3 investment opportunities for charities

24 November 2017

In their quest for income, charities must consider where to invest now and the prospects for 2018 to safeguard their future…

Charities remain under increasing pressure to grow their income ahead of inflation. Ensuring that the real purchasing power of income is protected enables charities to continue to do more and to help safeguard their future.

Recent data from the Charity Commission (as at December 2016) confirms that sector income as a whole is experiencing a welcome period of growth; total annual income of £71 billion for 2016 represented a 2.9% increase on the same figure in 2015 and, backed by a 4.2% year-on-year increase in the total value of long-term investments, this enabled charities to increase annual spending in 2016 to £69 billion (4.5% more than in 2015). 

A positive trend

This is a positive trend in increasingly turbulent times, as charities continue to take on more responsibility for service delivery to society from traditional public sector providers. However, with many sources of funding under threat, income produced from investment portfolios is playing a more prominent role for many charities that are, by their very nature, operational organisations for whom regular cash-flow is vital.

Inflation is what charities should keep a constant eye on, both to ensure that invested capital maintains its real value, and to ensure that the level of income produced maintains its power to benefit society. In the UK, RPI inflation has experienced some upward pressure, reaching a rate of 3.9% at the end of September; while the key drivers have been more transient, cyclical factors (such as food price and fuel price inflation), this still represents a more demanding target to hit compared to the average RPI rate of 2.8% over the past 10 years. 

The inflation gap

In what is generally perceived as a period of low inflation, it is interesting to note that in the 10 years to end of September every £1,000 held in the average UK savings account would be worth just £1,030 whereas RPI inflation has led to charities needing £1,320 to do the same amount of good as £1,000 would have achieved in 2007.  In our experience, the magnitude of this “inflation gap” remains under-appreciated.

As the chart below highlights, when you adjust for inflation, ‘safer’ assets such as cash deposits, UK Government gilts and other western government bonds are offering negative real returns; in effect, if you buy a 10-year UK gilt, you are paying the government for the privilege of you lending them money. So, where are the opportunities to access higher income that can grow at least in line with inflation?

  1. Equities

Although equity markets expose investors to greater levels of capital volatility, and with stock market indices across the UK, US and Western Europe all at near historic highs, there is understandable caution.  However, it is important not to lose sight of the fact that not all equities are expensive; for investors focusing on high yield and income growth, there still exists a plethora of opportunities to recycle profits from shares that have performed strongly and now sit on lower yields to pick up shares offering more compelling valuations on higher yields.

Short-term bouts of market volatility can offer real opportunities to active managers who have a disciplined approach to identifying long-term value at individual company level; and a little bit of extra inflation in the economy often proves beneficial, particularly for certain sectors such as banks and other financials.

The average yield available across the FTSE All-Share Index stands at 3.6%, which is a very competitive starting point for income seekers when compared to cash and UK gilts. Generally speaking, overseas equity markets will not offer the same degree of starting yield, with the average across World Equities presently sitting at around 2.5%; but both UK and overseas equities continue to offer attractive year-on-year dividend growth which can go a long way to protecting the real value of your income against inflation.   

  1. Corporate bonds

Alongside gilts, corporate bonds have enjoyed a strong 30-year run of delivering solid income yields and significant capital growth. This is mainly because the UK has experienced a structural collapse in inflation and interest rates. At the high-quality end of the corporate market, higher inflation and rising base rates from their record lows will lead to capital erosion, and income yields available will not return to competitive levels until we have experienced further rate rises. 

Higher yields can be obtained by investing in lower-rated bonds, but this comes with greater risk which is more closely linked to the fortunes of the individual companies to whom you are lending.  Bond funds continue to be useful as a diversifier away from equities, but will not now offer the significant capital and income growth that investors had got used to.

  1. Property

Standard commercial property funds continue to offer access to a stable asset class with reliable income and value as a diversifier; however, prospects for future income growth are less certain.  Again, higher income yields are available by investing in a lower quality portfolio, which will carry additional risk.

Outlook for 2018

Based on RPI inflation averaging around 3.5% during next year, our belief is that long-term charity investors seeking income should continue to favour a significant bias towards well managed equity funds offering a diverse spread of exposure to quality UK and international businesses.  Minority weightings in bonds and property can continue to play their role in managing capital volatility, but it is equities that offer the greatest potential to deliver higher and growing income streams. 


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Richard Macey

Richard Macey is business development manager of charities at M&G Investments.

His primary responsibility is for supporting investment intermediaries who manage charitable assets, including consultants, stockbrokers and IFAs.

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