Catherine Everett provides a step-by-step guide.
About 40 per cent of the 180,000 registered charities in the UK have sufficient funds to invest. Approximately 90 per cent of those use investment managers to take care of their assets, according to the Charity Finance Directors' Group.
This, says Chris Finnill, secretary to the Alexander Duckham Memorial Schools Trust, is because "however skilled your financial managers are, they're probably not stockbrokers and won't have the inside track on what's happening in the market".
It also makes sense for trustees - who, according to the Trust Act 2000 and Charity Commission guidelines, have responsibility for investment decisions - to monitor rather than determine performance. Not least, says Finnill, "because it's comforting to know that your funds are being looked after professionally".
Most charities simply don't have the relevant investment expertise on their board of trustees, says Nick Rickard, head of business development at the Charities Aid Foundation's financial services unit.
"They don't have access to reviews in the same way specialised investment managers do, or have time to track the market, which moves constantly," says Rickard. "You're taking a risk if you do it yourself, unless you've got a good investment background - but even then you can miss a trick if you go on holiday."
So what should charities do if, for example, they receive a windfall from a donor and want to obtain a higher return than they would by putting it in a high-interest deposit account? This guide gives you the essentials.
1. Planning: The Charity Commission's CF14 document on the investment of charity funds is a good starting point, according to Lisa Burger, treasurer of the National Theatre Foundation.
"It's easy to read and takes people through what they should be thinking about in a straightforward way," she says. "It's also clear about the specific duties of trustees, such as having to consider the sustainability of investments, to diversify them and to obtain proper advice when reviewing them."
The next stage is to step back and review the charity's goals and objectives as a basis for formulating a sound investment policy. This process should involve not only trustees, but also operational staff such as treasurers or financial directors.
It is important to establish what your charity intends to use the return on their investments for, and whether such returns need to be short, medium or long term, or a mix. Any ethical considerations should be taken into account, too.
Ric van Weelden, a partner at HR consultancy Watson Wyatt's investment practice, explains: "It's important to set long-term rather than short-term objectives because the latter can be quite volatile. Also decide how flexible disbursement needs to be and how much risk you're comfortable with. If you've got short-term commitments, for example, you may be able to afford to take more of a risk than with any long-term ones."
However, it is also useful for trustees to have some knowledge of the basics of investment to ensure they make informed decisions.
Tom Sterry, a trustee at the CFDG and head of finance at the Henry Smith Charity, says: "It's useful to attend a training course or seminar to familiarise yourself with the jargon. You're paying investment managers to make coal-face decisions, but if you're accountable for this or reporting on it, you need to ensure you know what they're talking about."
2. Devising an investment strategy: This should be based on policy set out in the planning stage and will be different for each charity. The most widespread form of investment, according to Rickard, is the common investment or pooled fund, and the average sum invested is about £50,000.
With such funds, assets are pooled with those of other organisations and managed "in one big pot".
Rickard adds: "Because pooled funds are more diversified, they're lower risk than other forms of investment. It's about economies of scale, so they're a less expensive option because managers have to look after only one fund, rather than different ones individually."
Charities with £500,000 or more to invest, however, tend to go for a segregated portfolio that is diverse enough to spread the risk - the most common investment types are relatively low-risk UK equities and gilts.
Following the low stock market returns of recent years, however, there has been a move among some charities to broaden out into overseas equities, property, private equity and, Rickard says, hedge funds - though to a lesser degree.
"Charities' understanding of risk has changed to the point where they appreciate that some investments can offer better potential returns if they are prepared to take more of a risk," he says. There is also a wider range of investment managers and products built specially for them than there has ever been."
The essence of investment, however, is about managing risk and return.
"Some charities invest in funds that can provide capital growth for tomorrow, whereas others want a high income today and some choose to mix and match," says Rickard. "It's really about understanding what you need as a charity."
3. Locating investment managers: Once a basic investment strategy has been decided upon, charities can locate suitable brokers using a variety of routes.
Gillian Barker, director general of the grocers' association Caravan, says: "When you're starting out it can be quite daunting, but you could begin by speaking to the banks, which all offer this kind of service.
"There is no shortage of investment companies, many of which advertise in charity magazines or on the internet. But you could also talk to other charities in your orbit, and ask trustees to do the same."
It is then worth drawing up a shortlist of potential candidates and researching their reputations - through the press or by asking colleagues. Another option is to hire a consultancy such as Cambridge Associates or Watson Wyatt to do the donkey work for you, and match your requirements with the services available on the market. This, however, depends on each individual charity's budget.
4. Selecting an investment manager: The next step is to provide candidates with a suitable brief in which to lay out your requirements. According to Mark Freeman, chief executive of services company Charity Business, this should include information about the organisation's reserves, grant-giving and investment policies, as well as "clear directives" as to income and total return requirements.
"Once managers can see your specific needs, they can respond with a written document showing how they plan to deliver it," Freeman says. "This will include investment mix, fund-management costs and their experience in delivering the required returns."
