Will the high returns that were produced in 2013 lead charity investors to alter their investment stance in 2014? At the start of last year, the issues that the markets were worried about were deflation, whether the euro would survive and what the effects of a slowdown in China would be. Risk was perceived to be high and money poured into the perceived safety of bonds and into high-yield assets. As the year progressed and risk dissipated, riskier assets such as equities generated strong returns. Charities that had invested in low-risk assets such as government bonds generally lost money, but those that invested in more volatile assets, such as US equities, would have made about 30 per cent.
The trouble with such good news is that as markets rise the potential returns from them inevitably fall.
Equities cost more and investors become more relaxed about the prospects for the global economy. As the economy recovers, spare capacity gets eaten up and the prospect of inflation increases. The authorities have to consider when to push up interest rates and fear of this leads banks to focus on those borrowers who might not be able to meet higher debt payments.
An improved market also makes it easier to sell companies. Consequently, there have been claims that banks such as RBS have started calling in the debts of so-called 'zombie' companies, whose revenue generates only enough money to pay their current low-interest bills. So although better economic prospects are beneficial to many, they can bring problems for others, particularly those that have benefited from unsustainably low interest rates.
Political risk is also low, with no elections in the UK until May 2015. But there are European parliamentary elections coming up in May, and the right could garner a larger share of the vote. This could in turn fragment the vote of the mainstream parties and encourage them to veer away from the centre to attract votes. While better economic news should be helpful to the Conservatives, Labour still leads in the polls, and constituency boundaries mean that the Conservatives will need a much larger share of the vote than Labour to stand any chance of claiming a majority of seats. Hence, a coalition parliament is still a possibility.
Against this background, one has to question what the behaviour of charities with long-term assets will be. Initially the likelihood is that, even though the potential returns in 2014 will be less than in 2013, some will be tempted to take on more risk. How exciting is a 'cash plus 4 per cent' return compared with making 20 per cent on UK shares? In addition to shares, property will be on a charity's horizon given its high yield, even though it is an asset class that tends to suffer as interest rates rise - common investment funds invested in property are currently experiencing strong inflows. As the attractions of riskier assets increase, demand for bonds, gold, absolute return funds and hedge funds is likely to fall. So charity investors could well alter their investment stance during the year.
Our view is that the backdrop for equities and property will be good for the foreseeable future as growth picks up in the developed world while inflation stays under control. However, we are mindful that these benign conditions will eventually end and that a pause for risk assets in the next few months is quite likely. Higher yields on bonds and a strengthening currency will be the first signs that a change in the investment climate is imminent.
John Hildebrand is an investment manager at Investec Wealth & Investment