Yoke's submission to the SORP consultation

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Yoke has now submitted its response to the consultation about the governance of developing the Charity SORP (the accounting regulations for charities).  In summary we make four points: 

  1. The goal of the SORP is to enforce standardisation and consistency of reporting

  2. Encouraging an infrastructure to interpret accounts (by sector) based on the Commission’s website data will improve transparency

  3. Reporting on impact should be undertaken by people who are appropriately experienced and accountable

  4. There should be a better way for niche or technical improvements to accounting policy to be considered and incorporated in the SORP.

The charity reserves conundrum

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Just before Christmas the Charity Commission published its findings on Charity Reserves. Although 92% of the charities sampled explained their Reserves Policy and 90% explained why they were being held, a third of charities failed to disclose the actual level calculated in accordance with the Commission’s guidelines.

There will be several reasons for this lapse but an underlying one is that there is confusion about what people think ‘charity reserves’ mean. At a simple level there were differences between the Commission’s definition (in CC19) and the SORP definition which charities follow when preparing their accounts. At a more fundamental level there is real confusion amongst users. The formal definition of reserves excludes illiquid assets such as the property the charity uses in its work (which suggests the focus is in part on liquidity) but investment property is included which suggests it is not. To many a charity’s reserves will be Trustees’ long term policy of what they feel is the right size of cushion to underpin their long term charitable purpose.

The problem for the Commission is surely that they are pulled in two different directions – some charities keep far too much, and some (Kid’s Company is the usual suspect) keep far too little. These are difficult aims to reconcile in one formula. Focussing on liquidity suggests that charity Balance Sheets can never reshape themselves into something more efficient, and arcane calculations undermine efforts to allocate more  reserves to beneficiaries.

Reserve levels in charities are a complete substitute for the profit line in commercial companies. Finance Directors should drive their organisations based on long term reserve planning. Unlike a business, in a charity a profit or loss only matters in the context of its reserves. 

We believe that Trustees should always be able to answer these three questions:

  • Do we currently have sufficient cash to pay our bills as they fall due?

  • In accounting terms are we fully solvent? 

  • How large a reserve to we want to keep, and for what purpose? 



Why the National Trust is not so bad

Blickling Hall, Norfolk - where a water-source heat pump has been installed in the lake to replace the existing oil-fired system

Blickling Hall, Norfolk - where a water-source heat pump has been installed in the lake to replace the existing oil-fired system

The National Trust is the latest charity to become embroiled in an ethical debate around investing. It is one of a number of not-for-profit organisations to fall into the public spotlight due to a perceived conflict between the charity’s mission and its investment policy.

This case revolves an investigation by the Guardian newspaper that highlighted the charity invested “tens of millions of pounds in oil, gas and mining firms – despite the conservation charity pledging to cut down its own use of fossil fuels and warning about the impact of climate change”.

The Green Party has added to the fossil fuel fire with their co-leader Caroline Lucas Tweeting, “It’s disappointing to see @nationaltrust so dedicated to protecting our natural heritage undermining its good work with significant support for dirty fossil fuels.”

Is the National Trust so bad? After all, as a member of the Climate Change Coalition the charity stated that climate change poses the single biggest threat to the sites they look after. They are actively adapting, managing coastal change and the impacts of severe weather. The National Trust has pledged to reduce its energy use by 20% by 2020 with 50% coming from renewable sources. Furthermore, it will be spending an additional £300m over the next ten years to clear a backlog of conservation work.

Of the £1.3 billion the charity has in reserves, it invests £166.7 million in the CAF UK Equitrack Fund. This is a tracking fund that aims to replicate the performance of the FTSE All Share index. As a result, the fund invests into BP, Royal Dutch Shell, Rio Tinto, etc, but the Trust’s exposure to these companies is less than 2% of the total investments. Legal & General, who manages the fund on behalf of CAF has a very strong record in corporate governance and responsible investment.

