Telling your equities from your hedge funds can be a daunting prospect for those without a financial background.
Yet a basic financial understanding is important in many roles - even if your day-to-day job doesn't involve reviewing investment performance or setting next year's strategy. The first step is to know what the investment options are and the pros and cons of each one.
The basic building blocks of a charity's investment portfolio should be cash, equities and bonds. These can be supplemented with property and, in some cases, hedge funds. Mian Ridge reports.
All charities need some cash to be easily accessible in bank or building society accounts for their running expenses. However, some also choose to invest some or even all of their capital in savings accounts. Banks or building society savings accounts give interest and are risk-free, and money in such accounts can be accessed easily.
The returns tend to be lower than those from equities, bonds or property, but sometimes charities have little choice but to keep their capital in savings accounts. This is often the case for smaller charities, which can have a hand-to-mouth existence and a small or negligible amount of capital.
Many charities keep their capital in savings accounts because they know they will need to spend it in the near future and cannot risk any of it being lost. The Passage, a homelessness charity in central London, has about £1.5m in reserves. It expects to use a large proportion of this on building work within the next couple of years, so the money is kept in cash form.
"We can't afford the risk of making serious investments at the moment," says Andrew Hollingsworth, finance director at the charity. "Our building is badly in need of repairs. If we needed the money to pay builders, and we had invested it and lost money, that would be a big problem for us."
The building conservation charity Save Britain's Heritage, set up in 1975, has always kept its capital in a savings account. Now that it is to receive a sizeable legacy, however, it is beginning to talk to fund managers to work out how it should make longer-term investment plans.
Bonds play an increasingly important role in charities' investment portfolios.
They are a kind of 'IOU': the issuer borrows a sum of money from the investor and pays regular, fixed interest. Both companies and the Government issue bonds, the latter often known as 'gilts'. Organisations such as the World Bank also issue bonds. Bonds can be bought directly, but more often they are bought as part of investment funds.
Bonds tend to be safer than shares and generate higher rates of return than savings accounts. The regularity of the income generated by bonds makes them an attractive investment choice for charities that rely on investment income. However, charities considering investing in bonds must balance the benefits of low risk and high interest rates with the fact that bonds do not generate capital growth in the way equities can.
Although bonds generally offer comparatively high rates of interest, this varies according to how risky they are. UK Government bonds are low risk and tend to carry low interest rates. Corporate bonds carry a higher risk and, consequently, higher interest rates. It is easy to identify the risks associated with bonds: rating agencies such as Standard & Poor grade them from the most secure - AAA - to the riskiest - D Bonds. Those without credit ratings are called 'junk bonds'.
Diversification is important in the bond market, too. This is most easily achieved by investing in bond funds.
RICHARD ROBINSON, group head of charities at Schroders Plc
"I have three pieces of advice: first, investment is a marathon, not a sprint. It's about the long term, not the short term.
"Second, good investment is about a broad level of diversification.
"Finally, don't believe everything you've been told - the financial services industry has made an art of the half-truth."
WILLIAM CUSSANS, Head of charities at Smith & Williamson Investment Management
"There is no golden rule. It is impossible to generalise about how charities should invest because they are all completely different.
"Charities need to ask: 'What are our objectives and how will we best achieve them?'
"Charities must be careful. They should look at bespoke portfolios rather than at funds only. However, that can be difficult because bespoke portfolios generally need more than a million pounds."
Equities - shares in companies listed on the stock market - still make up the lion's share of charities' investments. Charities can make money from equities in two ways: first, they can expect to be paid a dividend (a share of the company's profits); second, the value of the shares can increase (known as capital growth). However, the value of shares can also decrease.
Most large charities invest at least 50 per cent of their money in the stock market. The Royal British Legion, which supports those who have served and are serving in the armed forces, has funds of more than £200m.
Most of it is in physical property, much of which has been donated to the charity. But between £65m and £70m is in the hands of a firm of investment managers.
"We have had bonds and cash in the past, but currently it is all in a segregated portfolio of shares," says Roger Foreman, finance director of the charity.
UK equities tend to pay dividends twice a year. This provides a useful source of income and has served charities well in recent months. A survey by WM Performance Services shows that charities have seen returns of 25 per cent over the past year - growth built on equity.
"Some charities are concerned that, because the markets have risen back to their 2000 levels, they should be more defensive," says Ruth Murphy, director of charities business development at fund manager Newton. "We would be careful about that because it is still possible to earn very well." Murphy adds that diversification remains essential, both between asset types and within the stock market. Charities should play it safe by investing in different sectors and in different-sized companies, she says.
Some charities also invest in private equity by buying shares in businesses not listed on any stock exchange. This can take the form of investing in a new company, which may be riskier than investing in a well-established, listed company. Money in private equity also tends to be locked in for longer.
At the most basic level, charities can buy physical property themselves as an investment, but this is one of the least common ways that charities invest their money. Many charities own property because it has been donated to them or because a building is required for their operations (like a school or nursing home), but few actually set out to buy a building purely as an investment.
A more common way of investing in property is to buy shares in property companies or invest in a property fund. The Charities Property Fund, which lets on long leases to carefully vetted tenants, is a popular choice because it is exempt from stamp duty.
Property can be expensive and time-consuming to maintain - more expensive than bonds or shares - but it can provide a strong and long-term income stream in the shape of rent.
There are, of course, some risks: property prices may fall dramatically or it may be difficult to find tenants. And if a charity needs to get its hands on money quickly, property assets are unlikely to help because it can take a long time to sell a building.
In the long term, property investments have provided greater returns than government bonds, but lower returns than equities.
Hedge funds take advantage of loopholes or inefficiencies in the financial markets - such as the difference between share prices in London and New York - to make money.
They are 'funds of funds' that use a variety of methods, such as derivatives, borrowing and selling stock and betting on movements in markets. Hedge funds use these techniques to make a real return even when markets are falling. Although they offer protection when the market falls, they generally perform worse than the general market when the latter is rising.
However, hedge funds have been accused of disrupting financial markets.
Among the most controversial practices of some hedge funds is 'short selling' - when a fund borrows shares from investment institutions and then sells them, with a view to buying them back for less when the price has fallen.
Some commentators are concerned that hedge funds are not compatible with the philosophy of socially responsible investment: charities can't be sure where their funds are invested because investments are moved around so quickly. Some believe that too much financial risk is involved.
However, fund managers argue that they can ensure a charity's position is not compromised by taking a view on whether stocks are suitable or not before they are purchased.
The Charity Commission says investing in a fund of funds can reduce risk, but it stresses that hedge funds remain a complex form of investment for which expert advice is essential.
Despite the controversy, hedge funds have become increasingly popular with charities since the Charity Commission approved the first common investment fund that invests in hedge funds in 2002.
CASE STUDY - ARTHRITIS CARE
Arthritis Care has reserves of £2.7m.
Local branches manage some of this money, but £1.2m is managed centrally.
The charity has recently changed its investment strategy to take advantage of global markets.
"We don't rely on the income from our capital, thanks to legacies and so on, which really frees us up to take advantage of the world economy," says Elizabeth Lenderings, director of resources at the charity.
"We used to have much more UK equity; now we have more international investments. We can leave money sitting there without worrying about getting income from it. It gives our investment managers much more freedom, and last year we got a 17 per cent return on our portfolio."
The charity currently invests 34 per cent of its money in overseas equities and 49 per cent in UK equities. The remainder is in cash and government bonds.