Act like a trustee, think like a fund manager

The pressures of the current financial environment are taking their toll on a number of charities. Staffing and project work are under review, there is pressure to cut back expenses and outgoings, and the level of grants being made by grant-giving charities is being scaled back. Multi-year projects are being foreshortened and funding pledges are being reduced or revoked. For charities which rely on the public sector for funding, either because of substantial grant support or because services are purchased by central or local government, the pressures are likely to increase further. And yet, amidst the gloom, parts of the sector continue to fare well.

For those charities which are surviving the pressures of the economy, few are entirely resting on their laurels. There is much evidence of a drive to make sure that charity investments work to best effect, and identify and capture new sources of funding. This makes complete sense as markets can behave unpredictably, with knock-on effects not just on the capital value and yield of invested funds but also on the ability of external funders to maintain support at consistent levels. All the more reason, charities might think, to explore more carefully the changing face of charity investment.

Following the considerable changes to charity investment rules over the course of several decades, charities now find that they have almost the entire investment universe at their fingertips. Mapping a path through this universe can be a difficult task for charities with no detailed investment experience, and the pitfalls are huge.

Huge choice

Questions of suitability, risk and diversification are material factors to bear in mind, and are just as critical as ensuring tax efficiency, particularly if the aim is to maximise the longer term impact of invested funds. The risks to both capital and income as a result of insufficient portfolio diversification are only too obvious, as charities with direct holdings in BP or some banking shares have found to their cost. As a result, many charities are more wary of direct investment and seek diversification through other vehicles. All charities should also be mindful of HM Revenue & Customs regulations on approved charitable investments, which may be critical to the tax efficiency of a charity’s portfolio.

The Common Investment Fund (CIF), a collective investment scheme similar to authorised unit trusts, is still relatively new to Scottish charities and provides diversification in a tax efficient, administratively simple and cost effective way. However, while CIFs remain popular investment vehicles for charities, there remains some debate as to their benefits compared to other types of pooled investment funds. Tax advantages of CIFs have been eroded and the potential transfer of their regulation from the Charity Commission to the FSA may diminish CIFs’ perceived advantages further. New charity funds are continually being launched in traditional unit trust structures, and fund management companies are creating new share classes in existing funds specifically aimed at charities. These developments mean that a much wider universe of investment funds is available to trustees and their advisers. 

More recently, a range of social asset classes have opened up to charities, and these include investment in social enterprises, social impact bonds and other forms of social finance loans. These may look, on the surface at least, to be particularly attractive to the charity sector, but the reality may be somewhat different. There are initial encouraging signs with, for example, the progress of the Peterborough Prison Social Impact Bond, but in general these new vehicles remain largely untested and there is scepticism about how they might be used going forward. Time will tell whether this scepticism will prove misplaced. 

Freedom and responsibility

There is no question that these changes to the investment rules give charities much greater freedom and potentially allow charities to take on a greater degree of investment risk. The corollary of this is that charities are also potentially exposed to greater fluctuations in capital values and an enhanced risk of poor investment returns. This is why professional investment advice can prove invaluable.  

Nevertheless, some of the responsibility for investment decisions continues to rest with charity trustees, and that responsibility must be taken seriously. Producing an investment policy statement, articulating views on risk tolerance, objectives, timescales, strategic asset allocation guidelines and any appropriate ethical policy, can be used as the cornerstone of the initial and ongoing relationship between the charity and its investment adviser, as well as helping to meet requirements to disclose investment policies under charity accounting regulations.  

The choice of an investment manager is a decision to be taken with care. Understanding the needs and objectives of a charity should be a given. Added value requires a fuller appreciation of the duties of charity trustees, a sound knowledge of developments in charity law, and expertise in areas such as accounting requirements and administrative aspects, themselves increasingly specialised areas. In short, the ideal investment manager will be able to see things from the insider’s point of view, in essence acting like a trustee, while thinking like a fund manager.