FINANCE: Safety In Numbers

PATRICK MCCURRY

Common investment funds emerged in the early 1960s as a result of legislation such as the Trustee Investment Act 1961 (TIA), which restricted charities' investments. CIFs were authorised and regulated by the Charity Commission and allowed charities, subject to the act, to escape the legislation's restrictions.

The main advantages they offer are that they reclaim the ACT tax for charities, although ACT relief is being phased out. They are also exempt from stamp duty and generally charge lower management fees than other funds.

Up until a year ago there were about 30 CIFs, mainly offering equity or bond investments and ranging in size from about £20 million to £845 million. Since then several new CIFs have launched, or been authorised, in areas such as property and hedge funds.

At the end of June, CIFs had £4.75 billion under management, according to researcher the WM Company.

Until the late 1980s there were only a few funds but there was a major increase in the number of CIFs between 1989 and 1994 with the launch of 16 new funds.

This growth was due in large part to the winding-down of the role of the Official Custodian in the early 1990s. The Official Custodian, run by the Charity Commission, covered £1.5 billion worth of land or investments held by 40,000 charities. These investments were returned to the charities, who often found a new home in CIFs.

In the second half of the 1990s, there were relatively few new CIFs launched, which was partly due to a restructuring of the governance of CIFs, in which they became subject to the Financial Services Act and any new CIFs had to put in place a corporate trustee instead of the traditional board of individual trustees.

Common investment funds are increasing in popularity as an alternative to bonds and equities for small charities. Patrick McCurry looks at the rise of the "comfort

factor

When trustees at charity the Midlands Regional Chaplaincy Board were discussing what to do with their rising cash reserves earlier this year, the solution seemed obvious.

"Our funds had increased from £5,000 a few years ago to £20,000, which was in a building society deposit account paying relatively low interest,

says treasurer Henry Abrams. "We felt that we could get a better deal by putting it in a common investment fund (CIF)."

After considering various CIF providers, the trustees plumped for the Charities Aid Foundation (CAF) in August, putting half in CAF's income fund and half in the equities growth fund. "We felt we could earmark £10,000 for longer-term investment in the equities CIF,

says Abrams.

Like many charities, the chaplaincy board was attracted to CIFs by their tax advantages, relatively low management charges and the fact that they're specifically designed for smaller voluntary organisations. There is also the "comfort

factor, as CIFs are charities authorised by the Charity Commission. "We felt comfortable with CAF because of its high profile in the sector,

says Abrams.

But not that long ago, some investment experts were ringing the death knell for common investment funds. They pointed out that the Government's phased abolition of dividend tax relief for charities would remove one of the funds' advantages and that the Trustee Act 2000, which gave trustees greater investment powers, would encourage charities to look at a wider range of funds.

Rather than withering away, however, it seems that CIFs are enjoying a new lease of life and in the past year, five new funds have launched or been approved by the Charity Commission. These include a hedge fund and an equities income fund managed by Cazenove, a property fund at CCLA, a global growth and income fund at Newton and a specialist CIF for army charities managed by Merrill Lynch. This represents a major increase to the CIF family, given that only 33 funds have been launched since the first CIF in 1963.

So why the new interest in CIFs, particularly when stocks are in a downturn?

One reason is that some new CIFs offer investment in asset classes, notably property, which have been performing well despite the downturn in financial markets. The Charities Property Fund CIF, for example, returned an impressive 17 per cent to the end of June this year since its launch in September 2000.

Another element in the growth of the CIF market is the trend in recent years for fund managers to increase the minimum investment for charities that want their own managed portfolios. Minimums for these segregated funds depend on the individual fund manager, but range from £2 million at smaller stockbrokers to £50 million at giants like Deutsche Bank.

At investment managers Newton, for example, the minimum for a segregated portfolio has risen from £1 million to £2 million and could soon rise to £3 million.

As a result of this trend, there are many charities that can no longer have their own portfolios and so consider pooled funds such as unit trusts and CIFs.

Richard Hughes, fund manager at the Charifund CIF, adds that the market downturn has probably made charities, which for historical reasons own just a few stocks, consider pooled funds. "They may have seen those single stocks fall a lot in value, whereas pooled funds offer more diversification,

says Hughes.

Andrew Hunter Johnston, head of charities at Merrill Lynch, adds that investors in general are more comfortable with pooled funds than they were in the past.

"Fund managers have realised it costs a lot to run small, segregated portfolios and are advising clients to go into pooled funds - this is something that's been going on in the pensions industry for 10 years."

Another reason for the growth in CIFs is that the Charity Commission appears more willing to approve funds, particularly if they offer new asset classes to invest in such as property or hedge funds, which in the current climate can offer better returns than bonds and equities.

Some in the sector detect a subtle change of policy at the commission.

