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Trustee Week - Investing For Charities

Charities are unique in many ways, and identifying and implementing specific investment solutions is a prime example. Whether it is fundamental philosophical issues such as ethical investing or their approach to environmental and social governance (ESG), charities need to achieve the right balance between current income and future growth.

If they don't, practical issues such as the level of risk they can tolerate must be considered before making any investment. Working closely with investment advisers is an important step in this process, but involving other professionals also helps.

A comprehensive investment policy statement is essential, as it helps trustees set a framework to invest in. However, it requires careful monitoring, as if it isn’t, good intentions might be undermined. For example, paying out income is a reasonable objective, but what about its impact on capital in those periods where gains are limited? Working with multi-disciplinary advisers can help with these kinds of issues.

When it comes to ethical and risk issues, clarity is key. Certain areas of investment, like the tobacco industry, are regularly excluded on ethical grounds. However, the rules surrounding other investments need to be very clear.

This is especially relevant in the light of recent financial innovations like Exchange Traded Funds (ETF’s). As these can be very useful investments, especially for smaller charities, but they can have unintended consequences for example an exposure to tobacco.

Risk is an essential and sometimes confusing issue, particularly in finance, because it refers to the fluctuation of capital rather than the potential loss of that capital. No one likes to take too much risk, but avoiding risk in the short term by investing in cash deposits can increase the long-term risk due to the impact of inflation rates.

However, looking at returns over a shorter time period, such as a year, can provide a misleading picture and encourage the wrong kind of activity. This is because history shows that the probability of a return from an asset that is typically viewed as risky increases over time, while that of a less risky asset decreases.

An important consideration that is receiving a lot of attention is whether to take an active or passive approach to investing. This is a broad topic, but it boils down to whether a current low cost is preferable to the prospect of better profits over time.

A key element of this debate will be the role active asset allocation takes and what limitations should be placed on a manager. A passive manager will generally select a mix of different assets consistent with an agreed objective and risk tolerance, which will change very little over time. An active manager will switch between different assets over a cycle. Done well, active management can produce better returns and smaller losses, but this is very much subject to execution risk and can disappoint.

While managing investments may appear to some to be a dark art, It is vital that everyone working with a charity's finances understand what goal is being worked towards, how it is going to be achieved, and what the risks are. Therefore, it is critical to maintain an open and regular discussion with individuals who make investment decisions.

Read more about Irwin Mitchell’s financial planning services