Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Introduction
Regulation, investment markets, risks and requirements for Charity Trustees have all evolved rapidly in recent years. In November 2022 we brought together an expert panel to discuss these challenges and set out how Trustees might best address them. We hope that this summary of the event will be a useful guide and training resource for Clients, Trustees and their advisors.
Introduced by Ed Jewson of PMCL Consulting and Hosted by Robert Hayes of BlackRock the panel consisted of:
- Tatyana Mursalimov – Director and senior consultant at PMCL and advisor to many charities on questions of investment policy
- Paddy Zervudachi – Director of Finance for Buttle Trust the specialist children’s charity
- Yasmin Meissner - co-Head of Sustainable Investing for the BlackRock Multi-Asset Strategies and Solutions team
We have summarised the discussion into four sections;
- Drafting an Investment Policy Statement
- The outlook for risk and returns
- Setting objectives
- Aligning with purpose and responsible investment,
Drafting an investment policy statement
The Charity Commission requires Trustees to have a written investment policy that covers the remit and responsibility of any investment manager and the principles that any manager must follow when taking investment decisions on behalf of the charity.1
There is very little specific detail in what the Charity Commission require, therefore there is quite a lot of flexibility for Charities to develop their own policy statement. A lot of statements are reasonably short and lack detail. Investment policies cannot be totally delegated to the investment managers and do need to be developed by Trustees, although they can use the help of consultants or run them by the investment managers to ensure that they are practical and implementable.
PMCL think that the investment policy is an incredibly important document and, rather than being copied from your neighbour, needs to be properly tailored and reflect the charity’s actual requirements. No matter how brilliant the fund manager is in managing the asset classes they are managing it wouldn't help much if they are managing the wrong strategy for your particular charity. PMCL set out the following key elements that a policy needs to cover:
- the scope of investment powers
- the charity’s investment objectives
- the charity’s attitude to risk
- how much is available for investment, timing of returns and the charity’s liquidity needs
- the types of investment it wants to make, including whether the trustees have decided to take a responsible investment approach
- who can take investment decisions (for example, trustees, an executive, an investment adviser or manager)
- how investments will be managed and benchmarks and targets set by which performance will be judged
- reporting requirements for investment managers
The outlook for risk and returns
All the panellists were keen to stress the importance of considering the outlook for investment risk and returns in the context of a higher inflation environment.
The last decade or so has been a benign one where inflation has been low and asset returns have been positive in real terms. Now however Trustees are challenged by high inflation, negative real returns and greater volatility in returns. For charities this raises two specific issues - the first is ensuring that you are not over distributing and the second is knowing in more detail what your actual tolerance for asset volatility is.
There are a combination of shorter term macro- economic challenges combined with longer term structural issues that need to be considered.
We are now moving into a period where there will be a challenging combination of higher inflation, higher interest rates and slower growth. This creates challenges which have implications for how you set objectives and how you allocate across portfolios.
Setting objectives
Paddy set out the history of Buttle Trust, how the endowment has grown significantly since being established in 1953 and how their investment strategy has evolved significantly over this period - responding to both changing opportunities and requirements. He then highlighted a number of key elements in the setting of their investment objectives.
- A timeframe that was long term – linked to their requirements
- A total return approach – blending income and capital returns
- A global approach but with currency hedging to reflect their UK commitments
- An objective of ‘inflation +’ – which he acknowledged was relatively aggressive and reflected a high degree of risk tolerance
- Allocations to lower risk diversifying and alternative strategies introduced after the losses of the 2008 financial crisis
- An increasing allocation to ESG focussed funds
Risk: Diversification and asset allocation may not fully protect you from market risk.
In response to this, Tatyana highlighted the crucial importance of matching the timeframe of your investment strategy to the structure and requirements of the charity. In particular there was a discussion about the difference between a genuine ‘permanent endowment’ and charity which may have substantial assets which are actually ‘accumulated reserves’ which may get called upon. The experience of the pandemic when many charities had to call on reserves to meet operating activities and cover shortfalls in income at a time when markets had fallen was a good reminder of how risks might combine to the detriment of an organisation.