The conundrum does highlight the level of detail that might be employed to match a negative screen. In this case excluding mining, oil and gas producers is easy, but should this also include Weir (world's leading engineering business that is involved in mining and aggregates) or Marshalls (who operate their own quarries for the manufacture of natural paving stones)? There will be many active fund managers who will argue that they have the resources to screen these issues from a portfolio, but this adds to the time and cost of managing investments. There has to be a level of proportionality in making Ethical, Social and Governance (ESG) judgements.

National Trust has responded to the criticism, stating they adopt a policy of not investing directly in companies which derive more than 10% of their turnover from the extraction of thermal coal or oil from oil sands. They also engage with companies to improve their environmental performance and see their role as one of actively influencing behaviour and driving environmental improvements.

The charity has adopted a proportionate stance to ESG investing, knowing that it is very difficult to totally exclude certain issues that might be at odds with its mission. The charity has opted for a charity tracking fund to reduce its overall cost of investment and the Trust actively engages with companies to influence behaviour, while investing directly in renewable energy projects on its estate.

The National Trust is a high-profile charity that often attracts criticism. This case highlights the fundamental difficulty for a charity investing with clear ESG perspectives. There are often grey areas and trustees need to be proportionate in managing investments and reputation.

When trustees can lose it all

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This blog celebrates Trustees Week.

Trustees have many responsibilities and significant power to guide their charity for good or ill. Occasionally circumstances become so stressful, particularly during a stock market panic, that long held strategies can be quickly abandoned.

In one scenario trustees might have instructed their investment manager with a high earning but high risk mandate, only to find that it falls by 30% (so far). Not knowing how much further it will fall, they change their mandate to one focussed on preserving the remaining capital, usually by selling equities and holding cash. Too often the market then recovers, but the portfolio doesn’t. Only trustees can do this.

We should always remember that being a trustee is very rewarding but can involve a variety of stressful situations: think of safeguarding, expenditure decisions, data and of course investing. It is not as simple as rolling some dice and hoping for the best outcome, as it is rarely that simple. The key is to be prepared and rehearse these situations as far as possible – which is a good use of the Risk Register.

Where organisations have mission critical components it is important to make sure they are resilient and well supported. It is up to senior staff to make sure that their trustees are properly supported so they can exercise their duties and responsibilities as effectively as possible.

A Fable of Aesop

Saint Anthony the Abbot Tempted by a Lump of Gold, Fra Angelico (1436)

Saint Anthony the Abbot Tempted by a Lump of Gold, Fra Angelico (1436)

There was a man who was so worried about the safety of his possessions that he sold them all and bought a lump of gold which he buried on the outskirts of town.

He had no greater pleasure than to visit it and to muse or dream. He did not own the gold, but the gold owned him.

One day he found the gold gone. He was distraught and told a neighbour of this loss.  The neighbour told him to put a stone in its place – “since you never meant to use it, the stone will be just as good as the gold”.

Aesop’s moral is that the value of money depends not on its accumulation but on its use. It remains as true today for trustees and advisers as it did 2,500 years ago.

The huff and puff of ESG investing

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As a follow-up to our recent blog on ESG investing we note that the government in Canada has announced the legalisation of cannabis for all uses. Meanwhile in the UK the drug is still illegal, but specialist clinicians will be able to legally prescribe cannabis-derived medicinal products to patients with exceptional clinical need. So how does this sit within the investment debate over Ethical, Social and Governance investing?

The leading Canadian company to get onboard the marijuana puff is called Canopy Growth Corporation. It is the first Canadian cannabis grower to debut on the New York Stock Exchange with a valuation of more than US$10 billion. Putting this into perspective, Canopy is now worth more than Canadian company Bombardier, one of the largest global aerospace businesses and manufacturers of many trains in the UK. Like ‘dotcom’ and ‘bitcon’ before, is cannabis the next tulip bubble and how should charities approach this possible investment?

