After
a nerve-shredding few months, when at times it appeared that
the Western world’s whole financial system was set to
go into meltdown, could the worst of the credit crunch be
over? The Bank of England apparently believes the storm could
be passing; at the beginning of May it asserted that “market
conditions should improve as confidence returns and market
participants recognise that some assets look cheap”.
This relatively upbeat assessment will be mulled over by the
trustees of charity investment portfolios. Should they assume
that there is more bad news to come and a defensive stance
is the best policy to adopt? Or is this unnecessarily cutting
back on potential returns if, indeed, the worst is behind
us?
“Charities are asking whether the market has yet reached
the bottom but it’s difficult to say, given the degree
of uncertainty,” says Louise Hall, head of the charities
team at Rensburg Sheppards Investment Management. “If
the current logjam isn’t eased, then mortgage rates
won’t come down and there will be much greater economic
pain.”
Her own firm’s view is that, although the degree depends
on the charity’s specific circumstances, overall charities
should maintain a defensive stance while retaining at least
some of their equity holdings. As most charities adopt a long-term
outlook, they do not draw regularly on their income or rely
on it too heavily, she adds. As a result, they can ride out
any downswings in the market.
“Market volatility produces some excellent investment
opportunities and it’s not a bad time to diversify,
but charities do need to be wary,” suggests Hall. For
example, the weakness in global equity markets earlier this
year provided opportunities for moving into the Far East and
emerging markets, which offer good long-term prospects.
However, in the shorter term conditions are rather less favourable
as “many people are still taking risk off the table”.
The emerging markets are still regarded as relatively high
risk and China’s markets have proved particularly volatile
since the onset of the credit crunch; falling swiftly and
sharply from their peak of last October but more recently
staging an impressive rally.
Commercial property has fallen from favour, but has proved
a popular area of investment in recent years. Hall says that
charities with a presence in this sector tend to divide into
three camps; those that are themselves property owners and
tend to steer clear of the sector, those that have included
it in their investment portfolio in the past five years both
to benefit from attractive returns and to diversify, and those
seeking income.
Over the period 2004 to 2007, commercial property offered
a good income yield and many charities were attracted to it.
We have now entered more risk-averse times, although Hall
suggests that charities can be more proactive with their cash
and still play safe. “Many are sitting on fairly substantial
cash balances and some banks are offering excellent rates
of six per cent and more,” she observes.
A question of yield
The priority for charities is to maintain their income levels,
and capital preservation funds provide them with a good
balance of fixed income and equity investment says Fred
Robinson, director of portfolio management at Killik &
Co.
He suggests that charities should regularly review the relative
yield offered by each form of investment. In recent months,
the yield from the equity market has increased to the point
where it is similar to that provided by gilts. This last
occurred during the bear market of 2000 to 2003, when the
yield from equities exceeded that from gilts for the first
time since the 1950s when the “cult of equity investment
first got underway”.
By contrast, in 1987 when the stock market nosedived in
October of that year, gilts were yielding three times as
much as equities in the period immediately preceding the
sell-off.
So Robinson believes that this is an opportune time for
charities to consider increasing their exposure to equities
and take advantage of growing dividends – although,
as he stresses: “It’s a question of confidence
and also of timeframes; equity investment should involve
taking a view of at least three to five years”.
He reports that the charitable funds that he handles are
now looking at sectors such as utilities, telecommunications
and tobacco – all of which offer attractive yields.
“Charitable portfolios have struggled of late as they
haven’t been able to go into sectors such as mining
and the emerging markets due to their relatively low yields
– although this is just starting to change,”
he comments.
“This isn’t necessarily a bad thing; the dotcoms
produced little yield during the boom of the late Nineties
and charities avoided them as a result, thus avoiding the
bust that followed the boom.”
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Banking is another sector offering good yields now that
the banks show signs of tackling their subprime problems,
although not all investors are convinced that most of the
bad news has come to light.
Robinson says that the other big issue influencing investment
decisions is the outlook for inflation. Rampant inflation
erodes the value of fixed interest investments and, typically,
interest rates rise to keep it subdued.
However, soaring food and fuel prices are presently the
main motors for the rising level and neither is that responsive
to rate tightening.
This means that charity trustees, who typically like to
see their investment portfolio split 50-50 between fixed
income and equities, might currently benefit from shifting
the proportion to 60-40 in favour of equities. At other
times, it will be more appropriate to have the balance in
favour of fixed income.
The cost of caution
The question now is whether the traditional aversion to
risk has cost charities dearly. The Institute of Philanthrophy,
an advisory service set up in 2000 to further the cause
of altruism, believes it has.
A recently published report, produced by Beth Breeze who
is a former deputy director of the Institute, suggests that
if charities managed their endowments better they could
boost their collective annual revenue by some £750
million.
Based on a survey of 277 endowed charities with assets of
£10 million or more, which included such major organisations
as the Wellcome Trust, the IoP report presented four main
findings:
- charity investment performance shows a wide disparity,
ranging from some excellent examples to poor performers
that have barely kept up with inflation
- despite this disparity, nearly all charities (96 per
cent) said they were satisfied with their investment performance
- there is a relationship between higher returns, the
presence of an investment committee and a more diversified
portfolio of assets
- the importance of investment issues is widely underestimated
and the investment process is often under-resourced. Charity
trustees, with responsibility for a combined £56bn,
too often regard investment issues as ‘off the radar’.
Breeze said that although she didn’t start out with
any particular hypothesis when embarking on the study, it
appears to confirm “that charities with an investment
committee show a greater ability to diversify, and that
larger charities are generally more organised and achieve
better returns”.
The report finds that over the five years from 2002 to 2007
– a period that for much of the time was marked by
a share market recovery from the dotcom boom-to-bust –
the annualised rates of return achieved by UK charities
ranged from a low of 3.1% to a high of 22.1%. The median
was 8.7% with charities lagging their counterparts in the
US, which achieved a rate of 12.4%.
The star of the US is undoubtedly Yale University, which
has used high-powered investment management to almost quadruple
its endowment over a decade, from $5.8bn to $22.5bn today
– although Breeze stresses that this figure should
be taken in context. “Yale is a massive institution
and its chief investment officer is a superstar in the charity
endowment world,” she adds.
She remarks that “if the money comes rolling in, it
may appear that everything is going fine, even if returns
are less than they could be potentially.” This was
the case with much of the period under review, with equities
steadily moving higher after stock markets bottomed out
in March 2003.
“Trustees may be averse to risk, but there is also
an element of risk in not diversifying and keeping returns
low by doing so,” Breeze adds.
Her research revealed a suspicion by some that charities
may not allocate the best-performing fund managers. Almost
one in three of those surveyed said that it did not put
its investment services out to tender and it appears that
many opt “for an investment manager they like hanging
out with rather than a cutting- edge fund manager”.
Some charities may also be hampered by not reviewing their
investment portfolio regularly enough. “In volatile
times, things are constantly changing and there is a need
to keep up to date with events. This can’t properly
be achieved by taking decisions only once every four months
at the board meeting.”
Improving future investment performance
The recommendations set out in the IoP report include:
- wider dissemination of information on basic investment
principles
- revision of the Charity Commission’s CC14 guidance
- greater encouragement for charities to form investment
sub-committees
- new efforts to recruit suitably qualified trustees
- more emphasis on trustee training in investment issues
- exploration of a larger role for non-profit pooled
funds
- support for information sharing among charities with
assets
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