Squeezing the most out of your money

With interest rates historically low and inflation relatively high, it is a struggle for many charities to maximise their income. As part of our Third Sector Extra on investment, Patrick McCurry reports on how organisations can make their assets work better for them.

Maximising investments
Maximising investments

In today's uncertain economic climate it is even more important for charities to maximise their returns on investment. Organisations struggling to cope with a decline in statutory income are particularly under pressure to squeeze as much income as possible from their portfolios in the short-term, while also safeguarding the value of their long-term investments. That's a tricky feat to pull off, especially at a time when interest rates are so low and inflation is relatively high.

In the not-so-distant past, charities could seek refuge from the storm by taking the relatively safe option of buying government bonds or other fixed-income investments that guaranteed a decent return, but the value of these has been eroded by inflation.

Organisations investing in equities have had a better time of it recently: the FTSE 100 Index climbed by 9 per cent last year and the broader FTSE 250 Index was up by 24 per cent. Shares have continued to rise in 2011, albeit less strongly so far.

The search for growth and diversification has led some charity investors to overseas equities markets, but picking the right one is tricky. Last year, the Chinese market plunged by 15 per cent; Argentina's was up by 82 per cent.

So despite the extremely difficult environment, there are opportunities for those charities that put together the right investment mix. The Church Commissioners, for example, last month announced a return of more than 15 per cent on their investments for 2010, thanks to a series of measures, including greater investment in shares - particularly of companies with overseas interests - and less exposure to bonds.

Here are some of the key issues facing charity investors now, with some ideas on how to deal with the challenges.

Low interest rates

Investors have had to adapt to historically low interest rates for more than two years because of the Bank of England's decision to hold its base interest rate at 0.5 per cent since March 2009. This, coupled with relatively high inflation, has dramatically reduced the attractiveness of bonds and other fixed-income investments. For example, government 10-year bonds are paying about 3.5 per cent in nominal terms, which means that there is no real return after inflation is taken into account. Charities are reacting accordingly.

"We used to have a fund invested in bonds and fixed-income vehicles but we closed it because returns were so low," says Andy Copestake, finance director at the National Trust. He says most of the money in the fund is now invested in equities.

Very low interest rates have also affected the attractiveness of cash. If cash was yielding 5 to 6 per cent and inflation was 2 to 3 per cent, it would make sense to hold significant sums, says John Kelly, head of client investments at the fund manager CCLA. But with cash yielding such low rates and inflation remaining high, it is harder to justify keeping it, except when an extremely liquid investment is required. But charities in need of money in the short term should be wary of moving into more volatile, longer-term investments, even if those appear to offer the prospect of higher returns.

High inflation

In April, the Consumer Price Index rate of inflation fell to 4 per cent and the Retail Prices Index rate of inflation fell to 5.3 per cent - but both figures are still well above the Bank of England's 2 per cent target. High inflation creates a problem for charities that are seeking to protect the value of their investments.

According to Richard Maitland, head of charities at the fund manager Sarasin & Partners, charities need to have generated at least 5.5 per cent on investments in the past 12 months merely to stand still. "How to make real returns when inflation is high will continue to be the main challenge for charities," says Maitland.

John Hildebrand, an investment manager at Rensburg Sheppards, advises charities pondering this dilemma to keep a significant proportion of their portfolios in "real" assets, such as equities and property. "Charities need some kind of index-linked protection that can give them a rising level of income after taking inflation into account," he says.

High inflation has prompted some investors to switch from low-yielding cash investments into higher-yielding bond or equity funds that can return more than 5 per cent.

But Kelly warns that, as well as being wary about putting money needed in the short term into longer-term investments, charities should also be aware that payments from bond funds are likely to fall in the future as higher-paying bonds from the past mature and are replaced with lower-paying ones. In the case of equity funds, charities also risk getting back less than they invested at the end of the term, no matter how attractive the investments appeared at the outset.

Generating a decent income

Low interest rates and high inflation have made it hard for many charities to turn in any kind of decent investment profit. With cash rates so low, higher savings returns can be gained if charities are willing to sacrifice instant access and instead deposit money for a fixed term.

But many long-term investors are tending to prefer equities, which offer potential not only for capital growth, but also for income generation. The National Trust's portfolio, for instance, is mostly in equities and, in the year to February 2011, its investment income rose by about 12 per cent - in line with the UK stock market.

While the UK equities market historically yields more than 3 per cent, in order to squeeze more income out of their equities portfolio some charities have sought to increase investment in higher-yielding equities. But this might be suitable mostly for charities that have been very prudent in the past and spent less than they could have done, Maitland says.

Property is also a potentially attractive investment option in the current climate, given the strength of the rentals market in many places, particularly London.

"We've had an increase in enquiries about property because good quality properties can generate up to 7 per cent a year," says Kelly, who describes this as an excellent return in the current environment.

Getting the right asset allocation

Deciding how much to invest in different assets is a continuing challenge for charities. In the current volatile economic climate, it seems particularly important to have a diversified portfolio to provide protection against the unpredictable market.

Putting all your eggs in one basket, even one as apparently attractive as the UK stock market, increases exposure to risk. The BP oil spillage in the Gulf of Mexico prompted the company, which is usually one of the largest dividend payers in the UK, to suspend dividend payments.

Maitland says BP and Shell have historically accounted for 25 per cent of UK dividends, making investors vulnerable to unforeseen crises at these companies. "In recent years, we've consistently advised our clients with high investment in UK equities to have more money in overseas equities," he says. "This has helped them reduce the negative effect on UK dividends caused by the banking crisis and, later, BP's problems."

Having investments in overseas markets also enables charities to benefit from higher growth in certain countries. The charitable foundation Trust for London, for example, has moved significantly into overseas equities in the past three years, says Carol Harrison, finance director.

She says all investors are trying to diversify in order to get the best returns. "But the room for manoeuvre is much tighter at the moment because there are fewer options available than when things are going well," she says.

Dealing with investment managers

The increasingly difficult task of choosing the right investments and getting the best returns has highlighted the importance of regular contact with investment managers. "We pursue an active dialogue with our investment managers to discuss whether we should be investing more in one geographical area than another," says Harrison.

The move to greater diversification of equity portfolios is also leading some charities to seek more specialist fund-management services.

"We've moved towards appointing specialist managers for specialist areas, such as overseas equities, rather than having a general manager deal with the whole portfolio," says the National Trust's Copestake.

With money tight, fees are also likely to be more closely scrutinised. "If you're paying your investment manager a 1 per cent fee and he or she is making you 12 per cent a year that might seem fine," says Maitland. "But if that return shrinks to 7 per cent, it's a different situation."

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