Income is the lifeblood of a charity. The more charities can earn from their investment portfolios, the more money will be available to further their objectives. That has become a real challenge, however. Interest rates have been at 0.5% for more than six years while the return on many of the other income-producing assets traditionally used by charities has been relatively low given the subdued growth/inflation environment. Returns have also arguably been distorted by economic policies pursued since the financial crisis.
Charities have to be aware that returns can be eroded - or even eliminated - by inflation. Even with the current low levels of inflation, which the Bank of England believes may continue for some time, generating a real rate of return requires careful planning and asset allocation. It should also be remembered that income forms a significant part of total returns: academic studies consistently emphasise the importance of dividends to returns, so even charities which are less focused on income than on the total return generated on their portfolios need to keep yield in mind in their investment planning.
As Ruth Murphy, Head of Charities Brewin Dolphin points out: “It is the relationship between all these factors and how they relate to the wider financial circumstances of the charity that has made for a more substantive debate about the role and structure of charity portfolios in recent years.”
Gilts and bonds
Gilts were historically the mainstay of charitable portfolios but yields are currently low due to generally subdued levels of growth and inflation. It could also be argued that programmes of quantitative easing (QE) used by governments in several major economies have taken bond yields to abnormally low levels for a sustained period (as this keeps the cost of the high levels of debt across the world down). Charities have already been moving away from gilts in favour of other sources of income: the WM Charity Universe, the largest and longest-running analysis of performance data in the sector, shows that bond weightings have halved over the last 20 years.
Although seen as a ‘safe haven’ asset, government bonds are not without risk and – particularly during periods of rising interest rates – charities should be aware of the risk of capital losses (yields will rise and – in the arithmetic of bond investing – prices will fall). On the other hand, bonds have important diversification qualities – as during times of financial distress or when deflationary fears rise they would typically outperform company shares.
Corporate bonds and those issued by international governments can offer higher yields than UK gilts but trustees must be aware that these also carry higher risks whether of default, particularly for corporate issuers, or of currency fluctuations, for bonds issued in foreign currencies. The highest-quality corporate and international government bonds have also been influenced by QE, and are trading at very low yields; those with higher yields also carry a significantly greater risk of default and thus capital losses.
The income from equities can be more attractive than bonds with many leading British companies offering dividend yields of 3% or more and, in contrast to the fixed income of bonds, there is the prospect of income growth as dividends rise. But share prices can be volatile and dividends can be cut, so careful market analysis and stock selection is vital.
Alternative assets such as commercial property and infrastructure can produce income and, because they can behave differently to equities and bonds, help charities diversify risk. Liquidity can be an issue, however, as buildings can be hard to sell, although investing via a diversified fund will reduce this risk. The gyrations in the price of gold and other commodities over the last decade underline the higher risks associated with these assets, while the income from them is also generally low (or non-existent in the case of commodities).
It is vital that charities fully understand the nature of any assets they are invested in. The structure, risk profile, rewards and income-generation potential varies sharply between different asset classes. A diversified portfolio, invested across a range of asset classes and types of investment within each class, is likely to be appropriate for most charities. This should be accompanied by regular, careful monitoring to ensure that the performance remains in line with the objectives.
The value of your investment can fall and you may get back less than you invested. Past performance is not a reliable guide to future performance. Performance is shown before charges. All information is for illustrative purposes only and is not intended as investment advice; no investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us or your financial adviser. The opinions expressed in this publication are not necessarily the views held throughout the Brewin Dolphin Group.