Spreading the risks
This view is echoed by James Saunders Watson, head of charities at JPMorgan Fleming, who says a growing number of charities are attempting to tackle increased market volatility by diversifying their investments.
"It's about looking across the portfolio and not having all the assets moving in the same direction," he says, noting that property and bonds, for example, tend to perform well when the equities market is doing badly and vice versa.
The extent to which a charity will invest in some of these alternative asset classes will depend on the organisation's needs, he says. A property fund will provide an income stream, while hedge funds and private equity investment generally do not, although they may give a good return at the end of the investment term.
But, on the whole, for long-term investors the equities market is still viewed as the best place.
"We've moved marginally into cash and bonds but, on the whole, we are sticking with equities because we think the market will recover," says WWF's Les Jones.
Saunders Watson, of JPMorgan Fleming, notes that a recent study by Barclays Capital of investment returns going back 102 years, showed equities offered higher returns in the long run than cash or gilts. But it showed that investors needed to be in the stock market for significant periods, not just a year or two, to benefit.
"The study showed that in any 10-year period equities were likely to outperform cash by 97 per cent and gilts by 85 per cent," says Saunders Watson, adding that the outperformance, when measured for two-year periods, was much less.
WHAT THE FINANCE EXPERTS THINK
JAMES SAUNDERS WATSON, head of charities, JPMorgan Fleming
The charities worst hit are those that have been spending a proportion of their capital to fund services, rather than those relying purely on income from investments.
We recommend that investors seek to achieve 'risk adjusted returns' - in other words, to smooth the returns from their investments. This means having a diversified portfolio. Research shows that over the long-term the stock market is likely to perform much better than cash or bonds.
For any equity investor, timing is crucial when deciding when to invest and when to sell. You might get out at the right time but will you get back on at the right time?
JOHN HILDEBRAND, fund manager, Investec
Different charities have different objectives so it's crucial for charities to check that their investment strategy is appropriate. Some charities may feel that being in the stock market is not the best approach.
Investors need a balanced approach, which means not putting everything in one basket but having a mix of assets. We expect some economic growth this year, albeit slight, which means there should also be some growth in share dividends.
We regard UK equities as attractively valued and there has been a bounce back since mid-March. It's possible interest rates could fall further, which will put even more pressure on income for charities.
JOHN DALE, charity client relationships manager, Allianz Dresdner Asset Management
The real problem facing the sector is declining income flow. Charities are finding it hard to achieve the income they need, especially with the abolition of advanced corporation tax relief. They are cashing in gilts they bought 10 years ago and are finding it hard to replace them.
The appreciation of the corporate bond market has been a slight compensation, but the bond market can change quickly.
Some charities have been able to increase their income by moving into areas like corporate bonds and property, particularly as there are now two property common investment funds.
DAVID KIDD, chief investment officer, Chiswell
There's a polarised situation with some charities relatively unaffected because they've protected their income, and others hit hard because they were expecting to spend capital and found that capital eroded.
While charities should be looking at the full range of investments, they should bear in mind that equities are cheap. Our clients that invested in equities recovered as much in April as had been lost in the first three months of the year.
We expect equities to do quite well over the next 18 months but, of course, there are always uncertainties. One risk is that a rise in the stock market will lead investors to sell equities and buy bonds.
The plunge in the stock market has eaten away at charities' income. But a diverse portfolio and a long-term view can improve their prospects, says Patrick McCurry.
Rarely has the environment looked so gloomy for charities that rely on income from financial investments to fund their work. The same goes for charities that depend on legacy income or that have to fund final salary pension schemes.
With three years of stock market falls, historically low interest rates and the abolition of advanced corporation tax relief on share dividends, many charities are having to cut costs.
Les Jones, finance director at WWF-UK and deputy chair of the Charity Finance Directors' Group, says: "Charities that rely on income from reserves to meet operating expenditure are being hit, not only because share prices have fallen but also yields and legacies. At the same time, many may find their levels of grant income at risk because charitable trusts have seen their own investments fall."
Nicholas Baring, chair of the Baring Foundation, says: "We rode the upturn in the stock market in the 1990s and now there's a painful adjustment."
Like many grant givers, the Baring Foundation relies on stock market investments to fund its programmes. So far it has only had to cut back slightly on its grants but further squeezes cannot be ruled out, according to Baring.
