The economic environment within which charities invest continues to be tough. But what are the main challenges, and more importantly, where are the opportunities?
Heather Taylor joined the Trust for London as director of finance and resources about a year ago. “I don’t have an investment background, which was the first test. We also have a relatively new chair and chair of the investment committee, and are working on a new funding strategy. Our biggest challenge is thinking about how that applies to the whole endowment, and seeing investment through the lens of our mission – what we are funding as well as needing financial returns to pay out grants.”
Also new to her role as head of finance at the Tudor Trust is Navjyot Johal. “We are currently closed for new applications. Change at the board level is coming as the Trust has started recruitment of new trustees. We will be looking at reviewing the funding strategy and investment policy once that process is complete.”
As chief operating officer of the Diocese of Westminster, Paolo Camoletto is responsible for 200 parishes and 200 schools. “Historically, our investments have been generated to fund long-term things such as the retirement of priests, and to help smooth the volatility of our mission. We are now trying to build investments for every parish, and using an ethical – or faith-consistent – approach to implement that.”
Mark Morford is regulated products manager at CFSL, part of the CAF group, which provides investment funds and cash deposit services to the sector. “CFSL offers the IFSL CAF ESG funds to charities and the group also manages significant investments on behalf of donors. My views largely represent what our donors, beneficiaries and charities are telling us.”
Alex Geere has been an investment consultant at Mercer for 11 years, and for the last five years or so has worked closely with charities and not-for-profit investors. He finds that, since the Covid-19 pandemic, financial markets have been very volatile. “The headline return figures for some assets over the last few years may now look healthy again but hide a lot of ups and downs. That’s fine for a long-term investor, who can ride it out, but causes headaches for those spending as they may have to sell at depressed prices.
“Meeting real return objectives in a period of high inflation is also a key struggle our clients are facing. I don’t know any investor who has outperformed the retail price index (RPI) over the last year or so, let alone adding an extra 5% if that’s what they’re targeting.” He says this creates lots of interesting conversations with different stakeholders to get across the point that this has been a particularly challenging period for real-return investors.
“We are also doing a lot of work with investors on making their investments more mission-aligned and this is on a lot of agendas at the moment. This is interesting because different investors want different things, although generally there is increasingly an emphasis from investors on being more targeted in their impact investments by geography and specific sub-sectors.”
CC14
The discussion takes place just a month after the publication of the Charity Commission’s long-awaited refresh of its CC14 investment guidance. But will it make a big difference?
Camoletto guardedly admits to being a little disappointed in it at a first glance. “I was expecting more in some sense, perhaps a little stronger language on how charities can align mission to investment. But it helps provide the language to allow people to go forward. We mostly moved on from the discussion about responsible investment affecting return several years ago.”
Taylor doesn’t believe it will change a lot for her charity, “partly because we are on that journey already, so it strengthens the case rather than shifting what we do, or at what speed”.
Morford expects it will help smaller charities with fewer assets. “And, the examples are very useful, as is the clarity around the need to take investment advice. It has also given more scope and confidence for trustees to realise that they can take environmental, social and governance (ESG) factors into account. The removal of different terms for similar approaches in the space should be beneficial.”
ESG
Morford explains that CAF did a lot of work on charities’ requirements a couple of years ago. “We had a range of investments that had no ESG filters, but now our funds exclusively have them. The majority of enquiries involve how ESG is incorporated, as there is confusion around the terminology the wider funds market is using. It is certainly true that ESG is becoming more mainstream in the approach from managers, especially around the governance element. Who doesn’t want to invest in a firm that is well-governed? It will definitely help when there is more clarity around how the industry describes ESG and what the terminology they use actually means.”
“ESG is part of what we do anyway,” says Johal. “However, we get reports from our managers and I struggle to understand how true some of it is. It looks good on the paper but what is the depth of information behind it? But certainly, the social side of it, and being more impact-driven is becoming more important and we are looking to increase it.”
Geere says it can be difficult for trustee boards and investment committees when the reporting they receive is largely numbers versus a benchmark. “The trick is to go a step further in your manager engagement and get specific examples of where ESG considerations have impacted investment decisions. We are also seeing a shift where investors are increasingly concentrating on what fund managers are doing within their own firms, for example around diversity and inclusion, as well as in respect of the companies they invest in. They see their fund manager as a partner they want to align values with.”
For Taylor, the challenge is that Trust for London has seven different managers. “Engaging on ESG is incredibly resource intensive. At our last review, as we are a big funder of the Living Wage Foundation, we asked about whether the managers were signed up. Two weren’t but did so post-interview, which is a great example of aligning values. Our funding policy review will lead us to be more specific about examples of good practice. It is easy to receive reports, and get general examples. But our poverty work funding means a strong focus on the social, whereas a lot of examples tend to be around environmental. While net zero is obviously still really important, we are more interested in the employment practices of firms we invest in.”
Camoletto thinks that the term ESG can become inflammatory in how it gets used. “I prefer to focus on being coherent and consistent across what we do. We have 150 food distribution centres, for example, so how are the firms we invest in engaged in food poverty and the cost-of-living crisis? It is a work in progress and we need to be patient with ourselves. We will make mistakes but we have to do it. Being consistent investors means engaging with companies on what we think society should be like, for example, on the living wage. But how do you do that as a charity, who relatively is a small investor? Alliances such as the Church Investors Group are crucial to engagement. ESG is about working with companies to convert them to better practices, which are also wanted by the staff at those companies. You need to look at how your fund manager votes.
