Rethinking your charity investment strategy

Third Sector Promotion The Business School (formerly Cass)

David Rowe, Visiting Fellow on Investment Management at the Centre for Charity Effectiveness at the Business School (formerly Cass) and tutor on the Charity Investment Course explains what the upcoming Charity Commission guidance consultation could mean for charity investments.

At the Centre for Charity Effectiveness we believe that it’s time for charity investment to look to become current and not anchored, unhelpfully, in the past. The Charity Commission agrees with this, which is why in January 2021 it announced a consultation as to the way forward for its guidance.

The starting points for charity investments are:

  • Charity Commission Guidance 14 (and the legal underpinning)

  • UK case law, which refers to Harries v Church Commissioners for England 1992

  • Harry Markowitz’s 1952 book, Portfolio Selection, identified that if portfolios were well diversified, there was little risk of great surprise.

Why do charities have investments?

A question often asked is: "Why do charities have investments when they should surely be spending all their money on supporting their beneficiaries in the moment?" Investments and reserves are critical in terms of being able to give funders confidence that the money they are giving charities will be used to continue to deliver long-term societal benefits and that they have enough money in their reserves to be able to use if needed.

Over the long term, investments allow you to have extra income or spendable returns to finance your long-term activities. From an internal point of view, investments provide a platform for budget planning as well as ensuring that your obligations to your stakeholders and funders can be met. Charities having investments is important and, in our view, not superfluous to their needs.

Maximising financial return

In the Charity Commission Guidance 14 and the legal underpinning, the concept of maximising financial return is key. It’s also key to the legal precedent. However, this often causes problems, not only for trustees but also for fundraisers and funders, on whether just matching an index return, or an agreed outcome, is the right way forward. How does this actually relate to a charity’s objects or public benefit?

Proving that the return you achieve on your investments meets your agreed benchmarks, targets and objects is important to a funder, too. If a funder were to look at your investment portfolio, and it underperforms its targets consistently, they would surely want to know what you were doing to address that issue of underperformance. They may view their funding as, in effect, giving your charity money to make up for the failure in governance in not having the right investment manager or policies.

Maximising financial returns is a question technically in the Guidance but, from a fundraising point of view, being able to show that your investment portfolios are well governed, and therefore have objects in return terms that are met, is another support to the idea that funders should be funding charities who have reserves and investments.

The Financial Conduct Authority (FCA) does not stress the importance of financial return

The FCA focuses on risk and loss rather than on maximising financial return and professional advisers can be held to account for taking too much risk. What we want, in the sector, is to get good investment advice from firms that understand our objectives, and what we want to achieve, and that they only recommend investments that meet those objectives.

Looking to the future

We will want to see the guidance rewritten to reflect that we are optimising the balance between risk and return. The questions that we can see being asked are:

  • Can trustees justify paying higher fees when evidence is that active managers underperform?

  • Are trustees expected to acknowledge flaws in index construction as proven by research?

  • Is sustainability a factor?

  • Is Smart beta a solution?

From a fundraising perspective, charities are trying to show that, if they have reserves and investments, they are then thinking about how to manage them to the benefit of their beneficiaries. Over the past six or seven years, we’ve seen sustainable investment become a large part of charity sector portfolios. We’ve seen US endowments retain their distinction as the top environmental, social and governance (ESG) incorporator. In 2020, 65 per cent of them had ESG as part of their outcomes.

Investments can ensure the continuation of services and activities for years, decades and even centuries, which provides comfort to funders. The legal precedent of Harries v Church Commissioners for England is now 29 years old and has restricted the way that some trustees are prepared to act. Funders will require an inclusion of sustainability or ESG factors into portfolios. The evidence is that this does not harm investment outcomes.

Our view is that we will not see a radical change with the Charity Commission guidance consultation but rather a move with the times. Harry Markowitz’s work on diversification is still the starting point to give comfort to funders, charities and beneficiaries in that the money is being used in an appropriate way to meet the objects.

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