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Looking ahead with purpose

While the ongoing COVID-19 vaccination programme offers some light at the end of the tunnel, research published at the end of last year suggests that the short-term outlook for the UK’s charities remains very challenging. So, how can charities build resilience into their investment strategies? Julian Rathbone, head of charities at Rathbones, answer this question.

A narrated version of this blog is available at the bottom of the page

Given the impact of lockdowns on the economy, unemployment levels and mental health and wellbeing of the population, charities experienced unprecedented demand for their services during 2020. Looking ahead, three-quarters of charities expect to see even higher levels of demand this year. At the same time, 83% believe their income will decline over the next 12 months compared to pre-COVID expectations.

Indeed, charities have seen a number of different strains on their income streams: lockdown has significantly curbed (or completely halted) fundraising efforts, struggling businesses have had to reduce their charitable donations, and charities’ retail outlets have been closed for most of the past year. And, while the general public is still giving, there has been some shift in focus, for example towards charities in the health sector, to the detriment of others. Furthermore, those charities reliant on investment income also saw a drop in income as many companies faced with little or no clarity over the future cut their dividends. UK companies have been particularly badly hit, with dividends falling circa 40% in 2020.

But UK charities have also demonstrated remarkable resilience through the crisis. Many have adapted incredibly quickly to changing circumstances, developing innovative ways to stay connected with their service users and public, finding new ways to fundraise, adopting remote working practices and digital solutions, and collaborating with other organisations for mutual benefit.

Planning for the unplannable

Unfortunately, COVID-19 has disproportionately affected the thousands of smaller charities that tend to make ends meet from month to month, have little in the way of reserves and are generally more reliant on in-person fundraising efforts for income. Conversely, while the larger charities have also been negatively impacted and have seen their incomes fall, they tend to have greater reserves, and are therefore more likely to be able to weather a crisis. That said, 69% of charities believe it will take more than a year to return to pre-pandemic income levels.

Given this uncertain backdrop, it’s essential that charities consider what they can do now to manage the remainder of the COVID-19 storm, as well as ensure they’re prepared for any potential future crises. Suitable investment and reserve strategies lie at the heart of this and should be encapsulated within a charity’s investment policy statement.

While the Charity Commission guidance suggest that charities review their investment policy statement and approach to risk annually, depending on the charity’s circumstances, it might be prudent to increase the frequency of these reviews – or at least to communicate more often with their investment managers.

Regular discussion of a charity’s reserves policy is also key – while it very much depends on the specific circumstances of each charity, as a very rough rule of thumb, it’s recommended that charities hold between 3 and 18 months of liquid reserves on their balance sheet, either in cash or as liquid investments (and excluding endowed and restricted funds). How much and where these funds are held will depend on how reliant a charity might be on those reserves, and therefore how much risk it can take with them. This will be determined by factors such as the charity’s activities and the diversification and security of its income streams.

Essential ingredients of a diversified portfolio

The past year has been a stark reminder of the importance of maintaining a balanced, diversified portfolio. To achieve this, charities should work closely with their investment managers to review their portfolio’s mix of assets in relation to their objectives and appetite for risk.

Looking first at equities, assuming a charity is able to accept some equity risk and while still ensuring geographic diversification, it is also important, where possible, not to skew a portfolio too much to one approach – for example income and value versus growth stocks. Growth stocks have outperformed over recent years on the back of strong earnings growth and low interest rates, with 2020 being a particularly strong year as this category includes many ‘COVID beneficiaries’, such as technology companies.

However, rather than getting too hung up on value versus growth, it is the intrinsic value of equity investments that matters at the end of the day and certain quality value/cyclical stocks are trading on attractive valuations (for example certain banks and commodities based companies) providing some good investment opportunities. It’s important to remember that quality is key, with such an approach likely to lead to better long-term returns and greater capital preservation in more challenging market conditions.

On the fixed interest front, corporate bonds currently look more attractive than gilts, although the whole asset class doesn’t look particularly attractive at the moment (read our article on bonds to find out why). That said, these assets can still provide a certain amount of diversification and act as a hedge against a much more negative scenario. 

Alternatives such as infrastructure funds and actively managed funds can also act as a useful means of asset diversification, as they tend to be less correlated with equities and the economic cycle. This means they may also be able to provide better absolute returns over the economic cycle. Bricks and mortar property would also usually fall into this category, however, we are currently cautious about this asset class, given the potentially long-lasting effects of COVID-19 on the office property sector and the already-challenged retail sector.

Finally, it’s also important to know which other assets to be wary of, particularly with the level of cheap money available. Chasing ‘hot’ stocks and sectors, or those we regard as more speculative asset classes such as cryptocurrencies like Bitcoin, should be avoided.

Staying the course

As active investment managers, it’s our job to monitor the markets and adjust the assets held in our charity clients’ portfolios as and when necessary, in line with their objectives, requirements and risk appetite, as detailed in their investment policy statements.

It’s also our job to challenge our clients’ investment strategies – if and when required. Given the current circumstances, it may be the right time for some charities to reassess their ability to take risk in light of changing priorities, financial positions and future income streams. However, at the same time, it’s important to stay focused on the long term and, in these current times of uncertainty, it’s easy to lose sight of the bigger picture in favour of short-term changes to an investment strategy.

While the near-term outlook for charities is uncertain, with some charities facing more intense pressures than others through no fault of their own, the prudent basis and good stewardship on which charities are managed means resilience and perseverance should win over. Ongoing careful consideration of the challenges and their likely impact should help support the most appropriate investment approach, backed up by shorter-term actions where necessary, enabling charities to continue their invaluable work and to deliver against their objectives in the long run.

ACEVO members: learn how Rathbones can support you.

Narrated by a member of the ACEVO staff

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