Equities  

Risk, and you shall receive

Risk, and you shall receive

An enduring conundrum with charity investment is the relationship between the desired return a charity wishes to make on surplus reserves and the amount of risk it takes to achieve this.

A popular misconception is that charities are very conservative entities, averse to taking risk. After all, the assets that are entrusted within charities are for the benefit of the public and the specific beneficiary that the organisation supports.

Trustees of a charity have a duty of care and prudence over the assets of a charity. They should avoid undertaking activities that might place the charity’s endowment, funds, assets or reputation at undue risk. It is not uncommon for trustees to have a lower risk attitude while they are serving the charity as they ‘do not want anything to go wrong on their watch’, but in reality, charities can and should take risk where it is appropriate to do so.

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Charities share some attributes with pension funds; both are regulated and have an obligation to meet the needs of current and future beneficiaries, but there are also a few significant differences. While pension funds have defined liabilities relating to the age and payout of the pensioners, charities are mostly around for a very long time or in perpetuity.

They have a very long-term investment horizon, and while they do not have defined beneficiaries, charities that have surplus capital from daily expenditure will wish to protect the real value, at least in line with inflation over time. Therefore an investment into real assets, such as equities and property that participate in the real economy, is likely to achieve the need to have sufficient funds to meet their long-term charitable objectives.

The contrast between the long-term horizon of a charity, the shorter-term behaviour of a trustee and the current economic climate is apparent in recent research on UK charities.

As many as 41 per cent of charities are concerned about their performance over the next 12 months, reflecting short-term financial concerns and typical trustee behaviour. As a result, charities are focusing on risk when managing their investment portfolio. Indeed, 62 per cent of charities believe risk is the most relevant metric when managing an investment portfolio, while 33 per cent claim return and just 7 per cent state it is yield.

Notwithstanding market falls in 2000 due to the dotcom bubble and the credit crisis in 2008, and despite current global economic uncertainty, charities continue to invest in equities to deliver effective market returns. More than 81 per cent of charity portfolios were invested in equities, with bonds and property equal second at 56 per cent.

It is notable, therefore, that despite increasing levels of market volatility, the majority of charities remain allocated to equities. This underlines their long-term investment horizon and the fact that trustees, in general, view equities as medium risk, while financial regulators regard them to be more risky.

Interestingly, while charities are happy to invest into equities, more than 69 per cent of charities target ‘inflation plus’ return for their investments with 38 per cent targeting a combination of market indices. As many charities employ staff and need to keep pace with wage inflation, the retail price index is often seen to be the more appropriate measure. By adopting an inflation-based return requirement, the overall portfolio of investments can be relatively unconstrained by the type of assets that are employed to achieve the aim.