"A couple of years ago, the noises coming out of the commission were that there were enough CIFs and it was not in favour of increasing the number, but that seems to have changed,

says one investment manager, who asked not to be named.

Michael Carpenter, the commission's executive legal commissioner, denies any change of policy. "I don't recall any anti-CIF period here,

he says.

The Trustee Act embraces the concept of diversification of investments, affirms Carpenter, and it is good for trustees to have a wide range of investment options to consider.

This belief in diversification explains why new property or hedge funds have been approved, but Carpenter adds that there is no reason why the commission should refuse approval to more traditional equities or bond-based funds. "If they have a good business plan and have identified a gap in the market or in their own range of funds, why shouldn't they be allowed to offer a CIF?"

This is good news for fund managers, many of whom like the idea of CIFs because they can be marketed to charities as relatively safe investments that have the commission's seal of approval.

For trustees of smaller charities that cannot afford or choose not to take outside advice, CIFs offer a feeling of comfort that fund managers are keen to exploit. "The number of new CIFs shows that fund managers believe there's a good market out there and are keen to jump on the bandwagon,

says one fund manger.

Nick Reid, head of charities at Cazenove, denies any "bandwagon

effect and says that new CIFs like Cazenove's income fund are responding to the needs of charities. "A lot of charities are finding pressure on their income and many that are not being advised professionally, are looking for a CIF like this."

He says that there are marketing advantages in making the income fund a CIF rather than a standard commercial fund open to non-charities. "It gives you a higher profile because otherwise it's easy to get lost in the noise of the other funds."

John Rogerson, head of investment services at CAF, believes that instead of encouraging trustees to move away from CIFs, the Trustee Act may have made them more attractive. "The act made trustees more aware of their stewardship responsibilities and CIFs are seen as a relatively low-risk home for investments."

But Rogerson is concerned about the commission's approval for the Cazenove hedge fund, given that there has been widespread concern at the high-risk nature of some hedge funds, which use derivatives to bet on movements in the financial markets. "I am worried it could be a cuckoo in the nest,

says Rogerson.

"Charities regard CIFs as carrying the commission's stamp and that they are therefore 'safe' investments. But how much due diligence did the commission carry out to ensure this kind of investment is suitable for charities?"

Carpenter says the commission is "neutral

on the CIFs it authorises and that hedge funds have increasingly become a component of US charity investments and that UK charities should be given the option to invest in a hedge fund CIF.

According to Peter Warrington, head of sales at investment research company WM, the popularity of CIFs is largely unjustified. CIFs provide administrative benefits in re-claiming tax for charities, he says, but when the ACT dividend tax relief is phased out next year, the only advantage of CIFs compared with other pooled investments will be the exemption from 0.5 per cent stamp duty.

"There's not much difference between CIFs and unit trusts and the fund managers probably manage them in the same way as their other pooled investments,

says Warrington.

William Eason, chief investment officer at investment managers Laing&Cruikshank, agrees. "The only CIFs that offer real advantages compared with other funds are the property CIFs because they are exempt from the 4 per cent stamp duty on property that other investors must pay.

He adds that any fund manager being consulted by a charity should recommend a much broader range of investments than just CIFs, particularly given the new flexibility of the Trustee Act.

Supporters of CIFs highlight lower management fees than unit or investment trusts and argue that performance has often been better than the market average, although there are significant variations between CIF performance.

Sarah Millington, a vice president at Merrill Lynch charities team, says that CIFs are often regarded as "shop window

products by investment managers.

"CIFs performance record is public and accordingly they tend to be closely watched by senior managers,

she says.

THE NEW CIFS ON THE BLOCK

- COIF Charities Property Fund - the second property CIF, following the Carr Sheppards Crosthwaite Charities Property Fund - launched in 2000. The COIF fund, which aims to cash in on attempts to diversify investments away from stocks and shares, was launched in August and with a portfolio worth £50 million transferred from its sister fund, the COIF Charities Investment Fund.

- Global Growth and Income Fund for Charities launched by fund managers Newton in November 2001. The fund so far has £10 million under management and 12 investors. Newton says it is different to other CIFs because of its focus on global "themes

rather than picking individual stocks.

- Absolute Return Trust for Charities is the first hedge fund CIF and is managed by Cazenove. It will invest in a portfolio of around 25 different hedge funds. The Charity Commission says hedge funds can provide an extra degree of diversification because they are in a different asset class to charities but it stresses that hedge funds are not for everyone and that caution is required.

- Enhanced income fund: also managed by Cazenove and due to launch on 1 November. It is different to other income CIFs, says Nick Reid of Cazenove, because it focuses on UK equities.

- Army CIF, due for launch in September. Three service charities are contributing £100 million to create a CIF, which will be managed by Merrill Lynch. The fund hopes to attract other smaller military charities as investors.

A BRIEF HISTORY OF COMMON INVESTMENT FUNDS

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