If there is a consensus among the investment cognoscente it is that the bumper years for charity investments are over – at least for now. Charities scaled the heights of performance in 2012 and 2013, posting returns of 10.8% and 15.9% respectively. 2014 was markedly more modest. Returns to the end of September stood at 3.9% and are expected to finish the year at 6- or 7%. 2015 is anticipated to follow a similar, muted, pattern.
Jeremy Wells, investment relationship manager with investment management firm Newton, has a “reasonably cautious” view about market prospects. “What we are seeing this year is something of a pause for thought across markets,” he says. “Our central assumption is that markets are in a phase of delivering a lower average rate of return than historically has been the case. We think the current backdrop is likely to persist into next year.”
John Hildebrand, senior investment director with Investec, concurs, expecting returns to be weaker. “What we would caution against is expecting the double digit returns generated in 2012 and 2013,” he says.
The reason for the shift is that charities primary investment is in equities, and although these assets have not fallen precipitously, they are definitely more subdued. 2013 was a very strong year for equities, notes Kate Rogers, head of policy of the charities team with Cazenove Capital Management.
“Equities were up 21% in 2013. In the first three quarters of this year, equities were only up 1%”, Rogers says. “Last year, you wanted to be concentrated in equities, this year what you want to be as a charity is diversified.”
But though charities have branched out into alternative assets such as the resurgent commercial property market, equities are still where they hold their largest stakes, to a greater degree than institutional investors such as pension funds. According to the 2014 Newton Charity Investment Survey, the average charity’s asset allocation is 59.1% in UK and overseas equities, 15.4% in property and 8.2% in UK bonds. The heavy stock market falls in October this year prompted by an array of fears such as the Eurozone crisis, the spread of Ebola, a stuttering global recovery and tensions in Ukraine, indicate that markets are noticeably less optimistic than they were 12 months ago. And charity investments will unavoidably follow market sentiments.
Rogers argues that the best way to forecast the investment climate for 2015 is to look at the state of the global economy, which is still in recovery.
“But it’s a much slower recovery than historic recoveries from previous recessions,” she says. “The fact that it’s lower and slower than normal means that any little bumps in the road are amplified, even relatively small changes in global growth forecasts. That is why we will probably see markets go up and down reacting to news flow.”
David Cameron warned of a second financial crash in November and Newton’s Jeremy Wells believes that although crises can’t be predicted, indebtedness is a chronic problem for the global economy. Austerity in Britain has merely slowed the build-up of new debt.
“We think that this debt burden is a real issue that has yet to be addressed in any meaningful way,” he says. “It could cause a crisis or it could cause a long period of anaemic growth in a Japanese style lost decade way, or it could just lead to a period of very mediocre returns.”
But whatever predictions are made now for 2015 they are conditional on a very difficult to quantify set of factors. “All sorts of things are going to be happening in 2015 that could change sentiment, change direction or change policy across different markets,” says Rogers.
One issue is government policy, which since the advent of the 2008 financial crisis and Quantitative Easing, has been reactive and inventive.
“The volatility of equities has settled down this year, but we are still in pretty uncharted territory in policy terms,” says Heather Lamont, client investment director at CCLA. “People don’t quite know how to react to new announcements from the US Federal Reserve about the extent of the end of Quantitative Easing.”
The US central bank announced the end of its $4.5 trillion, six year bond buying programme in October, while the European Central Bank has suggested it could begin Quantitative Easing in 2015. Quantitative Easing has (artificially many would say) raised share values and the prices of other assets, so the market reaction to its termination in the US will be eagerly watched.
“How the US economy shrugs off the end of the QE experiment will probably be crucial,” says James Brennan, business development director for charities, with Rathbones.
More volatility seems inevitable. “As the cold fronts from some central banks collide with the warm fronts from others,” says James Bevan, chief investment officer at CCLA, “at the very least we expect more market storms than seen in the past few years.”
When announcing the end of Quantitative Easing, the Federal Reserve stressed that interest rates would remain at their current, rock bottom rate for the time being. There is speculation as to when central banks feel that their economies are strong enough for interest rates to begin to rise. Many investment managers believe that time will come in the second half of 2015. And any rise in interest rates will have an immediate impact on charity investments through dampening returns on equities.
Bevan believes that 2015 “could be a year of two halves”, with gains in equities given up in the latter part of the year. An increase in interest rates would also make holding cash as an asset more attractive. Currently, below inflation interest rates mean charities holding cash are in effect losing money, though they may choose to hold it because it is considered more secure than the volatile equity market.
But the appeal of cash will be bolstered by any rise in interest rates.