It is always an option to organise a beauty parade, but on this Rickard warns: "Many larger companies won't come out unless you're investing about £2m, although some of the smaller firms will."
Caravan did choose this route, however, and took on CAF to invest its assets in equities and bonds. "It took a lot of time, especially as all of our trustees are volunteers," says Barker. "We probably took three full days to meet all of the candidates and have them explain what they could do with our money. It took us ages to understand exactly what we were being told, but it's important to ensure the wool isn't pulled over your eyes."
The most important piece of advice, Barker says, is to "ask questions, ask them to explain jargon and make clear what they really mean. Remember that these organisations don't get poor because of us. Sometimes we need to remember that charities are businesses too, so don't let yourself be fobbed off."
According to Rickard, one vital question to ask yourself is whether you can work with these people. "That does play a part," he says. "When it comes down to it, you could talk to two managers with broadly the same offerings, so it can often hinge on personality."
5. Sorting out the details: Once a suitable investment manager has been selected, it is important to draw up a contract. Although Sterry says that most are "fairly routine", they may also include specialised appendices to deal with specific circumstances.
"These are signed by the investment house, the charity and the trustees, and act as guidance on how the brokers will operate," he explains.
The situation regarding a fee is more complex, and will vary based on what investments have been chosen and the amount of money invested.
As a basic guide, however, Freeman says: "The larger the amount of money a charity has to invest, the less it will have to pay in fund-management costs. For funds in excess of £10m, for example, they may typically pay between four and seven base points, depending on the level of active management required."
Smaller funds, on the other hand, may see charges increasing to 10 or 15 base points, or 1-1.5 per cent of the value of the fund.
As for real returns, Rickard says that cash deposits currently generate about 2 per cent, bonds about 2.5 per cent and equities about 5 per cent.
6. Managing the ongoing relationship: How charities should manage the relationship with their brokers tends to depend on the size of their investment.
Rickard explains: "There are different levels of service for different levels of assets.
"For example, if your investment is about £100,000, you'll get a quarterly report and that's it. But if you've invested £100m, your fund manager will talk to you about performance as often as you would like."
Finnill says that the Alexander Duckham Memorial Schools Trust has invested in the region of £1m in equities and bonds with CAF. He obtains a quarterly performance report and invites managers in "to explain how funds are progressing" once every three years. "Although if something was going wrong," he adds, "we'd do it more frequently."
Caravan's investment committee meets each quarter to review performance and report its findings to the trustee board. "We log on to the CAF website twice a month to see how our investments are going," says Barker. "This allows us to track the situation historically, which is great from an audit perspective because everything's clear and visible."
Barker adds that, "out of due diligence", the organisation reviews how and where its money is held every three years.
The National Theatre Foundation, which hired Merrill Lynch only four months ago, intends to meet with the company at least three times a year to evaluate the performance of its investments against the benchmarks that were set.
"We want to hear its views on the market, what's likely to be coming up, what's gone where in the last quarter and what it anticipates will happen over the next period," says Burger.
But the foundation also plans annual reviews of both its brokers' performance and its own investment policy and strategy.
"Stewardship is key," says Burger. "You don't change fund managers every five minutes, but it's not a once-and-for-all decision. We'll keep an active eye on performance, compare it with that of our peers and ensure that benchmarks are being observed."
CASE STUDY - NATIONAL THEATRE FOUNDATION
Some time ago, the foundation received a £5m gift from a donor. It placed this in deposit accounts and in a common investment fund.
Last year, it revisited these funds in a bid to diversify risk, obtain more of a return and to ensure it was complying with Charity Commission guidance and the Trust Act 2000, which requires trustees to take responsibility for investment decisions.
After establishing its requirements, the foundation put together a request for a proposal, which it sent to eight companies it had located through recommendations from trustees, colleagues in other charities and voluntary sector-focused magazines.
"On the basis of their responses, we asked four to meet our investment sub-committee to present on the best investment strategy for us, given our objectives and policy," says treasurer Lisa Burger. "From there, we whittled it down to two candidates and, after another meeting and supplementary questions and references, signed up Merrill Lynch."
Deciding factors, she says, included how clear the presenters were in providing information, whether what they were saying made sense and how much of a priority they gave to customer service.
"We wanted to be confident that they would look after our investment properly," she says, "but also that they could clearly communicate what they were doing to the trustees. It's important to feel that people are acting in your best interests."
QUESTIONS TO ASK
- What can you deliver and how sustainable is it?
- In the light of our objectives and attitudes towards risk, how would you recommend that we segregate and invest our assets?
- What total return can we expect?
- Could you provide examples of your past performance and ability to deliver required returns over one, three and five-year periods?
- What experience do you have of the charity sector and how long have you been working in this area?
- What differentiates you from your rivals and why?
- How do you go about servicing and building a relationship with your clients, and can you show examples?
- How much are your fees and what impact will they have on our total return?