Having confidence in your investment manager

After the recovery in markets since the credit crisis in 2008, charities might be forgiven for feeling calmer now that their investment portfolios have probably risen in value and are generating good income.  Nevertheless, stressful or unexpected events often cause charities to give more focus to their third party relationships.  Investment managers may have also revised their investment processes in light of changing economic conditions and hopefully have improved their relationships with the charities they look after. 

Managing client expectations with transparency and honesty, offering good customer service - these generally maintain goodwill during volatile times.  However, when the going gets rough, are trustees really prepared to hold their nerve and stick with their manager if the roof falls in, and if so, for how long?

On the whole, charities are a forgiving lot.  After all, they are benevolent by nature and forgiving of others difficulties.  This is acceptable to a point, but when they are paying for a service from a professional organisation, being charitable doesn’t apply.  The trustees' dilemma is that they have a duty of care to maximise the returns of the charity within a given level of risk, while at the same time ensuring the assets that they entrust to an investment manager are secure and properly looked after. 

Monitoring the investments

Trustees need to monitor the investments and the manager to ensure that both are performing in line with stated expectations.  On a periodic basis, charities should review the broader range of investment managers as part of their duty.  This should address changes to investment styles available or the financial circumstances of the charity, and to ensure that the charity is getting best value for money.

As anyone who has been through the process of appointing an investment manager will know, it is a laborious process if done correctly.  Trustees should first identify what they want to achieve from their investments and articulate this in an Investment Policy Statement.  They should consider any restrictions, needs for current income, any ethical or social investment. 

They should also consider the level of service from their prospective investment manager.  This could range from a fully discretionary relationship where the manager offers investment advice and has the power to invest within agreed guidelines, through to an advisory service where the investment manager acts on the instructions of the trustee.  A charity also has the option to make its own investments by directly purchasing investment funds, such as a Common Investment Fund.

The general rule is that if trustees do not have someone on their board or within the charity who has investment expertise, they should obtain independent advice and outsource the investments to an organisation that is regulated to carry out this function.  An increasing number of charities have someone with investment experience on their board, or co-opted in to offer assistance on asset management on a pro-bono basis.  This is useful as it could save the charity time and money in gaining investment advice and market developments, provided they are independent of the manager.

So what should be done if an investment manager consistently underperforms or fails to uphold the service to the charity that was understood and agreed at the outset?  Usually a clear and frank discussion with the incumbent manager at a regular review meeting should address any issues. 

Analysis of underperformance

Analysis of why their investments are underperforming a pre-agreed benchmark should take place.  Is it the investment philosophy of the manager that is out of favour?  This was the case in the late 1990s when high growth technology shares were very popular during the infamous dotcom boom.  If your investment manager was investing in undervalued stocks, it was likely that they missed out on the boom in technology companies whose shares were very highly valued. 

This issue continued for a number of years until the tech bubble burst in March 2000.  Such investment bubbles have occurred a number of times over time, from the Dutch Tulip bubble in the 1630s, the South Sea bubble of 1711 in the UK, through to the Wall Street crash in 1929 and finally the real estate bubble in the US that led to the credit crisis in 2008.

The instinct of a charity at this stage is to sell or sack the manager at the point of panic or a period of underperformance and reinvest with those who have recently done well.  Ironically, this is usually the wrong time to jump ship as often managers, investment styles or certain assets, like smaller companies or commodities, outperform their peers following a period of weakness.  This is largely due to the cyclical nature of economies and investment markets.

Charities which are making a commitment to financial investment, by default taking risk with the capital value of their assets, should give themselves and their manager a reasonable period of time to achieve their aspirations.  There is no given time period, but it is normal to expect a full economic cycle for the reasons previously given.  Provided the investment objectives are clearly articulated at the outset, the expectations should be understood by both parties.  Periodic statements about the investment, meetings with trustees and regular market updates will assist with this.

Other underlying issues

Performance is only one dimension of a charity’s investment manager review.  The question should always be, what is causing the underperformance and what is the manager doing to resolve it?  The answers often lead to other issues affecting the firm or management of the investments.  The following factors will typically affect the overall relationship and should be watched out for by charities:

  • The change of ownership of the investment manager.
  • A change or turnover of staff.
  • A change in investment style or taking undue risks with investments to improve performance.
  • A change of emphasis towards charity business or downgrade of service.
  • Any fines for misconduct from the regulator.

Any of these issues should prompt a charity to raise a red flag, with the manager being put on watch for usually six to twelve months. These changes are not normally conducted in accordance with the best interests of the manager's charity clients, but in many cases, a significant change may not have a detrimental impact on the charity in the short term.

There has been a considerable amount of change in the charity investment management sector over recent years with firms merging or being sold, key people moving jobs and certain firms all but withdrawing from offering charities investment advice or discretionary services.  The latter has largely occurred as a result of changes in regulation as part of the Retail Distribution Review in 2013, which dictates how investment firms must treat retail customers – as most charities are classified. 

There is now a higher burden of responsibility on regulated firms to treat their clients fairly and ensure they have advised them suitably.  This means they must have carried out sufficient due diligence on the charity’s requirement for risk and return.  While these changes have been brought about to prevent customer dissatisfaction, financial failure and fraud, a number of larger firms have withdrawn from offering investment advice to all but a few very large charities.

Taking all these issues into consideration, it is important to monitor the investment manager on a continuous basis.  Unless the charity has expertise on board, it is not easy to spot changes or developments especially when trustees may have more pressing financial issues to deal with.  If appropriate, it is sometimes wise to establish an investment sub-committee which may have delegated powers to give the investments of the charity a proper review.  Alternatively, it may be worth employing an investment consultant to offer independent advice about the charity investment market, which might lead to a full review.

Whatever the circumstances, trustees must from time to time review the investments as part of their duty of care.  This might not result in a change in the manager, but it is good governance to meet the investment manager annually to review the suitability of investment as the circumstances of the charity or manager can change.  A formal review of the manger in relation to other investments available to the charity should be undertaken every three to five years.  While there are a number of established charity investment management firms which are well known in the sector, trustees should cast their net wider and look at different managers offering a fresh approach.

Change of investments

It has to be appreciated that the time, cost and effort to change investment managers can be quite significant.  All trustees are under considerable regulatory pressure to ensure they have sufficient information about the manager's capability to offer suitable advice, not to mention the usual security checks.  Notwithstanding the issues raised in this article, ongoing reviews of investment are very important but a change of investments should only take place if there has been either a significant change of circumstances, the investments or manager are not meeting expectations, or there is a better alternative that meets the needs of the charity.


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