoring in risks, and how to get the biggest return on investment, but this has now become a wider thought process certainly as regards ESG.
ESG might come with its own ethical conundrums, as seen with Russia’s invasion of Ukraine and the investment in defence and fossil fuels. However, ultimately, it is important for charities to try and invest in companies which follow the ESG approach, and which have the same ethical approach as the charity in order to conduct responsible investments.
