Successful investment portfolios rely on a realistic strategy.
When is a benchmark not a good benchmark? When it bears no relation to what you're trying to do.
In his 2001 review of the institutional market, Paul Myners recommended that "trustees should set an investment objective that represents their best judgement of what is necessary to meet the fund's liabilities". He added that "objectives should not be expressed in terms which have no relationship to the fund's liabilities".
These sentiments were echoed in the Chips report, published later by Acevo. Yet many charities have failed to heed them, either within their investment portfolio or, worse, in their final salary pension schemes, leading to a significant mismatch between strategy and purpose.
This has become an acute problem in the UK; a recent report by Watson Wyatt suggested that public sector pension liabilities amount to almost £700bn, while estimates for the private sector deficit range between £50bn and £60bn.
The issue for charities is no different. For too long, charity trustees and finance directors have focused on beating the WM, Caps or FT All-Share benchmarks, with little or no regard for the overall effect this might have on achieving their long-term objectives.
Charities need to refocus their attention on two simple questions: what is the money for, and how much risk can you take? Doing so will give context to the investment objective and should help determine the strategy for investment portfolios and pension schemes.
With charity investment portfolios, I would recommend trustees direct greater attention towards the size and duration of their organisation's commitments. In recent months, Merrill Lynch has created bespoke benchmarks that more accurately reflect these long-term needs, often moving significantly away from a peer group allocation and introducing a wider asset mix. Only by understanding these commitments, and the risk and return tolerances required to ach-ieve them, can overall expectations be met.
Many charity pensions' investment strategies have not delivered against their main objective: having sufficient money to fund future liabilities.
Increasing risk to boost returns may only exacerbate the deficit, while a reduction in risk can simply 'lock in' the problem.
The deficit issue is compounded for charities, which, unlike the private sector, cannot ask their scheme sponsor for a large cheque. Sadly, the reality can be much starker: reduce benefits or use charitable income to support the scheme. This latter option has significant PR implications.
The environment for charities is hard enough. Choosing the wrong benchmark can make it even harder.
Andrew Hunter Johnston is head of charities at Merrill Lynch investment managers
- A Watson Wyatt report has suggested that public sector pension liabilities amount to almost £700bn
- The private sector deficit sits between £50-60bn
- Charity trustees and finance directors have focused too much on beating the WM or FT All-Share benchmarks.