Focus: Finance and Governance - Outlook - Total return could be the best option

John Hildebrand, head of charities at Investec Asset Management

The past five or six years have been difficult ones for many charities.

First they saw their capital being eroded by market falls; then they realised their income was struggling to keep up with historic levels.

This has led many of them to look into ways of achieving higher incomes.

However, could chasing income lead to charities missing out on other opportunities?

Most charities want to see their incomes grow over the long term. That way they can commit to more projects and grow as organisations. With the gradual removal of the tax credit attached to dividends, many charities have been faced with falls in their incomes. If charities do not want to cut back on projects, they can invest for total return and add some of their capital gains to their income.

This presupposes that the trustees are happy to draw on capital and that the trust deed allows it. The trustees can also ask the Charity Commission for permission to adopt a total return approach.

Failing this, charities could invest in high-yielding assets, such as property. The risk in this case is that by investing only in high-yield assets they miss out on attractive opportunities in lower-yield assets and end up with a less diversified and hence higher-risk portfolio.

At present, Japanese equities yield only 1 per cent, compared with a yield on UK equities of more than 3 per cent, so they do not look attractive from an income perspective. However, Japanese stocks are trading on the lowest multiple of earnings for 20 years and should benefit from rising earnings as the Japanese economy picks up.

Rather than invest at the asset level in higher-yield asset classes, charities could also invest at the stock level in higher-yield stocks.

This has proved to be an attractive strategy historically, and in particular over the past few years.

However, this same strength in returns from high-yield stocks means that many of them have already performed and no longer look such good value.

High-yield bonds have also performed well, with the average spread on European Grade 'B' corporate bonds having fallen from more than 10 per cent to 3.5 per cent over the past four years. Clearly, the risk in buying corporate bonds when spreads are narrow is that charities suffer when spreads widen again.

Charities may have more opportunities now, but they still face tough choices. Adopting a total return approach looks superficially to be the most attractive option; the next most attractive is to invest more in high-yield assets. Both look better than investing in high-yield stocks at the moment.

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