Finance

Investing strategies for smaller charities is it time to take the leap?

27 October 2016

Should charities consider investing in shares which are traditionally seen as a riskier asset than cash or bonds?

Cash is by far the favourite asset class of charities, especially for smaller charities. However, as the following chart illustrates, holding cash is becoming increasingly untenable as an investment strategy because of the paucity of return.

Even in this relatively low inflation environment, the real value of cash funds are reducing each year.

This trend is set to continue, at least in the medium term because of the risks associated with the Sterling weakness which we have seen post the EU Referendum vote, making many goods and services more expensive. With Brexit, this situation could potentially get worse.

In 2017, UBS believes there may be a spike in inflation to over 2.5%, whilst in the longer term it thinks a figure nearer to the Bank of England's long term inflation target of 2% is realistic.

Either way, short term cash deposits are likely to deliver meagre nominal returns and negative real returns over the next few years. Negative real returns pose a risk to your grant-giving capability.

So what can a small charity do then to achieve better returns whilst also considering risk?

GBP Sterling Overnight Index Average: cash rates to remain low for some while

Source: Bloomberg, UBS (09/09/16)

When I was a Charity Finance Director in the 1980s, receiving a legacy windfall led me to consider a longer term strategy for our excess cash.

At that time, the logical next step was to move up an asset class and consider bonds which meant UK government debt (Gilts). Sadly, such an easy option is no longer available as Gilts are producing historically low levels of return (a 10 year gilt year yields c.0.8%).

Corporate Bonds are still an option, but as the traditional investors in government debt have needed to search for better returns, this asset class has now seen yields reduced.

At present, investment grade bonds are yielding 1.4% which, whilst better than cash at 0.8% in a one year cash term account, it raises the question - does the additional risk associated with Corporate Bonds justify the very small premium being paid for taking that risk?

So should charities consider investing in shares which are traditionally seen as a riskier asset than cash or bonds?

James Brooke-Turner, Finance Director of the Nuffield Foundation, challenged this orthodoxy in his Cass Business School Charity Investment Course Lecture and argued that, for a long term investor the "riskiest" assets are the safest.

His key proposition was based on the concept of investment over time.

Irrespective of size, charities need to consider one question – what is the money for? If funds are being held for short term cash flow purposes, then cash is the only asset to be considered and the dual focus is to get the best return but with the lowest risk. Remember the Icelandic banking crisis and the importance of choosing a well capitalised and safe bank?

However, many small charities, often due to their lack of confidence in cash flow planning, end up sitting on too much cash. Equally, many small charity endowment funds are being held in cash or bonds as they need to produce an income but their real capital value is being eroded by inflation. In the last ten years the real value of the pound has reduced by 25%.

Adopting the Brooke-Turner mantra, if a charity invests funds over a longer term – say ten years plus – then equities, far from being risky are in fact the exact opposite. Over this longer time frame concerns about market timing and fluctuating capital values recede.

Instead, if there is a steady income needed each year with a moderate expectation that the fund's value will keep pace with inflation, then good quality company shares that are producing dividend yields year on year of c.3.5% look remarkably good value.

Risks and costs associated with equity investments are usually the fear words which discourage smaller charities from investing in shares, but again, is this true?

First, let us look at risk. Rather than consider individual shares, instead, like a small private investor the charity should consider holding investments in an Open Ended Investment Company (OEIC). These organisations hold a basket of company shares or other asset classes and thereby diversify the risk associated with holding single company stocks.

Charities have had their own special vehicles called Common Investment Funds (CIFs) for many years that were set up to enable smaller charities in particular to enter the market. There have been concerns that CIFs and OEICs are expensive but fees paid are now much clearer than in the past due to recent regulatory changes.

With initial one off advisory fees of some 0.25% and then annual fees ranging from 0.35% - 0.75% once these are deducted from an average total return in the region of 6%, these returns are substantially higher than those on cash and worth consideration.

With all this in mind it may now be time for smaller charities to consider taking the leap into more proactive investing and reap the benefits.

Professor Paul Palmer is Director of the Centre for Charity Effectiveness at Cass Business School, City, University of London.

www.cass.city.ac.uk/cce @CassCCE

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Paul Palmer

Paul Palmer is professor of voluntary sector management and charities course director at the Cass Business School. He also acts as independent charities consultant to UBS Wealth Management

www.cass.city.ac.uk/cce

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