Focus: Finance and Governance - Outlook - Are charities hooked on UK equities?

Mirko Cardinale, senior economist with financial consultancy Watson Wyatt LLP

It is well known that UK institutional investors have a preference for equities.

Despite Boots' decision in 2001 to move its pension assets entirely into bonds, which led to much debate, British pension schemes are still heavily invested in equities. A large number of UK charitable institutions share this preference for the stock market. Equities accounted for almost 80 per cent of the WM Charity Fund Universe in September 2004 and, from an analysis of the latest annual reports, it appears that most large charitable foundations invest at least 50 per cent of their assets in the stock market, with the Charities Aid Foundation, the Wolfson Foundation and Christ's Hospital School the most notable exceptions.

Charities' equity portfolios are predominantly invested in UK shares (about 75 per cent in the WM universe). Is this a justified preference for higher returns or an irrational 'cult of equity'? Results from recent surveys carried out by Watson Wyatt among foundation trustees in the UK, Switzerland and Germany provide interesting insights.

About 50 per cent of responding UK trustees were convinced that developed markets' equities will be the best performing asset class over the next 10 years. Their German peers were less enthusiastic - 33 per cent chose equities, and 18 per cent thought corporate bonds will give better returns.

Swiss board members liked mainstream equities but were more optimistic about emerging markets and hedge funds.

We also asked trustees what they believed the long-run equity allocation should be for charities such as theirs. The most popular choice among UK respondents was the 25 to 50 per cent band.

There is obviously another dimension to the investment policy: risk diversification.

Finance theory teaches that investment efficiency is not about choosing the asset with the highest expected return but about constructing a diversified asset mix.

Most respondents (85 per cent) agreed that diversification was essential to a sound investment policy, although matters were hazier when it came to the practical implications: asked how the investment portfolio of a charity should be made up, only 8 per cent indicated a preference for a geographically diversified portfolio and more than 20 per cent chose UK assets only.

UK charity trustees appear to believe firmly in equities as a return-enhancing asset, although they would perhaps like to reduce current allocations slightly. But they have not yet come to terms with the importance of geographical diversification in terms of broadening the investable universe and maximising efficiency.

KEY POINTS

- Most large charitable organisations invest at least 50 per cent of their financial assets in equities

- Most charity stock market investment is in UK shares

- Trustees believe the long-term equity allocation should be 25-50 per cent

- Diversification is key to investment efficiency.

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