Investment issues being considered by charity trustees
After a strong performance in investment markets in 2013, charities are witnessing a more muted appreciation in their share portfolios in 2014 as the world digests mixed economic data from the US and China, and ongoing geo-political unrest notably in the Ukraine. Having ridden a generally positive market since the credit crisis in 2008, trustees have held their nerve and while there may have been a renewed focus on investments, there has not been a wholesale shift in attitudes towards risk and return.
One of the issues I face as a trustee of a number of charities is the ongoing appropriateness of their investment portfolios. Psychologically, my attitude to risk differs between the money I advise for charities and the small amount of investments within my own SIPP (self-invested personal pension). This may not be surprising given the different timescales for investment, but as the Trustee Act states under the General Power of Investment, “a trustee may make any kind of investment that he could make if he were absolutely entitled to the assets of the trust".
I therefore speak to others within the charity investment market and trustees who have an investment interest to gauge the current issues that are of concern.
Sometimes brief attention for investments
The reality of charity governance dictates that when trustees meet, general strategy, grant making, staffing issues, etc. are higher on their agenda. Investments are often the last item to be discussed and any difficult decisions are sometimes deferred to the next meeting.
As an investment manager, I sometimes find that trustees give a brief attention to their investments and unless there is a finance or investment subcommittee, there are a limited number of people who have sufficient interest in their funds to have a meaningful conversation in the brief time allotted to it at trustee meetings.
Conversely, certain charities are so obsessed by their investments they watch daily volatility of markets and are not afraid to berate their investment manager as soon as performance strays below expectations.
So what are the current issues that are discussed by charity trustees? They typically heighten as a result of market corrections, when the capital value of the charity’s portfolio takes a unexpected fall. Changes in the corporate structure of the investment manager, such as a merger or acquisition, will prompt trustees to consider their investments. Furthermore, if their nominated investment manager moves to a new fund management firm, it could cause a formal review.
A reduction in service, poor relative investment performance or a significant change in the charity’s finances will also provoke discussion and certainly comment. Against the background of good investment returns in recent years, I have not seen a significant increase in the formal review of investments or adverse comments about their investments by charities. This doesn’t necessarily mean that all is well, and indeed a period of status quo may be tested if current dull market returns continue for a prolonged period.
Issues which do crop up
There are a number of issues that trustees are discussing when considering their respective investments and will frequently crop up irrespective of whether they are considering an investment review.
In no particular order these are:
PERFORMANCE. this is always a subjective point as comparing past performance is not a reliable indicator of future performance. As a general rule, investments that demonstrate very strong returns in rising markets are likely to fall further than average in a downturn.
When comparing one manager against another, it is important to ensure that the underlying investments or mandate are similar in order to achieve a fair comparison. It is also important to know if the performance quoted is before or after fees have been deducted, as the cumulative effect of fees can be quite marked over a longer time period.
INVESTMENT APPROACH. There have been a number of in-vogue investment approaches designed to get better returns in varying market conditions, with varying results. The attraction of absolute returns has diminished as hedge fund returns have been anaemic at best, considering the higher fees. Target return and inflation based investing, where the investment is not necessarily linked to a particular asset class or market, still remains popular.
An extension of this is the concept of global multi-asset investing. This entails, as the term suggests, having a global investment strategy incorporating different asset classes from equity, bonds, property and other alternative assets. Whatever the process, one trend charity trustees have accepted is the greater diversification in portfolios and higher exposure to overseas markets.
STOCK PICKING VERSUS POOLED FUNDS. There are no hard and fast rules about the alternative approaches but they do polarise opinion between the traditionalists who value the ability to pick one company over another to gain extra returns and those who are happy to use a pooled fund.
A generally recognised and academically proven aspect of investment is that asset allocation - the amount you invest into shares, bonds, cash, etc. - is the most important investment decision and derives most of a portfolio’s return.
How you implement the asset allocation decision comes down to investing directly into shares or using a pooled investment, such as managed fund or a tracking fund. Costs will have an impact on this decision, but if you can find an investment manager who can outperform through good stock selection, this might be worth paying for.