“We’ve had a long period of time where cash has been a very expensive asset to hold because there’s not return and that’s pushed charities, and all investors, towards riskier assets which carry some positive yield over cash, be they government bonds, equities or property,” says Wells. “If you start to see a progressive normalisation of cash interest rates that will have some effect on asset allocation. You might see some increase in asset allocation towards cash, because once cash earns a positive return, it’s an easier decision to hold it.”
2015 will also be replete with external factors that could bear a strong influence on the investment climate. May will see the General Election in the UK. Wells believes that unless there is a “very materially different outcome” to the expected hung Parliament, there will not be a great deal of market impact.
Others are not so sanguine. Hildebrand thinks the election could result in uncertainty, “which markets tend not to like - a lack of clear results.
“The danger is that you get an uncertain outcome which means you could have another election, and you could have sterling weakness and this could delay investment.”
Another consequence of the General Election will be, in the event of a Conservative victory in some form, an in-out referendum on membership of the European Union. The prospect of leaving the EU could also have a negative effect on share values.
However, Wells believes elections in other regions could have bigger repercussions. A Parliamentary election is likely in Greece in 2015, and with the left-wing Syriza party ahead in the polls and committed to a large cut in Greece’s debt to other Eurozone countries, the result could “re-open the euro can of worms” and presage “a re-run of the Euro issues we had a couple of years ago,” he thinks.
There are also wider geopolitical issues that could flare up in 2015. October’s stock market fall was attributed in part to the Ukraine crisis and the Ebola outbreak. In December, the Russian rouble experienced its biggest daily fall in 16 years, as sanctions from Western countries took effect.
“These are the sorts of things that hurt confidence and they can be very damaging,” says Brennan. “People are worried, they don’t spend money and that affects retail spending. But the biggest challenge we have as investment managers is trying to cut through the noise, because there is so much of it; Ebola and Ukraine being two examples.”
But the most conspicuous characteristic of 2015, many investment experts feel, will be divergence across the global economy. Different regions will exhibit different degrees of economic strength and respond with contrasting policy measures.
“It’s such a mixed picture and you have economies firing in opposite directions. It’s not something we have seen for a while,” says CCLA’s Lamont.
At present, the US and UK economies are delivering decent corporate profits, while the Eurozone is stagnating, Japan is mired in economic difficulty, and there are worries about China, which though it easily outperforms other regions in terms of growth, is experiencing increasing debt and weakening GDP levels.
“This divergence in global policy, this divergence in fortunes is extraordinary across a global economy,” says Rogers. “We are seeing stimulus being withdrawn from the UK and US and added to Europe and Japan. That means interest rate differentials will become larger which has big impact for currency and the fortunes of the different companies in different areas, so I think the divergence of all these areas of the globe will again play into performance and volatility.”
This divergence, says Rogers, underscores the importance of regional selection in stocks. Close to 80% of revenues from the UK stock market come from overseas, and therefore the yields and price of shares will reflect where companies do most business. Forty-five per cent of the sales of UK drugs giant, GSK, take place in the US, for example. So charities need to “look under the bonnet” of companies to see where they primarily trade, says Rogers, now, perhaps, more than ever.
“There will probably be return enhancements, or the other way around, to be made from being in the right place at the right time,” she says. “At the moment, we are still favouring US exposure because that is where corporate earnings seem to be coming through.”
Active vs passive
All this leads inevitably to the debate about active or passive investment management. Lay investors should retain a certain scepticism because investment managers, who actively pick stocks, tend, unsurprisingly, to favour active management, as opposed to buying a tracker fund which merely follows a benchmark, such as the FTSE All Share index. Nonetheless, Rogers says active management is of particular value now in the context of global economic divergence. “That’s when you need somebody there managing it, taking advantage of it, because there should be opportunities,” she says. “That’s not to say active managers will do well, you need to pick good active managers, but it’s not like everything is going to be performing the same over the next year.”
But given that equity returns, regardless of their country of origin, are unlikely to come anywhere near the highs of 2012 and 2013, would charities do well to look to alternative assets? As Rogers says, in 2013 the advantage lay in being concentrated in equities, in 2015 benefits are likely to accrue to those charity investors who are more diversified. This is not a leap in the dark for many charities. According to the Newton survey, 15.4% of charity investors have exposure to property and 7.3% to hedge funds and absolute return funds (although the survey respondents were larger charities).
All investment managers seem to think property, specifically commercial property, will enjoy a strong year in 2015. Property, after languishing for some time, rose 14% in the first three quarters of 2014. Property supplies a decent yield and the many investment managers now say they are “reasonably” or “relatively” keen on it as an asset class for the coming months. Secondary properties - those outside central London - are now starting to do well.
With market storms forecast, more exposure to alternative assets, such as property, may well be an astute move.
Mathew Little is a freelance journalist