The large majority of charities which the panel come across have moved to a total return approach – often combined with a move to international investment, reflecting the lower yields typically available from overseas markets.
There was an active debate about ‘inflation +’ objectives. Whilst it is a natural aspiration to, for example, preserve capital in real terms whilst paying out the excess return, Yasmin was keen to point out that Consumer Price Index (CPI) is not an investible asset class and so it is hard to think of it as a specific benchmark. She also noted that over shorter time periods, the volatility and levels of inflation we have seen recently imply a lot of variability in risk appetite to deliver this type of target.
Therefore, the way that she thinks about it for her portfolios is to be focused on delivering capital growth and delivering income distribution at the fund level that is in line with inflation over the medium term, not year to year. All panellists agreed that inflation plus type objectives need to be considered only over the medium to long term – with 3 years being an absolute minimum.
In terms of the level of return that it might be reasonable to look for in excess of inflation there was also consensus that the historic targets and realised returns of the order of ‘plus 5%’ are going to be very challenging to achieve in the future. As Tatyana explained a target as high as +5% may not be practical or realistic on a prospective basis and would imply a high level of tolerance for risk which would only be suitable for certain charities. Risk tolerance and return ambition are crucially linked.
Alignment with purpose and responsible investment (ESG)
The panel agreed that many charities are increasingly looking to align their investment policies with the wider purpose of the charity. Whilst climate change is a key area of focus for some, the topic is a broader one incorporating, for example in the case of Buttle, areas such as the treatment of workforces and children.
Yasmin kicked off the discussion with an explanation in her view of how she differentiates between ‘value’ and ‘values’. In her framework ‘values’ are really about the concept of understanding your purpose, designing your own philosophy, identifying, your core set of beliefs, what you're willing to do, and what you're not willing to do in your portfolio. Then, ‘value’ is about generating returns based off ESG investment ideas and she believes that there can be space in portfolios for both.
Picking up this theme Paddy commented that focusing particularly on their values and investment value Buttle launched a 2025 organizational strategy. This covers all aspects of the charity – ‘looking at what our values are, what our mission is and, how our endowment is deployed and the way in which we deliver grants’. They have been exploring ways to align their endowment with their mission and different ways of investing.
One area of great debates is about exposure to fossil fuels, whether to go the divestment route or the engagement route. Currently the Buttle Trustee board has decided to go the engagement route since they believe that in fact, the largest fossil fuel companies are also the largest investors in renewables and are a necessary part of the transition to a net zero state going forward.
This prompted a debate about the potential implications of the Butler-Schloss court ruling.2 Tatyana made the point that what has changed is that once you talk about balancing risk and having discretion, it all of a sudden opens a lot of other considerations for setting investment policy. For example, reputational risk is incredibly important to many charities because if you believe that by doing something in your portfolio, or not doing it, you will harm your fundraising or upset your stakeholders, or potentially, even beneficiaries, then it needs to be taken into account.
In PMCL’s view, specifically in relation to the ruling and what it says about climate risk, the observation was that whilst climate may not be directly linked to the charity mission it is a potential risk from a reputational standpoint.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Sources:
- Updated 1 August 2016, Charities and investment matters: a guide for trustees - GOV.UK (www.gov.uk)
- 15 November 2022, https://www.gov.uk/government/news/update-on-investment-guidance-following-butler-sloss-case
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.
This information should not be relied upon as research, investment advice, or a recommendation regarding any products, strategies, or any security in particular. This is for illustrative and informational purposes and is subject to change. It has not been approved by any regulatory authority or securities regulator.
The environmental, social, and governance (“ESG”) considerations discussed herein may affect an investment team’s decision to invest in certain companies or industries from time to time. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.
