The current economic environment is pushing charities to restructure their assets and reconsider the size of their cash reserves. Angele Spiteri Paris reports.
“We considered moving a small amount of cash into our investment portfolio to reduce the risk of sitting in cash generating a negative return. In fact, we have.”
Kevin Barnes
In a world of low yields and negligible cash rates, charities find themselves the unenviable spot of making sure people’s donations are spent effectively and investing to protect capital and generate return, all while keeping the charity’s reputation intact. This unforgiving environment may push charities to skim some of their cash reserves and place those funds in higher performing, but also higher risk assets.
Charities have historically been very conservative with the money the public bestows upon them, often keeping large swathes of it in cash for liquidity’s sake. However, in the current environment, the cost of that liquidity may be proving detrimental, which arguably makes the case for charities to take small measures of increased risk.
David Rowe, managing director at UBS, says: “Charities are in a hard place at the moment because income sources such as funding from government and giving by corporates are declining.”
One of the main issues, which leads to the income proportions observed below, is that operating charities in the UK, that is the household names that carry out fundraising activities, do not have a large amount of money to invest since they are often dutybound to spend a considerable amount of the money they bring in.
Operating charities also tend to keep around four to six months of their operating cash in reserve which in the past, when interest rates were at acceptable levels, was of no major concern. Now however, things may have to change as cash was the worst performing asset class within the charities sector, returning 0.4% over the 12 months to 30 June, according to the WM Charity Fund Monitor from State Street.
Rowe says: “The sector tends to hold quite a lot of cash outside of their investment portfolios. I would estimate that anything of up to 30% of their liquid assets, so many tens of billions, could be held in cash in one form or other.”
Although charities, and operating charities in particular, would still need to have a considerable amount of liquidity, they might be able to do more.
MORE RISK
Andrew Epsom, senior investment consultant at Towers Watson, says: “There may be a benefit in increased returns from adopting a slightly more illiquid asset strategy and following the trend insurance companies have recently been setting.”
Insurance companies have been generating higher return by moving assets from low yielding government bonds to corporate bonds.
However, according to Epsom, “charities are never going to be very aggressive in their investments”. Indeed, being aggressive in investment markets is not part of a charity’s mission. They need to invest enough to keep pace with or slightly outperform inflation. The worry is when their cash holdings are making a negative return and not doing the job they historically were put in place to do – that is generate an inflation- linked return.
Kevin Barnes, director of finance at Barnardo’s says cash is not considered a long-term investment but is primarily kept to manage working capital requirements. “Increasing inflation eroding the value of cash is therefore a factor, but not a major one,” he says.
Although the cash is not meant to be a long-term investment, having its value being eaten away when it could be put to work could be considered a disservice.
Epsom says: “Some charities could potentially afford to take more risk while still meeting their spending requirements.” Rowe agrees: “They might be able to squeeze a bit more return if they could or were prepared to take more risk.”
The ultimate aim of the increased risk, in traditional terms, would be to protect the charities’ assets and not to generate as much return as possible.
According to Kate Rogers, chair of the Charity Investor’s Group (CIG), charities have been debating this move for around four years since cash reserves have been generating a negative real return and inflation remains a key risk.
“We are seeing charities move assets from cash into higher-yielding assets because they have experienced this drop in income. I cannot say whether this is the right or the wrong thing to do since it depends on each charity’s structure and investment objectives,” Rogers says.
Some charities have already made this move. Barnes, at Barnardo’s says: “Yes we considered moving a small amount of cash into our investment portfolio to reduce the risk of assets sitting in cash generating a negative return. In fact, we have done so.” Barnes is not able to disclose the amount that was transferred and into what assets, however the charity’s investment portfolio currently holds a mixture of equities, fixed income securities and cash.
Investment is a very small part of an operating charity’s total income. In Barnardo’s case for example, the income from investment and property development accounted for around 3% of the charity’s total income, as at December 2013.
The decision for any charity, especially an operating charity, to transfer some of its cash reserves into longer-term, more illiquid investments will depend on its other income streams.
Rogers at CIG says: “ If they have secure funding streams, or feel they do, from donations or from government, then perhaps they can afford to take more risk for a better return.”
COMFORT BLANKET
Joe Saxton, author and founder of nfpSynergy, a research consultancy to thenon-profit sector, describes cash as “a comfort blanket, and sometimes a very expensive one”. Saxton estimates the charity sector overall has around a whole year of expenditure in reserve, something he calls “a cautious underestimate”.
Cash reserves in some of the largest operating charities in the UK have dropped in recent years, albeit by small measures. The NSPCC’s reserves reduced by £0.8m and the Prince’s Trust also reported a drop of £3.2m between 2012 and 2013 from £34.5m to £31.3m.
Although there is a level of increased opportunity risk by sitting on large amounts of cash, this is not to say all operating charities should place 10% of their money into an investment portfolio to generate significant return.
A large portion of their income will continue to be sourced from fund raising activities, and they should continue to have four to six months’ expenditure in reserve. However, siphoning off a small amount of cash to inject into those investment portfolios can mean considerable performance improvement over long periods of time.
CONSERVATIVE?
The question is, if charities do move some of their cash into their investment portfolio, what asset types should this money flow to? According to Monica Issar, global head of the Endowments and Foundations Group at JP Morgan Asset Management, this cash does not need to sit in long-term, very illiquid assets.
She says: “Charities should create a third portfolio; one that is not their liquid cash reserves, but neither is it long term. This should be an intermediate pool of assets with an investment outlook of three to seven years.”
In terms of where this money should be invested, Issar says she is currently talking to endowments and foundations about moving away from their historical home bias and looking closer at emerging markets and other parts of the world.
Rowe at UBS says charities are actually achieving quite a reasonable return from the assets they do invest: “People say charities are very conservative when, in fact, they hold large allocations in equities, which is not typically considered a conservative approach to investment.”
According to the most recent figures from State Street, as at 30 June UK charities held 62.3% in equities (34.8% in UK equities and 27.5% in overseas equities), 11.1% in alternatives and around 10% in fixed income. This asset spread could hardly be considered conservative.
REPUTATIONS AT STAKE
The potentially negative fallout of lowering reserves to increase investment is the reputational risk charities could incur. When people give money to charity, they generally expect that money to be used in aid of the charity’s mission, not be invested in equities for the long-term return.
So what is the price trustees place on potential reputational risk?
Epsom at Towers Watson says: “Reputational risk is significant in this space and it needs to be considered as part of the overall equation. Trustees tend to err on the side of caution when it comes to balancing the need for return with the potential reputational risk from the wrong investment.”
Rogers at CIG adds: “The public perception is that charities should not be holding investments and public perception is very important to charities reliant on income from donations.
“Trustees should consider the overall financial health of the charities they oversee and this includes balancing the public perception while generating return and making most of the charities’ assets. Ultimately, trust may be more important than making money.”
Having said this, Saxton of nfpSynergy, believes it is just as unexpected for charities to keep such large cash reserves.
He says: “Reserves hamper fundraising and create a disconnect between a charity and its donors. It is deceitful to people who make a donation expecting it to be used to deliver services, when in fact it is being put aside for a financial meltdown that will probably never come.”
According to Saxton, charities should not appeal to donors who believe the charity needs funds, when in fact the said charity has months or even years of income in reserve.
Actually putting that money to work in investment markets may be a better use of some portion of those reserves since, especially given the current state of affairs, the cash holding is actually riskier than many would think.
Issar says: “Transparency and communication, together with a prudent investment policy are the keys to keeping potential reputational risk in check. The man on the street needs to be educated on how the money they donate will be invested.”
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