At first blush, charity investments look to be heading in an unmistakably negative direction. In 2013, returns stood at an impressive 15.9%. In 2014, they declined to 6.3%. In the first nine months of 2015, they posted a negative score of -1.3%. Though subsequent stock market rises have likely improved the picture slightly, Philip Young, charity investment director with Brewin Dolphin, cautions, “If you get a positive return at all, you will be doing quite well.”
In a sense this downward movement is to be expected. The 2008 financial crash wiped billions from the value of shares and other assets, and the stock market recovery from that nadir has reached its limit. “Most charities, since the bottom of the market, will have seen returns in excess of 80%. And it’s unsurprising that from a very low point you have a very strong initial recovery that begins to tail off,” says Richard Maitland, head of charities at investment management firm Sarasin & Partners. Cheap to buy equities have become expensive and returns have suffered. Besides, low or negative returns are not unprecedented. From 1999 to 2002, in the wake of the dot com crash, charities endured three solid years of negative returns. “Markets don’t go up in a straight line,” says Maitland.
However, there is a perception now that charities are entering a ‘new normal’ of very modest performance. “I’m afraid what you see is probably what you’ll get now,” warns Marc Hendriks, chief investment officer with Sandaire Investment Office. “Charities need to accept the likelihood – no-one can be absolutely certain – that their returns are going to be much lower.” Andrew Pitt, head of charities in London with investment firm Rathbones, predicts “lower nominal returns from risky assets, such as equities.”
The reason for this is twofold. One factor is that central bank efforts to stimulate the financial system and economy have either ended or are losing their power. A six year long policy of quantitative easing (the buying of government bonds from banks and corporations) was terminated in the US in October 2014, though the European Central Bank has started its own programme. “It’s been a one way ticket over the last seven or eight years,” says Young. “QE has basically lifted all boats. That story is slowing and it’s going to be harder to get the returns.” And the official policy of rock bottom interest rates aimed at stimulating borrowing and spending has also come to be seen as inadequate in generating long-term economic growth. “Very, very low interest rates and lots of central bank buying of government bonds, isn’t having the desired effect,” says Jeremy Wells, client director for charities with Newton Investment Management.
The other is an acknowledgement that the global economy has definitively entered a phase of low growth, low inflation and low interest rates.
In November, the ratings agency Moody’s predicted muted GDP growth of 2.8% for the developed nations over the next two years. UK inflation was parked at -0.1% in September and October. And while many believe the US Federal Reserve will, in December, finally raise interest rates from their seven year low of 0-0.25%, few think they will be raised aggressively or that other countries will immediately follow suit. “Even if the Fed raises rates in December, we’re expecting a very long, gradual return to normalised interest rates, which could take years,” says Young.
Young believes that in this new environment, “the whole investment framework is different.” The most important consequence is that company earnings, and therefore the dividends they pay out to shareholders, are going to be appreciably lower than they have been historically. “If dividend growth is 3% that would be a very good result in this low inflation environment,” he says. “This compares to the double digit earnings growth of 5, 6 or 7% which we got in the past. There’s a material difference already in this low inflation, low growth environment.”
One caveat is that in a low or negative inflation climate, returns don’t have to be that high for charities to feel the benefit. The low capital and dividend scenario is “not necessarily a disaster” maintains Young “as the real level of dividend (after inflation) may be the same as previously in an environment when inflation is materially lower.”
It is also the case that charities are facing, not only lower returns, but greater market ups and downs, or in investment-speak, “elevated volatility”. Across the board, in the wake of the stock market mini-crash in August prompted by the slowdown in China, investment experts anticipate 2016 to be marked by increased stock market volatility. The fears over China, says Kate Rogers, head of policy with Cazenove Capital Management, “shows how vulnerable we are even after quite considerable market performance, to investor sentiment turning negative”. The question is whether stock market shocks will involve sharp dips followed by swift recoveries or whether a serious 2008-style crash is on the cards. The Swiss-based Bank of International Settlements warned ominously in September that financial markets would soon have to “take their bitter medicine”.
However, the strong consensus among investment experts that while shocks, probably from the hotspot in China will occur, the world will not be drawn back into recession or another financial crisis. “It doesn’t mean that we are in a bear market, it’s just that we will probably see some bumps in the road,” says Rogers. However, as charities have moved more of their investments from the safe but barely productive havens of cash and bonds, into the inherently more risky realm of equities, it is also the case that they are more susceptible than in the past to stock market volatility. And this especially applies, as shown by Newton’s 2015 investment survey, to charities with under £20 million invested.
A common assumption is that many charities, particularly endowed foundations, are long-term investors and should be able to ride out any increase in volatility or lower returns. However, Hendriks warns that lower share prices can reflect expectations of lower profit growth and therefore result in a lower dividend pay-out. And in a lower share price environment, charities may not be able to sell their investment assets to support their income. “It’s not a great position to be in,” he says and predicts some charities will be forced into the “painful discussion” of how to lower their grant or operational spending.
Traditionally, after a bull market in equities like the one that is now coming to an end, charities have responded by increasing their fixed income allocation and reducing the equity-content portion of their portfolio. But with low interest rates and low inflation, a flight into government bonds is not recommended. “Charities that have high exposure to fixed income would be wise to think about how they might reduce that somewhat,” says Pitt. “Bonds from here look like a pretty poor investment.”
So a more experimental approach to diversification seems to be in order. According to James Bevan, chief investment officer with CCLA, “in a world of rising uncertainty you definitely don’t want to back just one horse.” Property has become a staple form of diversification for charities and hasn’t lost its income generating character. But infrastructure – which can take the form of roads, schools, prisons or sewage projects - is increasingly coming into the picture. Charities can invest in infrastructure firms or buy their debt which is often underwritten by the government. “We are getting far higher yields in that sort of asset class we are in, for example, gilts,” says Pitt.
So, while investment managers warn of muted performance, they are not wholly pessimistic. “If you’ve got the right active investment strategy you can do just fine,” maintains Wells. “We’re in a world of low returns, not strongly negative returns.” Maitland concurs: “Just because the average is muted doesn’t mean there won’t be some very good and very bad investments out there.”
Mathew Little is a freelance journalist