“We look at how fund managers are engaging and are reporting on it. You can’t win them all but if you have a voice it can lead to real change, although not overnight. Having evidential information about engagement is important.” He also raises the divestment debate.
Camoletto says that the Diocese is transparent in its accounts about what it does, but people have different views. “You can get attacked on how you approach divestment. We do think about it a lot, it isn’t just an emotional debate but an intellectual one, but you need to explain these decisions. Stakeholder reaction is a concern. There is a fear that you may be in the press for divestment. You need to think way ahead of time, determine what may be an issue in the future, and meet the need to address it now.”
“There has been a shift from blanket exclusions,” observes Geere. “There may always be some red lines for some investors, especially perhaps faith-based organisations. But trustee boards and their investment committees need to work with their stakeholders to articulate why they have made decisions.”
Taylor says the worry with divestment is that if you divest, who moves into the space? “You also have to consider a just transition. These issues are far more complex than we sometimes assume.”
The biggest barrier with changing behaviour is time. “How much resource do you need to employ to have the level of engagement needed?” muses Johal. “But I do think there is a greater role for trusts and foundations to work with engagement because there is a lot of knowledge held due to the work we fund. The optics shouldn’t just be through our grantmaking but through our investments.”
Geere feels that a lot of investors want to move to the next level with their overall investment strategy through mission alignment. “The challenge can be finding pooled products for small and mid-sized investors. These are emerging, certainly with environmentally-focused products, and a number are linked to areas such as affordable housing on the social side, but it is currently somewhat more limited beyond that.”
Return of the 60/40
Camoletto raises his concern over what he calls a paradigm shift back to the 60/40 – the once traditional portfolio constructed around 60% equities and 40% bonds. “This was being talked about a lot six months ago, but bonds haven’t done too well so is it happening? There also seems to be a shift to higher expected fixed-income returns at a time when we are living with one foot each in the old and new interest-rate environment.”
Geere says that “over the last 10 years, charities generally didn’t have much of their portfolio invested in fixed income because yields were so low. Now the starting point for yields is higher, and although inflation in the UK remains high, it has put the asset class back on the table. There may still be reluctance in the charity sector, however, because unlike with equities, investors don’t have a vote and the ability to influence may therefore be less explicit. Good investment managers do certainly seek to influence through their engagement efforts and there is increasing availability of things like green bonds, but it may still be harder than with equities.
“We are also having conversations with investors about the importance of cash and treasury assets being invested in the right place now interest rates are higher.”
Morford agrees that a lot of potential investors are looking at cash returns as they look attractive at a time when the economy remains uncertain.
Operational efficiency
The panellists finish off by discussing operational efficiency, and how the decisions on the issues discussed already are made at a strategic level.
Johal observes that from an operational perspective the challenge is that trustees have limited time together, therefore sometimes it is harder to have meaningful conversations around policy and strategy. “In my view, charities need to work towards adopting a more holistic approach to seize opportunities whereby they can have more impact. I have experience at other organisations where even though the trustees may have investment experts on the board, they often tend to look at things through their own lens rather than the charity’s.”
Camoletto agrees. “And sometimes you have people who have dabbled in financial things on a personal level and think they can apply it to the charity. But who do you give responsibility for policy to? You need to listen to the right people but decisions need to be at trustee level. We have advisers coming in quarterly but it is largely a passive process. The trustees are involved more in asset allocation, and exploring where the risks and opportunities are over the next 20 years.”
Johal says it is also about engaging everyone, and creating a space where the grants and finance team can be involved and work together. “Expertise needs to be shared. Formulating the investment policy shouldn’t just be driven by the trustees, even if they have expertise.”
Taylor concurs that this is so important, but not easy to do. “Our grants team will have more expertise on social justice issues, for example, so need to try and bring it all together.”
Morford says that the CFSL management team meets regularly to review the funds it offers, and looks to tap into the embedded knowledge created by the diverse end users from across the whole CAF group.
Geere says that going back three to five years, Mercer was typically either appointed to provide advice as part of particular strategy or manager selection projects, or to provide a full discretionary solution for clients who did not have the in-house governance budget or investment expertise.
“We are now doing a lot more with investors in the middle. All of the things we have discussed today create more work, time and resource requirements for trustee boards. Investors may want to set key asset allocation decisions themselves, but may require more support around the day-to-day and operational heavy lifting.”
Johal wonders what good practice looks like in terms of how trustee boards operate and in how meetings are run. Geere responds that he does notice differences in how boards and investment committees function. “If the board has been able to read all of the meeting materials beforehand, the meeting itself is often more effective, more of a Q&A. Focusing on key strategic issues rather than very specific points relating to underlying securities also tends to be a better use of the board’s time. Ultimately, it is a governance issue for charities to ensure they get the most out of their trustees and committee members, and help them to fulfil their roles and responsibilities.”
Thanks to Mercer for its support with this article
