FINANCE: WHAT COURSE IN THE STORM? - Free-falling equity markets and changes in the Trustee Act mean there has never been a better time to reassess investment strategies. Charlie Jacoby asks the experts what they recommend


"We've looked at property,

says Korner. "We are attracted by the yields but we don't believe there will be any capital growth. We are not mad about hedge funds. Their cost structure of up to 5 per cent if they perform well, means these things have really got to motor to earn their keep."

Newton is about to sign up to Ethical Investment Research Information Service software that screens client portfolios by ethical criteria. Korner says it's a false assumption that ethical funds under-perform.

"Most of the charities that we currently manage which have an ethical policy are filled with more traditional negative avoidance criteria,

he says. "There is a bit of a shift but not a seismic one to being more concerned with broader socially responsible investing in companies with good environmental and social records.

"The key is to be pragmatic. The policy has to be sensible and the fund manager's ability to implement it has to be clearly debated."


JP Morgan Fleming is blessed with pragmatic charity clients. "The majority of the bodies that we act for are mature, long-term investors and they take the view that there's short-term disappointment,

says head of charities James Saunders-Watson. "More often than not these upsets provide buying opportunities instead of selling opportunities. There's no panic."

Saunders-Watson maintains that strategies haven't changed as a result of the markets but rather as a result of falling incomes. "The thinking about what you do in order to support your objectives started as a result of the changes to the Advance Corporation Tax (ACT) regime in the 1997 budget,

he says. "ACT was one of the main drivers in getting trustees and fund managers to think about their objectives."

JP Morgan Fleming has a culture of investing in anything suitable. The routes to investment in property or bonds are not barred as they are at some asset firms. "We have always invested a lot in property, because it's a better income return than from bonds,

says Saunders-Watson.

"We invest in corporate bonds within our bond portfolios, but there is a note of caution. We would never recommend junk bonds to a charity unless they suggested it. One of the greatest skills in the market is to preserve the assets rather than to lose them."

About a third of Saunders-Watson's clients have an ethical policy of some kind. It tends to be on an exclusion basis rather than socially responsible investment. Only 6 per cent of that third implement a social responsibility policy. "There are charities which have been keen to be trendsetters in this game but generally the trustees have been trying to maximise returns,

he says. "There is potential for growth in the ethical world but it won't be taken up with speed."


Cazenove's approach to charities is to meet their investment objectives by putting money into bonds and equities, predominantly UK equities. Some charities invest overseas, according to their benchmark and their need for income, because dividends are less available overseas.

Poor equity returns have prompted the firm to broaden its approach to charity clients to address two issues: lack of income from bonds, equities and cash, and volatility and risk.

"Specifically, we are looking to include commercial property through property pooled funds managed by third parties; and pursue an absolute return strategy by launching a fund of hedge funds and an equity income fund,

says Nicholas Reid, head of charities at Cazenove. "We include corporate bonds in the firm's Income Trust for Charities common investment fund but only higher credits as we do not want to take much credit risk."

On the subject of ethical and socially responsible investment, Cazenove provides an automatic negative screening for tobacco. Otherwise, screening is specific to each charity client for its UK equities. "Our investment process considers sustainability issues when evaluating a company's suitability as an investment and, in particular, whether they are reflected in the stock market's valuation of its shares,

says Reid.

Cazenove has two new products for the charity market. The Absolute Return Trust for charities, approved by the Charity Commission, is the first common investment fund for hedge funds. Advised by hedge fund specialist Fauchier Partners, which has been working with charitable status funds for some time, it launches in the autumn. And the Equity Income and Growth Trust for Charities is a new common investment fund where the primary objective is to invest in UK equities to produce a yield premium to the FT All Share Index yield of 130 per cent and is due to launch in 1 November.


Baring's Andrew Raisman maintains that his approach has not changed because of the stock market slump of the past few months. He admits, however, that his approach has been evolving over the past couple of years. "Moving on from the basic total return approach, which some of our clients began to adopt in the late 1990s, we've been trying to encourage a number of them to widen the asset classes they're interested in,

he says. "We want clients to go beyond the traditional equity and bond split towards private equity and hedge funds. For those who have not invested in property, we want to encourage clients to invest there."

It has two products to encourage clients to look at alternative asset classes. One is its Private Equity Fund - a feeder fund for the Baring Collar Secondary Fund, that invests secondary private equity in private equity portfolios. The minimum capital needed is $10 million to get into this fund. Baring brings smaller amounts of money in, with a minimum investment of just $100,000.

