Pooled and segregated investing for charities
Let's first consider the characteristics of pooled and segregated funds. A pooled fund gathers the assets of a number of investors in a single collective investment scheme, which is invested in accordance with a given set of objectives. The assets are held by the fund, and the investor owns shares (or units) in that fund of a value equivalent to the size of its investment.
Pooled funds are referred to by different names, the precise name depending on the legal structure of the fund and its ability to accept new entrants. All such schemes offer the benefit of diversification to investors, irrespective of the amount invested. As pooled funds combine a number of clients’ assets, a smaller investment is required to achieve diversification of assets than is the case with a segregated fund.
In a segregated fund, also known as a "separately managed account", the assets of an investor are managed separately in a distinct account. Segregated funds are tailored and adapted to particular client requirements, for example to reflect the avoidance of investment in particular sectors or stocks. A pooled fund must adhere to its objectives and defined parameters, and does not reflect any specific client preferences.
In reality, an investor’s portfolio may well combine elements of both pooled and segregated approaches. An investment manager may, for example, hold units in pooled funds for a charity which, on a direct basis, has insufficient resources to achieve appropriate diversification in particular asset classes through direct holdings.
Such asset classes might include emerging market equities, commercial property and "alternatives". A manager may hold such pooled fund interests alongside a number of direct equities and bonds. Of course, it should be emphasised that whether a charity uses a pooled or segregated approach, the value of its investments can fall as well as rise, and it may get back less than it originally invested.
Choices for charities
In determining which arrangement is in its best interests, a charity should pursue an approach that concurs with its investment objectives most effectively. In this context, it is worth noting that a growing variety of pooled funds is available to meet a broad range of charity-investor objectives, including those focused on income generation, ethical investing, and absolute-return investing.
From a diversification perspective, the level at which one might consider a segregated rather than pooled approach can be debated. Nonetheless, there may be good reasons to take one or other approach, and a pooled approach may be appropriate even for much larger investments. These reasons include the benefit of locking into an investment manager’s flagship strategies, which, in contrast with segregated funds, will tend to have investment adviser ratings and a publicly available track record.
Other important benefits include economies of scale (cost), custody charges, and ease of administration, including fewer contract notes and corporate actions, and simplified dividend payments.
On a related point, when putting new money into a portfolio, or making a capital withdrawal from it, it is easier to do so when holding a pooled fund: it simply entails buying or selling units in one transaction.
By contrast, a segregated fund investor would most probably want to sell part, or add to most, of the individual holdings in a portfolio in such circumstances, in order to preserve the structure of the portfolio. This would clearly involve multiple transactions, and, when selling, also bring the added burden of having to account for numerous realised gains and losses.
Ethical and SRI considerations
Where charities want ethical or socially responsible investing (SRI), responsible investment should be a key element of the investment manager's philosophy and process, and environmental, social and governance (ESG) issues should be thoroughly researched. All stocks on its research recommended list should be scored according to ESG factors.
I believe companies which identify and manage challenges related to corporate governance and social responsibility effectively are often stronger companies which are well placed to meet investors’ long term financial objectives.
Responsible investment should be integral to the analysis of investment opportunities. Ideally a dedicated responsible investment team should exercise voting rights, conduct research and engage with companies on ESG matters in conjunction with our other analysts. In this context, all portfolios (whether segregated or pooled) can be invested "responsibly".
Many charities have an ethical policy, and the precise nature of such policies differs from one charity to another. In general, pooled funds are less flexible in being able to meet investors’ ethical criteria than segregated funds, which can be managed to reflect the precise ethical concerns of the individual charity. However, it is possible to invest in pooled funds which have responsible and ethical investment incorporated in their objectives.
Screening for criteria
These SRI funds seek to meet the responsible and ethical investing requirements of many charities by screening the investment universe for negative and positive criteria. There are different ways of doing this, but a good approach is to exclude companies which have exposure (at a certain level) to one (or more) of the following activities: tobacco production and sale; alcohol production and sale; gambling; pornography; animal testing for non-medical purposes; abortion; armaments.
Then one can go on to exclude companies in relation to which there are significant concerns about the following: environmental issues; human rights. Also, for instance, one can also exclude companies which have broken the international code on marketing breast milk substitutes in the developing world.
Inclusions (positive criteria) can include companies which promote sustainability through: corporate governance; equal opportunities; environmental issues; human rights; community involvement; positive products and services (which could include water scarcity solutions, climate change solutions, waste solutions, environmental solutions, and safety equipment.
Other SRI considerations
EASE OF SELECTION AND MONITORING. A segregated approach allows investors to set, and maintain close control of, portfolio specifications, and to make adjustments based on changing circumstances. Segregated arrangements require a greater degree of involvement from trustees in establishing and maintaining investment guidelines.
This involvement may be welcomed by trustees who wish to keep more direct control, and who have the requisite time and experience to do so. Segregated investment management generally gives rise to a higher volume of paperwork, and to more onerous auditing requirements than pooled investing.
Pooled funds, by contrast, have their investment guidelines described in a prospectus or a trust deed, as well as in related marketing material. The depth of publicly available information about their performance and composition, as well as the typical clarity of their investment objectives, may simplify the due diligence involved in selecting a manager and initiating investment. In terms of establishing and monitoring their investment arrangements, trustees should naturally seek to ensure that the level of guidance they obtain is appropriate to their requirements.
REPORTING. It is often assumed that pooled and segregated clients receive different levels of reporting information. This should certainly not the case. There should be the same level of reporting to both pooled and segregated clients. Ideally this should consist of a comprehensive overview of fund, sector and stock performance, in addition to commentaries on the prevailing market backdrop. There is also considerable information on many investment managers' websites in the sections or zones for clients.
Investment management fees
COSTS. Fees for investment management services vary according to a number of factors, including the investment objective and the size of a portfolio. For a given size of investment, fees tend to be lower for a pooled fund investment than a segregated portfolio.
In addition, VAT is not applied to the management fees of most pooled funds, including Non-UCITS Retail Schemes (NURSs) but excluding Common Investment Funds. For segregated client accounts, fees are calculated on an individual basis. Unlike most pooled funds, management fees for segregated mandates are subject to VAT.
I believe that investment returns in the years ahead are likely to be lower (and more volatile) than those to which investors grew accustomed during the last two decades of the 20th century. Assuming this is correct, the impact of management fees and other charges on overall investment performance will be proportionately more significant.
The total expense ratio (a measure of the total cost of a fund to an investor) on a pooled fund tends to be very visible, but costs can be more opaque in relation to a segregated portfolio, notwithstanding the requirements of investment managers to ensure that, in treating their clients fairly, they are transparent about the costs of their services.
There should be transparency of all fee charges for both pooled and segregated funds. Investors should be particularly cautious about the lack of transparency and "double charging" which can characterise multi-manager arrangements, in which a notionally segregated approach (for which the investor pays a fee) entails the holding of a range of pooled funds, which levy additional fees.
Fulfilment of investors' objectives
Pooled and segregated investment approaches have some distinct features, but they also share some characteristics. Both are intended, ultimately, to enable the fulfilment of investors’ objectives.
In pursuing one method over the other, a charity should seek to ensure that its chosen approach is appropriate for the task of trying to meet its investment objectives. Insofar as the charity has an ethical investment policy, it should ensure that the solution it chooses is equipped to meet the demands of that policy.
Some charities will, by virtue of their limited resources, achieve diversification benefits via a pooled approach that they would struggle to replicate in a segregated mandate. Even for larger charities, however, pooled investing may offer an administratively simple and cost effective way to harness the flagship, adviser-rated strategies of their chosen investment manager.