At the beginning of 2000, the foundation adopted a "total return" investment strategy, meaning that instead of just spending the income from investments, it reinvested that income and spent a percentage of the capital.
A total return approach is fine when the stock market is going up, says Baring, but uncomfortable when it is falling because then the charity's capital is eroded.
"We've had to cut the percentage we take from our investments in the current year and we'll be taking another look at the percentage of capital we are willing to spend on grants later this year," he says.
In response to the problems, the foundation took some money at the beginning of last year from the stock market and put it into property funds and hedge funds, which are investments based on derivatives and aimed at protecting investors from falling markets.
In a survey of charities with investment portfolios, published by JPMorgan Fleming in February, more than half the charities questioned said the fall in the market was affecting their work. More than a third of the charities said they'd reduced running costs as a result of the problems.
This finding does not come as a surprise when you consider that never in living in memory has the stock market fallen for three years in a row.
From its peak of 6,950 at the end of 1999, the FTSE-100 index had fallen to 3,609 last September - a plunge of 48 per cent.
After a rocky start in the first three months of this year it recovered somewhat in April and by early this month was hovering around the 4,000 level.
At the same time as the stock market fall, low inflation has meant that interest rates have been extremely low. This means lower nominal returns from cash deposits and bonds.
For some charities the financial environment has been highly damaging.
RNIB, for example, is making 100 of its staff redundant in response to a financial crisis largely fuelled by falls in the stock market.
Others, while affected, have been protected by alternative income sources.
RSPB, for instance, has been cushioned by the fact that contributions from its million-strong membership are a major income source.
The charity does not rely on stock market reserves for its everyday spending, explains RSPB's financial director Alan Sharpe. Its policy is to keep a high level of reserves - about 18 months' spending - in liquid investments like cash.
"A high level of reserves means that if some catastrophe hit our income we'd be able to wind down our programme gradually," he says. "So far our investment losses have been mainly on paper."
Pension funds feel the pinch
But the charity has been hit in one area: its final salary pension. Because of falling stock markets, among other factors, charities with final salary schemes are increasingly faced with deficits.
RSPB put a £2 million cash injection into its pension earlier this year and may have to find more money in the coming months to maintain the pension within the funding rules.
"Obviously that's affected what we can do in the future and means we can't expand our programme as we would have liked. It will mean there is less money for land acquisition and conservation," says Sharpe.
It was at the beginning of 2002 that charities began to realise they had a real problem on their hands. Private companies and pension funds were also being hit, according to John Dale, charities client relations manager at Allianz Dresdner Asset Management. Pension funds have probably been hit hardest, he says, because they have less room for manoeuvre and are having to pay much more for pension annuities.
So what can charities do to mitigate the problems?
Clearly, the kind of action taken will depend on the individual circumstances and objectives of each charity. For genuinely long-term investors the best advice is to sit tight, says David Kidd, chief investment officer at investment house Chiswell.
He argues that equities are currently cheap, particularly when compared with bonds, and so this would be the wrong time for investors to get out of the stock market.
"If a charity can afford to, it should stay in equities and any investor in equities should be looking at a five-year time period for their investment," he says.
Kidd believes there will be a stock market recovery this year. There was already a significant bounce back in April, partly because market fears that there would be a lengthy war in Iraq were found to be exaggerated.
"We expect equities, especially UK equities, to do quite well over the next 18 months. They've already recovered from their low point of 3,300 on 12 March," he says.
As an indication of how attractive equity investment is, he points to the fact that in March it was possible to buy equities that were yielding as much as bonds. This was remarkable given that bonds do not generally offer the same potential for capital appreciation as equities, and it was the first time this had happened in 40 years.
John Hildebrand, fund manager at Investec, agrees that for long-term investors, the stock market is best.
"This is not the best time to move large sums out of the stock market," he says.
But he adds that each charity must assess its investment objectives.
For charities that are not able to invest for the long-term, investments other than equities may be more appropriate.
Dale says there has been some transfer of money from equities to alternative investments such as corporate bonds and property funds, particularly with the launch of two property common investment funds aimed at charities.
"We've put some of our funds into other assets as part of a wider diversification," he says.