Collar buys private equity from institutions if, for example, they need to make an asset allocation change or if they need liquidity. So secondary managers can usually buy these at a discount.

The other product is a fund of hedge funds. Baring's Hedge Select Fund is managed by Baring Asset Management but the research into the hedge funds is outsourced to a New York-based group called Optima. Optima selects funds, which Baring then ratify. "We have 30 that we invest in at the moment,

says Raisman.

He has not even tried to persuade charity clients to look at high-yield or emerging market vehicles. "Though it's an area we like and we have a successful product in which charities can invest, we haven't even tried it out on them. To start with, we want to introduce charities to low-volatility investment classes."

Raisman believes charities are weighed down by their adherence to benchmarks.

"We are encouraging our clients to look away from peer group benchmarks to look instead at what their needs are. What is their foundation in place for? It's not just for trying to invest money in order to beat the competition,

he says.

A couple of Baring's clients have scrapped the benchmark altogether and set an objective to hit an absolute return on an annual basis. The firm believes that 4.5 per cent is reasonable, based on the premise that markets won't return over the next 10 to 20 years on the same level as in the 1980s.

The poor performance of the stock market worries a number of charities, according to Raisman. "A lot of charities which don't necessarily have the investment expertise, still have the mind-set that they're going to continue getting the sort of double-digit return from equities that they got in the 1990s. We are saying we don't expect that to happen,

he says.

As for ethical investment, Baring is able to offer some customisation of portfolios if clients want it. Raisman leaves you with the impression that he considers socially responsible investment as a fad. "It's not our core product line, but we are happy to exclude, for example, tobacco stocks."


Charities with long-term investment intentions should not change their stance in reaction to the market movements, says CCLA's managing director Andrew Gibbs.

"The key distinction for any charity is to know in their minds whether they're investing for the long term or the short term,

he says. "The point of distinction we make is whether it's for over five years or under five years. Those who have invested for five years-plus should consider equity, bonds and property in that order. If they have funds which they know they're going to need to use within five years, they should place it on deposit."

CCLA's immediate response to poor stock market performance has been to vary asset allocation in the discretionary funds it runs for charities.

In some instances, however, the charities' mandates predetermine how their assets should be invested. "We consider that it's right to invest 80 per cent of a discretionary fund in equities and the remaining 20 per cent in bonds and property,

says Gibbs. "We invest in both gilts (government bonds) and corporate bonds, but generally investment-grade corporate bonds. When it comes to equities, we pay attention to income considerations without having either a commitment to 'growth stocks' or 'value stocks'."

On the question of ethical investment, CCLA occupies some moral high ground by running Church of England funds. Anglicans have their own ethical investment advisory groups that "set the standard for others to follow,

according to Gibbs.

CCLA has also produced a leaflet on socially responsible investment.

Gibbs makes the point, however, that the primary duty of trustees is for the charity's beneficiaries, which is usually achieved by producing best return. "Broadly speaking, the funds themselves are not promoted as ethical funds,

he says, "but these funds avoid investment in companies whose main business is gambling, tobacco or arms."

CCLA's new charities property fund is scheduled for launch on 26 September.

"We consider it good estate management to look at the nature of tenants when buying property, for example,

says Gibbs. "Our main SRI position is with environmental care, where we take care that we acquire or redevelop properties with regard to environmental consequences."


Deutsche Asset Management is emphatically not cashing in on its charity clients' holdings. Vice-president of charities David Bailey maintains that they remain, "fully invested all the time. We felt no need to change strategy".

In common with fund managers across the City, however, Bailey admits that he is making sure there is a wider allocation for assets in other classes, such as hedge funds and property.

It boils down to Deutsche's risk-control model. "We run a very tight risk-control model. We're not taking additional risk because we have tight guidelines on risk control. And these were in place before the downturn in the market."

But he also says that investment houses should consider low-grade credit in order to achieve high yields.

Bailey's main problem is convincing charities to part with cash when depositing it seems to be relatively so profitable. Deutsche is launching a new fund, but it is not aimed specifically at charities.

"There's not a lot of merit in splattering the sector with products that are unfulfilled in their take-up by charity trustees,

he says. "Those charity trustees would rather sit on the cash."


David Kidd, chief investment officer and deputy managing director of Chiswell, is one of the few managers to take advantage of equities' low value to go on a buying spree. "In a small way, we've been taking advantage of low equity prices and selling bonds to buy equities - but that is just 2 or 3 per cent of portfolios,

he says.

