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What to include in your charity’s investment policy?

Author: Heather Lamont, Client Investment Director at CCLA*

Published: 10 May 2022

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Why it’s important to get clear about your income and capital growth expectations, express your board’s risk appetite with a quantified risk budget and to communicate your priorities clearly to asset managers.

Don’t be vague – quantify your investment aims

It’s axiomatic that ‘what gets measured, gets managed’, yet too often charity investment policies are centred on vague outcomes such as ‘a blend of income and long-term capital growth with a medium risk profile’. What a cop-out for the portfolio manager! A finance director wouldn’t get away with an operational budget that said ‘we expect to get some income next year’, or the chief executive with a strategic plan that said nothing more specific than ‘we think we can grow over the next 5-10 years’. And what does ‘medium risk’ mean anyway?

Establishing income and capital gain targets

You ought to be able to have a conversation with your portfolio manager to establish some meaningful targets against which you can subsequently measure progress.

An annual figure for investment income (in pounds, not just as a percentage – so it can go in your budget) should be relatively easy to forecast. Like almost all budget figures, the end result may not be in line with forecast, but your manager should be able to explain the reasons for any significant variance.

Capital growth is trickier. You won’t get the long-term growth you need to stay ahead of inflation without investing mainly in assets that can go down as well as up in value along the way, so it’s pointless trying to guess what the portfolio value will be on the particular day that happens to be your financial reporting date. However, it’s entirely realistic to agree with your manager an expected average total return over the longer term; something like CPI+4% net of investment management costs, over rolling 5-year periods, would be fairly typical for an endowment or similar long term charity portfolio. By definition, it’s only over that longer period that you can really measure the outcome against target, but you can still monitor progress in the meantime by reference to market returns and peer group reports and seek explanations from your manager for any marked divergences.

Determining the board’s risk appetite

What about your risk appetite? Just saying ‘medium’ or ‘low to medium’ might sound comforting, but it doesn’t give your manager a quantified risk budget, and it doesn’t enable you to assess whether they have controlled risk to within that budget or delivered returns in a risk-efficient way. Investment risk in this context simply refers to the volatility of returns relative to the average return over a given period, so it is measurable. You can use a quantified risk budget to tell your manager how much volatility you are ready to experience, and subsequently to measure whether they have been able to control risk to within that level.

You do have to be realistic – you won’t get meaningful long term returns if you aren’t able to tolerate significant volatility. But your portfolio manager should be able to give you a good indication of how that trade off might work in practice. Your investment policy might refer to your risk tolerance in absolute terms (standard deviations) or, perhaps more commonly, relative to an index such as ‘up to 75% of UK equity market risk’.

Communicate your charity’s priorities to investment managers

To help avoid unintended consequences, it’s also wise to make sure the manager understands how you prioritise income, total return, and risk relative to each other and to refer to this in your investment policy. If strong and sustainable total returns are your top priority, your manager needs to know that – and you may need to accept less certainty of income or a higher degree of volatility. Whereas, if the manager believes that either your annual income target or a limit on risk is the dominant requirement, you could be compromising the pursuit of the attractive total returns needed to sustain the charity’s real spending power over the long term.

Heather Lamont is a client investment director at CCLA, one of the UK’s leading managers of investments for charities, churches and local authorities, and a member of the advisory group for ICAEW’s Volunteering Community.

*The views expressed are the author’s and not ICAEW’s or CCLA’s.

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