Two reasons to keep faith with equity investments

European chaos has tested the mettle of charity investors, but you should keep faith with stocks and shares, says Kate Rogers of Schroders

Kate Rogers
Kate Rogers

Investment markets over the past three months have tested the mettle of hardy fund managers, let alone voluntary members of charity investment committees.

Equity markets lurched lower as European politicians failed time after time to reach an agreement. They got there in the end, at least in broad terms, although time will tell whether it is carried through. At least it allowed all of us involved in investing for charities a brief respite from the red screens and negative numbers.

But these volatile markets have left many investors shaken and questioning the inclusion of such an exposure to equity investments in charity portfolios. But what options are there for a risk-averse charity investment committee?

Cash is an obvious low-risk choice, at least as long as the institution that you choose to deposit with is stable. My advice to cash-rich charities is to check your counterparty exposure and spread the risk where practical. The European sovereign debt crisis could still spread to the banking sector. And although cash might be relatively safe, the available returns are low. In fact, charities keeping cash are guaranteeing a loss in 'real' terms, because inflation is much higher than the rates on offer. For long term investors, then, I would argue that cash is not particularly attractive. What about bonds?

Government bonds have performed very well this year. The UK is seen as a 'safe haven' and overseas investors have been happily lending their money to the government. However, the yield on 10-year government bonds now stands at 2.2 per cent, well below current inflation. Again, I'm not convinced that this is a good idea for long-term investors.

So where can a long-term investor look for inflation protection? Perhaps property, where at least yields are still attractive, although I suspect capital growth will be a little harder to find. And what of equities?

In my opinion there are two reasons for keeping the faith with equity investments for long-term investors. The first is income growth. The UK equity market is currently yielding 3.5 per cent, which, although not enormous in absolute terms, compares favourably with the paltry rates available on cash deposits and government bonds. This income is also growing, with expected dividend growth this year of more than 15 per cent and a similar double-digit growth expectation for next year. The importance of this for the charity sector should not be overlooked. Income growth enables charitable expenditure to grow, both in absolute terms and ahead of inflation. As a comparison, investing in bonds is a one-way ticket to the erosion of real capital over the long term, and although income is more certain, growth in income is impossible.

The second is inflation protection. Most charities are inherently long-term investors. As a result, protecting their capital base against the ravages of inflation is key to the preservation of value for future beneficiaries. Long-term studies show that equities can offer inflation protection. There is, however, a cautionary message from these studies. There can be decades in which equity markets do not meet return expectations, and as such your investment committee needs to be able to stomach the volatility of equities and remain committed. There is nothing more damaging to long-term asset value than capitulation, or selling out of equities when all looks bleak. Not all equities are created equal and I would counsel an active approach to choosing which companies to invest in.

I might be brave, and I may feel foolish at times, but for long-term investors I believe that inflation is the key risk. And for that reason good quality equities and property are the assets of choice.

Kate Rogers, Client director, Schroders.

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