Charities have different objectives when it comes to investments and this will be reflected in their differing investment policies. However, all charities should be looking at similar measurements to determine the overall performance of the fund…
Investment policies are determined by the trustees based on the financial position of the charity and its ongoing income and spending requirements as well as any restrictions it may be under, such as what it can invest in and what it can spend.
Regardless of the scope of the investment policy, a charity should be monitoring the performance of its investments from a number of perspectives and this article considers the following questions:
- Are the investments generating the level and type of return required?
- Is the balance of investments being maintained?
- What is the level of risk being taken?
The returns that a charity is required to generate will be determined by the investment policy, which may be specified in terms of relative or absolute returns and in terms of income and capital growth. After the fact, it is easy to measure the return on an investment, and break this down into income and growth. However, in order to determine whether the returns are acceptable, charities must provide a suitable target against which the return can be compared.
Absolute targets often involve a measure of inflation plus a margin (e.g. CPI +3%) and relative targets may be a market index or a composite of several indices.
While charity funds will typically only have one target return measure, many will use additional comparators, such as peer groups of similar funds (e.g. Teknometry CIG Charity Fund Universe of balance funds) to provide additional insight into the performance of their fund. The following chart illustrates how a fund’s return can be compared to a peer group universe over different time periods.
Return is measured over time, and targets should reflect the charity’s investment horizons and be embodied in the investment policy. While it is important to monitor return over relatively short periods (e.g. quarterly) to provide early warnings, looking at return over the longer term smooths out short-term fluctuations as illustrated by the chart below.
2. Asset allocation
How charities invest their funds will be determined by their investment policies, but it will invariably involve using a mix of asset classes (equities, bonds, property etc.) in different geographies. Similarly, a charity’s choice of investment vehicle will depend on several factors, not least of which is the size of their funds, and it is likely that one or more investment management firms will be used to manage the assets.
The asset allocation strategy will determine what proportions of the fund are to be invested in the chosen asset categories (asset class and region) and how the balance is maintained. As each asset category will perform differently, the funds may have to be re-balanced periodically to ensure the asset allocation strategy is maintained, and it is for this reason that the level of assets in each category should be monitored.
Asset allocation is a snapshot of the investment positions at a point in time. Determining the period over which any re-balancing is carried out should also be defined in the investment policy.
The above table illustrates the asset allocation positions as a percentage of a fictitious fund at the start and end of the quarter compared with the Teknometry CIG Charity Fund Universe of balanced funds.
Most people would agree that there is a trade-off between risk and return, so if a charity can define the return required in terms of capital growth and income then it makes sense not to take undue risks in order to generate greater returns than are required.
The mix of assets defined in the asset allocation strategy will have a significant impact on the level of risk in the fund and where charities use an investment manager’s discretionary services, then risk may be loosely defined in terms of broad asset allocation. Similarly, where a fund gains exposure to different asset classes by using multiple managed funds, the risks are somewhat defined. Diversification, both within and across asset classes, will reduce risk, but how is it measured and what should it be compared to?
Risk can be measured in many ways, such as calculating the probability of exceeding a specified level of loss over time (Value at Risk); or considering the return relative to the return on a risk-free asset, such as gilts (Sharpe Ratio) and many an academic article has been written on the subject. One measure, and the main risk measure used for the Teknometry CIG Charity Fund Universe of balanced funds, is volatility, which is a statistical term that measures the variability of returns in the universe over time. Volatility is best measured over longer periods (minimum five years) to provide a reliable number of observations.
However, as with return, it is important to be clear about what the risks being taken are measured against. Below shows the risk and return of a fund compared to the Teknometry CIG Charity Fund Universe of balanced funds.
In order to adequately monitor the performance of the fund against the investment policy, trustees should ideally be looking at reports for the whole of the fund, along with any separately managed portfolios on a quarterly basis.
While it is not absolutely necessary to have such reports produced independently of the investment managers, it does provide a check on the data and can often be the most cost-effective way of producing a combined report covering the fund and portfolios.
About the Teknometry CIG Charity Fund Universe
The Teknometry CIG Charity Fund Universe was established, in conjunction with the Charity Investors Group, in 2016 and the founding investment management firms each provided 5 years of data going back to the start of 2012. Now in its second year, the Teknometry CIG Charity Fund Universe is the most comprehensive peer group of UK charity funds in the multi-asset sector and is the only one to provide statistics on return, asset allocation, risk and income yield.
At the end of September 2018 the universe was comprised of 1,299 portfolios representing £14.9 billion of UK charity fund assets. The portfolios range in size from £1m to over £500m. Around 60% are under £5m, 30% are between £5m and £20m and 10% are over £20m.
The universe can be used as a peer group comparator to show how a constituent portfolio compares against the universe, across a range of measures.
UK registered charities can subscribe to the quarterly universe reports free of charge via the Teknometry website.