December investment analysis: Spreading the risk

Small and medium-sized charities have not always sat comfortably with the world of investments. Fundraising relies on public and corporate goodwill, but investments involve risk and therein lies the problem. Losing hard-earned charities' cash through bets on the stock market doesn't go down well at grass roots level. Then again, neither would the alternative of losing the buying power of funds deposited in banks through the corrosive effect of inflation, particularly when interest rates are as low as they are right now.

Reduce risk
The answer for many charity trustees are pooled investments that spreads risk across asset classes, industry sectors and international geographies and offer charities the reassurance of investing alongside their peers in a dedicated charities fund.

Such funds aim to reduce risk by offering far more diversification than investing in direct equities, where the dangers of holding a handful of highyielding stocks have recently been highlighted by dividend cuts and deferrals by several major UK banks.

Investors can therefore spread risk, even if they only have a small amount to invest, and Common Investment Funds (CIFs), which are pooled investment funds set up specifically for charities, also benefit from exemption from stamp duty. Constituted as charities in their own right, CIFs offer investment opportunities in equities, cash, bonds, property and hedge fund asset classes and can be invested in by a registered charity in England, Wales, Scotland and Northern Ireland.

Their management fees are typically lower than those of segregated investment funds because of the economies of scale that they and other pooled investment funds enjoy from serving many investors. The voluntary sector invests £8.2bn in pooled funds - much of it via CIFs.

Low admin costs
CIFs and other pooled investments also allow small charities in particular to benefit from a managed strategy of diversified investments, without heavy administration or an undue concentration of risk and the returns of some pooled funds make them attractive options.

For example, £100 invested in M&G's pooled charities investment fund Charifund back when it began in 1960 would by now have now accumulated a total return of £50,690.

According to the fund management group's calculations, the same amount invested in the FTSE All-Share index over the same period would have returned £21,755, while the sum would have grown to about £1,800 had it been simply stuck on deposit with a bank. M&G charges a management fee of 0.48pc for Charifund, which it says compares to an average of 1.25% -1.5% for most unit trusts or open-ended investment vehicles (OEICs).

It also says that Charifund's current 5.4% yield compares well with the 3.2% yield of the FTSE All-Share Index. Charibond, a later M&G charities fixed income investment fund that is structured as a CIF yields 6.1% "Many charity trustees are very nervous because they have seen the volatility of the stock market in both equities and corporate bonds," says Peter Knapton, M&G's director of charities investments.

"They're anxious that their investments are held in the most appropriate way. Deposit accounts with banks do offer security because the UK has not seen depositors lose their money in the collapse of a clearing bank for a long time but charities do need returns as well as security from the funds they hold.

"It's a question of perspective. If a charity wants to maximise total return over time, it's very difficult to maintain the right balance if you make segregated investments on a small scale and it can be expensive and risky too. It's a challenge that pension trustees face."

It is indeed a key issue. Figures from WM Performance Services show that the UK voluntary sector invests £8.2bn in 45 CIFs. That's about 10% of the £80bn of investment assets that WM says UK charities hold and Mark Morford, product manager for investments at the Charities Aid Foundation (CAF), says that a substantial proportion of the remaining £70bn will be invested in other pooled funds. This will include funds at charities that are attracted by more exotic risks, for example in emerging markets, than they can gain exposure to from CIFs, he says.

Strong argument
In addition, the investment strategies of some of Britain's largest charities, will include participation in pooled funds, alongside other direct and alternative investments. "You've got to remember that the UK charity market is skewed to the larger charities with a large amount of investment funds controlled by a small number of charities," says Morford.

"But there would be a very strong argument for using pooled funds if you're a charity with funds of less than £2m because of the simplicity of the holdings and the fact that they offer diversified risk in a vehicle specifically set up with the needs of charities in mind."

Not all fund managers offer CIFs. At Aviva Investors, for example, corporate affairs manager Allister Fowler says that charities and other socially-responsible investors are instead directed as Luxemburg-based SICAV open-ended investment vehicles.

"We do not currently offer CIFs," he says, "but we are not ruling out doing so. At the moment our focus in the charities sector tends to be on larger charities who are more comfortable with segregated mandates."

Roger Curtis, head of the charities business at Aberdeen Asset Management, adds that while some CIFs have ethical screens so they do not invest in the arms trade of tobacco for example, it is not the case with all CIFs and charities wanting such funds may need to invest in other pooled funds.

He says: "The key point, as for any other investments is that charities must ask themselves what their objectives are and what sorts of investment returns and risk profiles they are looking for.

"The very scary, very volatile times that we have seen in the financial markets over the last couple of years have caused a lot of charity investors to be much more risk-averse in terms of the volatility and liquidity of their investments.

"CIFs are attractive to smaller charities because they are authorised by the Charity Commission and are almost a kind of Kite mark for pooled charity investment funds."

This ring fenced universe is set to change, however, as the Government is considering whether to move the regulation of charity pooled investment and deposit funds away from the Charity Commission to the Financial Services Authority (FSA).

Regulatory change
A consultation exercise being led by the Treasury and supported by the Office of the Third Sector, the Charity Commission and the FSA includes a proposal to set up a new type of Authorised Investment Fund that is only open to charity investors whilst preserving the existing generous UK tax regime.

"The underlying driver of this move," says Curtis, "is to focus more on regulation of the investment element of CIFs and to move regulation to the FSA because it already regulates other investments and is a much more robust financial regulator.

"The Charity Commission's prime responsibility is looking at the charity sector as a whole, not just focusing on their investments. There are reasons therefore why the change can be seen as pretty sensible, but we're waiting to find out what shape the new vehicles will take and what they will look like."

Morford at the Charities Aid Foundation hopes the consultation and eventual action will address a number of key issues for the charity investment sector. "We welcome the proposals broadly," he says, "because generally they are likely to streamline regulation as the FSA at the moment regulates part of the distribution of how funds are sold to clients but the Charity Commission regulates the funds themselves.

"If everything was under one roof, it would make things easier to understand, particularly for smaller charities. I think there's a degree of confusion at the moment. But we would not want to see the uniqueness of the charity market get lost inside a much bigger regulatory framework and there can be a danger of regulatory creep."

Where he thinks change will be helpful is if it recognises that trustees of some very small charities have more in common with retail investors than the sophisticated professional financial investors that they can be grouped with.

Secondly, the CAF is keen that the changes don't overburden smaller charities or force them to change their voluntary oversight structures. "There's a degree of comfort in having independent trustee boards and we would want to see that continue," he says.

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