COSTS NEED TO BE TAKEN INTO ACCOUNT. Care needs to be taken regarding costs as investment managers are notorious for quoting an annual management charge but perhaps not all the underlying costs borne by the charity. The concept of the Total Expense Ratio (TER), which has been superseded by the Ongoing Charges Figure (OCF) should outline all costs of the investment, including: administration, custody, client service, investment management, any underlying fund management charges, and dealing commission.
Common sense on costs
The OCF is aimed to ensure that under current regulations, investors are treated fairly. Common sense should prevail on costs and careful analysis needs to be taken to ensure whatever cost is being quoted is true and fair. If it looks expensive, make sure you are getting value for money. If it looks cheap, it normally is for a reason!
INVESTMENT ADVICE. Offering advice to trustees on the suitability of their investments or in setting an appropriate investment strategy is becoming less common. A number of larger fund management groups have pulled away from offering this service to all but the very large charities which they manage investments for. Other managers can offer advice but it is restricted to the investments that they offer.
If the charity doesn’t have a qualified trustee or co-opted investment professional advising it on a pro bono basis, it might consider employing the services of a financial adviser at an extra cost.
STABILITY AND SECURITY. It is a fairly common factor that trustees will follow a path of least resistance when making difficult choices. This is certainly the case when it comes to selecting investment managers. If you study the league table of charity investment managers over the last 10 years by assets under management, it is not surprising to see the same names crop up year after year.
Trustees will never be criticised for selecting a firm which offers safety and stability. It is however a shame that smaller investment management firms which offer different approaches and high levels of client service are not included in reviews more often. Selecting a well known brand name makes sense from a point of safety but it might not prove to be the best outcome for investment performance and ongoing service.
RISK. This comes in a number of different guises from investment volatility, security of the assets, counter-party risk, the risk that the capital value will not keep in pace with inflation or liquidity risk should a charity want funds on a short term basis. There are a number of other risks charities could consider, but poor risk management will likely cause trustees sleepless nights.
Realistic expectations about returns
A large element in managing investments is to set realistic expectations. If trustees want annual returns of 10% or more, they will have to accept a considerable amount of risk that the investments may not achieve this rate and they will have to take on high risk to get there. Problems often occur if the respective risk factors are not clearly articulated at the outset and understood, especially if the charity is delegating investment management to a third party.
INCOME. Although most charities can now invest for a total return (a mixture of capital and income), charities generally still like to receive a relative amount of distributed income, by way of share dividends, bond interest or rents on property. In recent years, we have witnessed a period of low interest rates and the hunt for safe and sustainable income has been an issue on the minds of trustees, who are looking for money to gift to their objects or fund their charity's activities while not wanting to dip into the capital.
ETHICAL/SOCIALLY RESPONSIBLE/MISSION RELATED INVESTMENT. Following the revision of the Charity Commission’s guidance on investment, CC14, the focus on more ethical investment has been heightened. It states that trustees of any charity can decide to invest ethically, even if the investment might provide a lower rate of return than an alternative investment.
While adopting an ethical investment policy may not cause an investment review, more charities than ever are considering an appropriate ethical stance and the recent investigation by the BBC Panorama programme on the investments of Comic Relief highlights how charities need to give the issue serious consideration. While the market for specific mission related investments has not developed greatly beyond Social Investment Bonds, trustees will be giving this area more attention when they review an appropriate investment policy for their charity.
LOCALITY. An interesting factor for charities outside the main financial centres is a tendency to employ a local investment manager. This might be a larger national firm, with a local office, but the advantage of having a local presence to the charity is a distinct advantage for some trustees.
Issues may start to reappear now
The recovery in markets since the credit crisis in 2008 has calmed the of minds of trustees and in the good years such as 2013, with returns averaging 15% for mixed asset charity portfolios, the issues raised above tend to subside or are deferred for a while. Investment returns for the current year are not so great at around 2%. If things continue at this pace for the foreseeable future, added to a reasonable bout of investment manager changes over the last 12 months, trustees will start to give greater attention to their investments, as they have a duty to do.