He also points out the major advantage of markets in turmoil is that charity trustees have to think hard about what they want to invest in.

"Some charities have been carrying out a fundamental review of their spending plans - either because level of income on portfolio is not as high as they would like or because the capital gains are not there,

says Kidd.

"The other thing that's happening is that they are engaging in dialogue with fund managers. They want to know 'Is this a once-in-a-lifetime buying opportunity?' or 'Is this the end of equity markets?'."

One important item is the length of investment term. "We used to say that you shouldn't invest in equities unless you don't want the money for three years,

says Kidd. "Perhaps that should now be five or seven. And this is at a time that charities are looking at not putting money into one pot."

To say that charity investments are experiencing some turbulent times would be rather like calling the "perfect storm

a bit of choppy water. Take Guide Dogs for the Blind, which is reported to have seen a £20 million fall in the value of its investments. Or the RNLI, which lost more than £36 million on the markets last year, or Barnardo's, which is believed to have lost £6.8 million in 2000/01 and a further £1.3 million last year.

With that in mind, charities like the diversification that investing in other asset classes offers, even if they are higher risk than equities traditionally have been. In Kidd's experience, several charities are looking at having the bond exposure not just in government bonds but higher yield AA-rated bonds. But he says that most charities are wary of hedge funds.

"There's a big ethical debate about whether charities should be looking at hedge funds,

he says.

All of Chiswell's charity clients have an ethical policy in one form or another. To Kidd's regret, in the past few months, the so-called "vice

stocks such as tobacco and alcohol have been showing the best returns of all. "Our business is to understand the client's ethical policies,

he says. His advice is: "On balance, if you're between two investments, go for the more ethical."

Investment managers are under pressure as never before to perform the seemingly impossible - preserve both income and asset values while reducing risk. For some charities, the choice is limited to keeping a cool head and hoping things turn round.

Ron Green, senior marketing executive at the Charities Aid Foundation (CAF), says: "We haven't seen a huge response by the charity sector in relation to the stock market's moves. The view that most people take is that you have to take a medium- to long-term view. That's what the majority of charities have been doing. When the stock market drops by 30 per cent, there's a fear that you're going to be exiting at exactly the wrong time."

The pressure on investments, coming at roughly the same time as changes in the Trustee Act, which now allows charities greater flexibility in their choice of investments, means there has never been a better time to reassess strategies. Some of the remedies being proposed by asset managers are more far-reaching than the sector might have seen a few years ago.

CAF has seen above-average investment in the past 12 months in its income fund, which is based on bonds and gilts and has been less volatile than equities. It's a safer environment for spare cash and reserves, and this movement is exactly what one might have expected. But there is also considerable interest in alternative asset classes such as property and hedge funds.

So what exactly are investment managers recommending? Third Sector asked a cross-section of the leading ones how, if at all, their strategies and recommendations have changed. We also took the opportunity to survey them on their attitude to ethical screening and socially responsible investment.

Here, as with market conditions, charities seem to want their cake and eat it. Henderson, for instance, takes a strong ethical line for charity clients. Most, however, think that ethics are fine as long as they don't hit the bottom line. There is a sense that charities are morally as well as legally obliged to make the best return on their investments, even if it means not taking too strong a line ethically.

The view of David Bailey, vice-president of charities at Deutsche Asset Management, is typical. "We don't set out to be a house that is here for the ethical investors and not the other,

he says. "We tailor our portfolios on the ethical side to meet the demands of our charities."

The words "meeting the demands of our charities

could sound like Bailey is lining up to blame his clients if their portfolios sink without trace - ethics or not. But the truth is the belief is that the market is not that bad. And as long as nobody panics, or buys too much risk, fund managers are convinced they will make it to a safe harbour. There is just a tinge of regret that the boom of the late 1990s seems so long ago.


Schroder's basic approach hasn't changed much for clients with long-term investment portfolios.

"We recommend that the bulk of investment - typically more than 50 per cent - is in equities, with the remainder invested in bonds and other assets,

says head of charities Jean Smith. "We have talked to clients about alternative asset classes such as private equity and hedge funds. In November last year, the annual Schroder Charity Forum focused on alternative asset classes, including property."

As the market has taken a tumble, Schroder's response has been to be more selective about stocks. "In the past six to nine months we've focused on companies with solid balance sheets and financial strengths,

says Smith. "But they're not necessarily all FTSE-100 companies: we find small- and medium-sized companies which fit the bill as well."