Ethically, there has been significant clinical evidence to support the legalisation of cannabis as a treatment of many medical and psychotic problems. Socially, despite the health benefits, marijuana is illegal in the UK and many other countries. Campaigners highlight its link to violent behaviour and serious mental health problems. As far as governance is concerned, charities may be split as to the merits of having exposure to cannabis production in their portfolios depending on whether it is for recreational or medicinal use. But surely it would be difficult for charities to advocate putting pressure on the UK government to follow the example set in Canada?

While cannabis may boost financial returns in a global portfolio, is a useful example as to why charities find ESG investing both confusing and difficult.

Putting the 'S' into ESG

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Here’s an unsurprising statistic from the 2018 Newton Charity Investment Survey - 100% of environmental charities consider that Environmental, Social and Governance investment factors are ‘very important’ in the management of their investments.

Here’s the more surprising statistic: only half of social welfare charities consider that Environmental, Social and Governance characteristics are ‘quite important’, whilst 25% consider them not really important, and 25% of social welfare investors think them ‘not important at all’.

Why do social welfare issues command so much less commitment from social welfare charities than environmental issues do from environmental charities?

To save or spend - the trustee’s dilemma

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When things get tough at a charity the obvious place to look for a solution is by cutting the cost base. Sometimes trustees will invest in fundraising and sometimes trustees do both.

It’s much easier to cut the Sellotape budget because it is so visible, and it is naturally difficult to create more future income by incurring a fundraising cost first, because the future income is inherently uncertain. Sometimes cutting costs can be more damaging than taking the risk of creating more income – both need to be looked at alongside each other on an equal footing.

When it comes to charities that rely on investments for a large part of their spending, the uncertainty about the future is exacerbated by the remote and technical decisions that need to be made. Trustees might tell their fund manager ‘we need to spend more’ to which the manager is likely to respond by saying that it will reduce the likelihood of preserving the charity’s capital. That is an obvious truth – you cannot at the same time spend more money while increasing your chances of growing it if all other things are equal.

What are trustees to do if their professional advisers are discouraging about spending more? One thing to remember is that the object of the charity is not to exist in perpetuity, but to use its money to advance its objects somehow. After all, the reserves are held for times of stress as well as the long-term.

Trustees can also question whether all other things are equal – for example could they have a higher returning portfolio with tolerably more risk? This is exactly why trustees are allowed to take risks with the charity’s future, so long as they have thought about it; that’s their job. 

What trustees sometimes lack is the confidence (and occasionally the willingness) to push back against advice not to spend, and take a risk to do something more useful with their investments.

We believe that Trustees should be in the driving seat.

Getting ready for the tide to go out…

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Charity investors are offered two ways of investing: a discretionary manager who buys and sells shares directly for their client; or through an investment fund, usually called something like ‘Charity Income and Growth Fund’ and which have risk appetites varying from cautious all the way through to adventurous.  

The former (discretionary) approach requires the manager to carry out a suitability test so they understand each charity’s financial status, its need for income and its capacity to withstand capital losses. This includes looking across all the charity’s assets and liabilities. With a single investment fund it is not possible to do this. The manager cannot tailor the fund profile to the needs of each individual investor – it is a single product designed to have a specific risk profile.

A charity will commonly seek to invest in a ‘medium risk’ fund. However, the fund manager is only regulated to make sure the fund itself is ‘medium risk’ which means that the client, if they have other assets, may well have a completely different risk profile. If, for example, they hold property the overall risk the charity is taking might better be described as ‘adventurous’ rather than ‘medium risk’.

What should Trustees do? Trustees must remember that investing in a fund that is ‘low risk’ only describes that single fund. It certainly does not describe the charity’s total investment risk if it holds any other assets outside the fund. That’s why it is so important for trustees to understand the risks they are taking in the round and not simply to assume that labels on individual investment products apply to their entire charity.

Regulations don’t allow firms that offer products to consider the risks of the other assets and liabilities of the charity, only the risk of the funds they offer. That’s why independent advice is so important for any trustee body that is not confident in making these decisions about their total risk.

After ten years of very good stock market returns, we hope that all trustees will find that they are properly covered when the tide does finally go out.