Reviewing the reserves and investments of a charity
Charities which are in the fortunate position of owning long term reserves need to ensure that the assets in which the reserve is invested in are appropriately looked after. This aspect of governance is important to meet the current and future objectives of the charity. Trustees have a "duty of care" to ensure that the reserve is maintained in an appropriate manner. The purpose of this article is to highlight the key issues trustees need to consider when reviewing these assets as part of good governance.
Trustees have a "general power of investment" which ensures that charities have the power to invest the reserves in any kind of investment, subject to a number of restrictions within the Trustee Act 2000. The Act enshrines in law the powers trustees have when making investments on behalf of a charity and the need for good governance.
The governance imposed upon trustees covers a number of areas, specifically the power of investment, acquisition of land, the need to seek proper advice and the need to review any arrangements they put in place.
If we split down the key terms of the Act, it is easier for trustees to interpret what is expected from them to ensure good governance.
Reasonable in the circumstances
DUTY OF CARE. A trustee must exercise such care and skill as is reasonable in the circumstances. This means that a trustee is expected to use any particular specialist knowledge or experience they may have. Furthermore, if a trustee has specific skills in the course of their business or profession, e.g. a qualified investment manager, they will be expected to exercise a greater than normal degree of care over the charity’s assets.
GENERAL POWER OF INVESTMENT. The wording of the Act states: "a trustee may make any kind of investment that he could make if he was absolutely entitled to the assets of the trust". This replaces the Trustee Investment Act 1961 which obliged trustees to follow a very conservative investment policy.
The current broader investment powers allow trustees to invest in a wide ranging array of investment opportunities that they think are appropriate for the charity to meet its objectives. Further direction on this is given by the Charity Commission in their guidance note "Charities and investment matters: a guide for trustees (CC14)", available on the Commission’s website.
STANDARD INVESTMENT CRITERIA. Trustees need to ensure that the investments chosen for the charity are suitable, having exercised their power of investment. The Act does not define what is suitable but trustees have an overriding duty to invest in the financial interests of the beneficiaries of the charity.
There is also a need to diversify the investments as far as appropriate to reduce specific risk of investing in an asset that could detrimentally affect the value of the reserves. Furthermore, under the standard investment criteria, trustees should review the investments "from time to time".
Obtaining proper advice
ADVICE. Before exercising any power of investment under the standard investment criteria, trustees should obtain and consider proper advice. This means trustees should seek advice from someone who is reasonably believed to be qualified to give and have practical experience of financial and other matters relating to the proposed investment. The only exception to this is if trustees believe it is unnecessary to gain advice due to the nature of the investment or they have sufficient expertise within the trustee board or staff to make investment decisions themselves.
If trustees follow this process when thinking of their investments, it will enable them to set a good review structure and ensure that the governance of the assets complies with the law. If a charity is setting out to invest for the first time, possibly as a result of a large donation, a legacy, or has built up excess capital in its general reserves, trustees will need to consider a number of factors.
SHORT TERM CASH. Charities will need to consider an appropriate level of short-term cash balances to maintain their day-to-day activities such as paying wages and other overheads or pay grants. There is a need for immediate liquidity and as a result money will normally be held in cash deposits with a bank.
MEDIUM TERM RESERVES. Trustees are advised to set aside sufficient amounts to cover any unexpected significant capital payments or other costs should their short term reserves and income diminish for whatever reason. Such money will often be held on fixed term, short to medium term deposits or liquid investments such as money market funds or short term bonds.
Growing the value of reserves
LONG TERM RESERVES. These are assets that are not necessarily needed for the foreseeable future but the income and some capital could be spent on current charitable grants. Grant making charities which are not raising new funds are likely to rely on these assets and they form the endowment of the charity. Unless otherwise stated, most long term reserves that are kept for the interests of current and future beneficiaries should grow in value at least in line with the rate of inflation.
Having assessed these practical steps, trustees of charities need to decide on how best to invest the long term assets at their disposal. The first step is to draft a written investment policy statement. The Charity Commission’s guidance on investment is clear that regardless of size, having a written policy is important for all charities with investment assets.
The policy should be reviewed by trustees on an annual basis to ensure it is current in relation to the charity’s overriding objectives. Further useful information on investment policy statements are found in CC14 and the Charity Investors Group website.
As previously highlighted, charity trustees should review their investments from time to time. While there is not a prescribed interval for any review, it is customary to monitor the performance of the investments on an ongoing basis to ensure that it is meeting expectations. Common practice is to formally review the investments and any adviser to which trustees have delegated the responsibility for investing every three to five years.
This allows for normal cycles of general economic activity to have an impact and gives the investment manager a chance to statistically prove their value.
Two options for investment
By adopting the duty of care, trustees have essentially two options for investment. If they think they have sufficient expertise within the trustees or staff, they can make direct investments into an appropriate range of diversified assets. Some charities co-opt an independent qualified and experienced investment adviser to oversee investments and inform trustees. The alternative and most common route is to delegate any advice on investments to a qualified investment manager.
It is perfectly acceptable and good governance to delegate investment to a third party. This is likely to be an investment manager who would typically advise on the most appropriate investment strategy and implement the agreed approach with discretion from the trustees. This is typically done with a "two-way" agreement which clearly outlines what powers, requirements and restrictions the investment manager has been given by the charity. The agreement should complement the charity’s investment policy statement.
Selecting an appropriate investment manager can be as complex as trustees feel necessary. Once the general investment strategy has been agreed, a review of suitable investment firms could be taken by comparing the following criteria, most of which is now found on relevant websites or in the trade press:
• Corporate structure
• Regulation details
• Investment strategy
• Past performance
• Fees and costs
• Charity expertise
• Ability to provide investment advice
• Policy on responsible investment
For larger and possibly more complex investment policies, trustees may wish to issue a questionnaire to a selected number of managers to compare on a like-for-like basis. Based on the responses, it is typical to invite a short list of preferred managers to be interviewed in a competitive beauty-parade. For larger charities, in order to get good diversification, they may choose more than one manager or select particular managers to invest into different asset classes, such as one for UK shares and another for bonds or property where they have specific expertise.
Documenting all decisions
In choosing a manager, trustees must not apply any prejudices and must document all decisions made in writing. This will enable them to demonstrate that they have considered the relevant issues, taken advice if appropriate and reached a reasonable decision. The chosen manager and resulting investment must not in any way have a negative impact on the charity's donors, its overall objective, the beneficiaries or its causes.
Given the time consuming process in deciding, selecting and reviewing a charity’s investments, charities may find it helpful to have a trustee with specialist knowledge of investments on its board.
An alternative might be to establish an internal investment committee or a sub-committee comprising of trustees, co-opted experts or employees to advise the trustee board on investment aspects. Trustees should set out clear terms of reference for any sub-committee, framing their decision making and means of reporting to the board.
If charities follow this process of investing their reserves, they will hopefully take good decisions for the short and long term interests of the organisation. Governance is very important to ensure that proper controls are in place and trustees are protected from unintended consequences in their duty of care to charities.
