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A limited portfolio is high risk

James Brennan, head of Barings charity team, says: “Academic studies suggest that asset allocation is the biggest determinant of a portfolio's return. From a charity perspective it is important that charities look at all the available asset classes rather than following the herd and being constrained by a benchmark.”

However, says Brennan, some charities find it difficult to break away from their habitual investing patterns: “Charities do not necessarily shy away from [other] assets but many remain wedded to a traditional allocation which favours UK equities and bonds.”

There is a feeling among the decisionmakers in many UK-based organisations that staying close to home is the sensible, risk-averse thing to do. It’s simpler for UK-based charities to watch how UK indices perform, their liabilities are UK-based afterall, plus there is no risk of currency fluctuations wiping out returns, which could potentially happen with overseas investments.

The belief is to keep funds in cash deposits, as the money is safe — at least in theory. Stay too heavily invested in UK equities and you face a very real risk in having all your eggs in one basket.

You may be staying with what you know, but what happens if what you know unexpectedly goes down the pan?

“Given the economic situation in the UK, which is only going to get worse, charities should be looking at international equities, we a have a strong bias towards Asia,” says Stewart Newton CEO of Veritas Asset Management.

What’s more, if you lean too hard on cash, even with higher rates of interest, in today’s environment you could see your funds eaten away by increasingly elevated inflation.

A limited portfolio is a risky one.While a good spread of assets is a proven way to control volatility.

So what is stopping charities from branching out and investing in a greater range of assets, such as hedge funds, private equity or overseas investments?

Back to school

For Frontier’s Rickard, a large part of the problem is a lack of understanding. “It’s about education,” he says.

“Trustees need to attend seminars; they need to learn about the different asset classes. They need to understand where they are investing so that they can make decisions.”

In short, trustees need, in a sense, to go back to school, to make sure they understand exactly what it is they want to get from their portfolios and just what the different assets can bring to the mix.

Turning your back on certain asset classes because of their reputation or a misunderstanding of how they work could be detrimental to an organisation’s investment strategy.

Hedge funds, for example, make many investors nervous, when in fact they might be a useful tool when they form part of a diversified portfolio.

So if greater diversity is the way to go, just what should the mix be? What is the perfect cocktail of asset classes?

Not surprisingly, there is no such recipe. Every charity, whatever its size or income level, will have different needs and different investment goals, and these will dictate which assets are most suitable. from investments to continue operating, while also needing to retain a high level of liquidity to bridge potential funding gaps, some have longer investment time frames than others, and of course some charities can spread millions of pounds to benefit from asset allocation, while others have far smaller sums to invest.

Financial advisers and fund managers need to look at individual organisations to assess their requirements.

“Inevitably, the mix of assets one uses for charities is driven by their investment mandate, for example do they need income, what is their risk profile, their size and so on,” says Rathbones’ Clifton.

“The nature of a charity portfolio's diversification will be driven by the individual mandate. If income is a priority, some assets - such as fund of hedge funds - may be less attractive. But diversification might come more in the form of the range of individual equities, or the use of collectives for smaller charities.”

Getting the right mix

In today’s financial storm, there is little chance of identifying any asset classes which are sure to offer shelter, so getting the mix right is essential.

“Safe havens in the current market are an interesting issue and market changes dictate that anything I say now may no longer apply next week,” says Clifton.

“That said there is an inevitable flight to quality. Good diversification and strong blue-chip type investments, quality government bonds rather than corporate debt, reduced allocations to more volatile assets types or markets, such as the Far East, are bound to be features. Cash levels are also higher generally at the moment.”

According to Rickard, it is important to review your investments regularly to ensure they are continuing to offer your organisation what it needs, especially as those needs change and develop.

“Charities should review their portfolios once a year, and their fund managers once every three years,” he says.

However, making changes too many substantial changes too frequently can be counterproductive, as you may find the price of reshuffling outweighs any gains you may see in returns.

“Every time you transfer from A to B there is a cost involved,” says Rickard.

Regular reviews are necessary, but this does not mean you need to take any action every time a review takes place.

“While charities have favourable tax treatment and therefore may suffer fewer tax issues if assets are bought and sold frequently, by their very nature they have a longer-term outlook, and generally speaking a lot of frequent trading is unlikely to be helpful,” says Clifton.

What’s more, he adds: “Asset allocation in general terms is a medium-long term view issue so should also not trigger frequent changes in assets held.”

Barings approach also reflects this view, explains Brennan: “Our asset allocation is driven by ten-year forecasts that are reviewed annually to build a strategic portfolio.”

But current climates dictate a change of tack, he adds: “As markets are volatile, we move around this strategy on a tactical basis to capture returns or preserve capital, as appropriate. Yet we are well aware that trading for its own sake is an easy way to destroy value.”

So what about investment opportunities coming out of the crisis?

Bob Doll, vice chairman of BlackRock, says: “Our view is that, when the dust settles, investors will be attracted to those areas of the markets that have performed the best in recent years and that still have decent long-term growth prospects, such as most globally focused areas of the market.

“Much like the technology stocks, which were ignored for years after the collapse in 2000, we expect housing, consumer finance and retail-related shares will be shunned in favor of the more industrial side of the economy (namely energy, resources, industrials and technology). We believe those sectors that are currently suffering should return to favor as investors seek growth prospects with better absolute and relative valuation.”

Achieving a diversified portfolio encompassing a healthy spread of assets therefore is a sensible approach. Financially speaking, these are nervewracking times, but for charities too firmly rooted to UK-based investments, it may be time to leave the comfort zone.

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