UK
charities have something of a reputation for being a bit,
shall we say, reserved when it comes to investments. You would
imagine for example, that given the choice between a hedge
fund and UK equities or bonds, the majority of charities would
plump for the latter.
And the statistics suggest you would not be far off the mark.
According to WM Performance Services, UK charities had the
bulk of their capital, some 55%, invested in UK equities in
the second quarter of 2007, and 9.1% of their portfolios invested
in UK bonds. Only 2.9% was invested in “other”
investments, and somewhere in that small percentage you would
find hedge funds.
So, it would appear, UK organisations tend to keep their investments
close to home, and, broadly speaking, appear to steer towards
traditionally fairly staid income producing investments.
Meanwhile, the investments of charitable foundations in America
have been outshining those of charitable organisations in
this country. Professor Paul Palmer of Cass Business School,
in a presentation to the Association of Charity Officers,
said that US foundations had seen returns of 16% over the
past five years, while UK charities brought in returns of
10%.
Indeed, the largest of the US college foundations, Yale, reported
in September that it had seen a return of 28% over the past
year, so that it now stands at £22.5bn. The endowment
has seen an average annual return of 17.8% over the last decade.
And it seems asset allocation has a lot to do with this difference
in performance. Yale’s manager, David F. Swenson, who
has been running the endowment since the 1980s, was one of
the first to move away from traditional equity and bond led
portfolios and towards hedge funds, private equity and real
assets such as timber, and has published books promoting this
wider-reaching style of asset allocation.
Changing direction
The practice has plenty of supporters on this side of the
Atlantic. Gavin Rankin, head of investment consulting and
business development at UBS Wealth Management, speaking
alongside Prof Palmer to the ACO, explained that the way
in which Yale invests has changed drastically over the past
two decades. In 1985, 80% of investments were in US stocks,
bonds and cash. Today, on the other hand, these assets make
up less than 20% of the portfolio.
As Ron Green, senior manager of the Charities Aid Foundation’s
charity financial services, says: “The larger US foundations
have been quicker to adopt more modern portfolio theory
than their counterparts in the UK.”
This greater diversification into a wide mix of asset classes
appears to be successful, but then US foundations are typically
huge, and so have greater scope for having fingers in many
different pies. The average UK charity has a fraction of
the capital they have to invest.
What’s more, UK charities and large US foundations
are also operating on very different timescales. Rankin
says: “US endowments may have infinite time horizons,
which means they can ride through volatile performance,
and that gives them greater investment flexibility.”
Most UK charities, on the other hand, are dependent on income
produced by their investments and often need to keep a high
level of liquidity going just in case they need the funds
in the event that they hit a tight corner. They cannot afford
to tie up large chunks of their capital in investments that
require a long-term commitment, such as private equity or
hedge funds.
This being the case, can UK charities really be expected
to follow in the US foundations’ footsteps to reach
greater levels of returns? Gavin Rankin, says: “I
would say yes they [UK charities] can emulate those returns,
even though they are smaller.”
So what’s holding them back? For one thing, says Rankin,
there is a level of inertia among UK charities. They are
used to doing things the way they do, investing heavily
in UK equities and bonds and not looking any further to
better their returns. Their investments may not set the
world on fire, but they perform respectably, and they see
no need to look any further than those traditional assets.
“Some of the differences are cultural,” explains
Prof Palmer. “The UK likes UK equities. [Charities]
have begun to invest in private equity and hedge funds but
only really in the last couple of years.”
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Education is key
And, according to Rankin, one of the key barriers is a lack
of education. With the exception of giant charities such
as the Wellcome Trust, most organisations in this country
looking for investment advice will hire external advisers.
By contrast, “In the US there tends to be a larger
number of financial professionals within charities,”
says Rankin, giving them permanent access to the experience
and knowledge necessary to make the right investment decisions.
As such, UK charities often labour under misconceptions
that can hold them and their investments back. For example,
for many trustees, alternative investments such as hedge
funds are synonymous with high risk, and so decide to steer
well clear. In fact, explains Nick Rickard, head of charities
at PSolve: “Not all hedge funds are risky. You can
have a defensive hedge fund, and some have less risk than
UK equity funds.”
Cutting risk
But while charities are often criticised for not being aggressive
or adventurous in their investments, many argue that this
is not where the problems lie. Indeed, successful asset
allocation is not about taking charity portfolios further
up the risk spectrum, it is about spreading out investment
risk across a variety of different asset classes, and therefore
reducing the overall risk. As Rickard explains: “Charities
don’t have clear understanding of their liabilities.
It’s not a case of being more adventurous, it’s
more about lessening the risks.”
“UK charities on average invest between 50 and 60
per cent in UK equities,” says Rickard. “But
dropping that percentage down to 20 – 25 per cent
means you are less exposed.” It stands to reason that,
if a charity is highly exposed to UK equities and the FTSE
100 takes a beating, then the organisation’s investments
will have nowhere to hide. It’s a simple case of not
keeping all your eggs in one basket.
And CAF’s Green agrees: “In my view greater
emphasis by advisers and fund managers should be placed
on the reduction in portfolio risk that can be achieved
by successful diversification, as opposed to outright growth
at any level of risk.”
Differing needs
Of course, drawing a comparison between US foundations and
typical UK charities can be a dangerous game to play. While
the likes of the Wellcome Trust may have adopted a style
akin to that used by US foundations, complete with high-profile
private equity bids, the majority of charities are in a
very different place, and have very different needs.
It is safe to say that there is no one-size-fits-all solution
when it comes to getting asset allocation right. “Asset
allocation varies from charity to charity,” says John
Tickle, head of institutional investment at Legal &
General. “Some will be biased towards fixed income
because they need higher yields. Most are heavy-weight in
equities, and that’s not necessarily a bad thing.
One of the main aims is maintenance of their assets.”
Indeed, just chasing the highest possible returns is not
necessarily the right approach for all. A charity may need
to invest to save for a specific project, for example. Another
may need to keep a pot of money apart from the rest for
property. Some can afford to take a long-term view, others
have a poor level of cash flow and need to keep every penny
somewhere that they can reach it quickly should they find
themselves in a tight corner.
Nonetheless, whatever the size and shape of an organisation,
there should be some room for diversification, argues Rankin.
The entry point at UBS, for example, is £100,000,
and that gives charities access to six different asset classes.
CAF’s Green echoes this feeling: “It is certainly
possible to diversify across asset classes even for charities
with small amounts to invest; charities can easily access
a wide range of asset classes via holdings in different
common investment funds,” he says.
And in future, he expects an even broader array of investment
opportunities. “It is likely that we will see a growth
in the availability of multi- asset funds to both charities
and pension funds; these being funds that undertake active
asset allocation on behalf of investors across a wide range
of assets including equities, bonds, property, cash and
alternative investments such as hedge funds, commodities
and derivatives,” Green says.
“These funds will provide a real opportunity to harness
all the diversification and performance benefits in one
simple investment.”
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