Smith claims the company has not modified its attitude to risk for charity clients as a result of changes in the market and the law. "Risk should be given as much consideration as potential reward and this is something we have long focused on with clients,

she says.

Property and corporate bonds have formed part of Schroder's portfolios for some time. Managers have talked to charity clients about private equity and hedge funds, but they strongly recommend a fund of funds. Smith does not consider "high-yield

bonds a mainstream asset class, but offers a "Credit Renaissance Fund

to clients on request.

Like most City firms, Smith says Schroder will screen portfolios for ethical nightmares. "We have some clients for whom we adopt negative screening when that company's business is contrary to the objectives of the charity. We do that on a case-by-case basis,

she says. "We adopt socially responsible investment criteria - a positive, engagement-based approach as part of our investment process in the UK for every client, including charities."

Similarly, in common with most asset managers, Schroder does not offer specific products to the charity market but has a number of new products that are equally applicable to charity clients as to other clients. "Private equity, for instance, and a more 'absolute return' type of UK equity portfolio,

says Smith.


Rathbones' portfolios have become more defensive in their positioning, both in equities and in trying to increase the fixed-interest position.

The priority is to preserve capital. "The more defensive equities are the high yielders, which puts more of a floor under the shares,

says investment director Julian Rathbone.

He will consider alternative asset classes such as corporate bonds, property or hedge funds depending on each client's wants in terms of income.

"We're focused on investment-grade corporate bonds - certainly nothing near junk status,

he says. "We don't invest in hedge funds, as clients are still nervous five years on from the collapse of Long-Term Capital Management in the US."

Rathbones has a team in Bristol dedicated to checking companies' ethical credentials, but Rathbone says he is guided by each charity he represents.

"We're driven by the trustees, and even the trustees can't use their own principles and morals. Ethical policy has got to be relevant to the charity.

We look after charities on a segregated basis. Each account requires us to work within the parameters of what the trustees want. We don't do a package for all charities,

he says.


Charles Mesquita, charity specialist at Carr Sheppards Crosthwaite, begins his relationship with a charity client by working to understand their attitude to risk and whether their objectives are achievable. For Mesquita, it's about identifying and implementing an appropriate strategy: what a charity wants to achieve over a reasonable time period.

The firm has not changed its strategy since the downturn, but Mesquita admits that some clients are "like everybody, a bit bemused".

"Nobody likes to see money lost, even on paper,

he says.

Keeping communication channels open has given them comfort. The other thing is to stop people concentrating on the short term. When the market starts playing to sentiment and not to fundamentals then charities just have to hold their nerve."

As for widening asset classes within portfolios, Carr Sheppards Crosthwaite recommended property years ago. "Risk is a matter of balancing a portfolio,

says Mesquita. "You want a progressive income stream, and you're not going to get that from bonds."

Mesquita does not believe in off-the-peg products but prefers to provide tailor-made solutions. He warns charity trustees to "understand what you're investing in. Be especially careful if the product is flavour of the month. These can have a place in the portfolio as long as the trustees understand the risks with asset classes such as hedge funds. Common sense wins through every time."

As for ethics, like most other asset managers, Mesquita will do what he is told. "The Government has asked pension funds to make a statement about their investments,

he says. "But it's a grey area. The problem is, the further you dig, the more complicated it becomes. If you're an animal welfare company, do you ban all government or bank investments because those organisations have a hand in animal testing by funding it or permitting it?"


Jamie Korner, director of Newton Charities, says that despite the vagaries of the market, he is trying to give a broad spread of global companies that Newton thinks will show sustainable growth.

In November last year, Newton launched a common investment fund for charities, authorised by the Charity Commission. Balanced between equity and fixed interest, and UK and overseas, it is so far beating its benchmark.

One edge that the company has is mixing its equity and credit analysts, says Korner. "If you have an equity analyst and credit analyst working together, they throw up things that wouldn't come out if they were working alone."

Analysts are the key to riding out the storm in the market, says Korner.

He is also taking a cool look at risk. "Where you have two stocks in the same field but on different ratings, we choose the one that suggests lower risk, whether it shows higher or lower reward."

Newton positions itself as a lower risk player, so performs better against its competitors in bear rather than bull markets. "We've been holding fewer equities for the past two years than our competitors,

says Korner.

"We didn't hold any European telecoms apart from Telecom Italia because we couldn't see the fundamentals in them."

Newton's belief that plain equity and cash bonds give as good returns as newfangled property and hedge funds has kept them away from alternative asset classes.

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