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.

Who protects the protector?

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The government’s newly issued Civil Society Strategy has been described by NCVO as “an encouraging start but government could do more”.

One area where more work is certainly needed is in section 7 “Funding and Financing the Social Mission” where it says, “The government is working with the Charity Commission and UK Community Foundations to release at least £20 million over the next two years from inactive charitable trusts to grassroots community organisations.”

Charitable money shouldn’t be left doing nothing (it’s a common complaint of ours), and if there are inactive charitable trusts they should be reactivated or closed to make sure the money does reach the intended beneficiaries.

As we know, every charity has a defined area of activity that it exists to serve set out in their Objects clause, even inactive trusts. The job of the Charity Commission is to ensure those Trusts’ delivery of their purposes is properly fulfilled and to protect their assets from being expropriated to a new purpose (in this case, the grassroots community organisations). Trusts that are currently inactive should apply their money to their original purposes, and if not, to ones that are similar. If a benefactor had left their wealth to treat a particular medical condition, medicine should continue to be the beneficiary.

We trust that the Charity Commission will continue to protect the chosen beneficiaries, and not allow their interests to be subverted for political gain. Who will support the Commission in that role? As the famous Juvenal quote reminds us Quis custodiet ipsos custodes? The answer is that only the law can protect the protectors, so we all need to be vigilant in how the law is used, even in this small example.

Why charities need to engage

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At Yoke, we like to cycle to meetings. It keeps us fit and cuts our carbon footprint. While some say cycling in London or any city is dangerous, we manage the risks and take appropriate time between meetings, keeping within the law. The biggest risk on the road tends to be other cyclists or pedestrians, who do not appear to be aware of the rules of the road. 

We notice that it common for pedestrians at crossings wait for a bike to pass, when it is the person on foot’s right of way. This is because many cyclists think they are in charge and ignore the highway code by crossing red lights and zebra crossings, so pedestrians are naturally confused and avoidable accidents can occur.

An excellent recently published report entitled Time and Money highlights that charities who rely on investments to support their long-term mission can take advantage of their ability to make and spend more money and encourage good corporate behaviour. However, short-term thinking can get in the way.

Trustees can unwittingly be blown off-course and when investing for the long-term. It is important that Trustees should be committed and ambitious, not complacent, continually attending to the proper management of their assets but never losing sight of the main charitable goal.

Why do we link the poor pedestrian to a report about investment management for charities?  In many cases an investment manager attends the charity meeting and for usually 30 minutes, they entertain client with stories from the market. Rarely does the charity engage. Like the pedestrian at the crossing who is used to the cyclist ruling the road, charities tend not to challenge. 

Charities must engage, not be entertained, when it comes to investment. They must understand the risks and investment objectives. While the manager can advise, it is the charity that is in control and they must have the confidence to remind themselves of what they want from these assets, assess whether or not they are getting what they want, and if not, decide what action to take.   

Investment managers should also encourage their clients to be engaged by basing their presentation of how well they are fulfilling the mandate they have been given against the benchmark the charity has set. Fabulous tales of the far east and what’s going on in the Silicon Valley is simply entertainment and adds very little to the Trustees’ understanding of whether they are achieving their long term goals.

Like the pedestrian, trustees need to enforce their right and be in control of where they are going to avoid unnecessary accidents.  

When charities derail

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The accompanying photograph for this blog shows a Great Northern (Govia) train driver, who had to disembark from the train to check the station board and confirm the stopping points for his non-stop train! It reminds us of charities who may have great plans and a timetable of events, but what happens when these plans get derailed?

New train timetables were introduced on 20 May with the intention to provide more trains, more seats and new journey opportunities. Due to the large number of changes involved, Network Rail did not finalise the timetable until much later than planned. This has created chaos for train companies who failed to carry out specialist training for drivers required by the new schedules. It has resulted in misery for passengers and a blame game for all those involved. 

It is often said that charities are also on ‘a journey’ and always want to provide more for their beneficiaries, which is a poetic way of describing their strategy. They set a strategic plan with budgets, milestones, expected income and expenditure. These plans can go array due to unexpected events including planned income not materialising, an increase in demand for a particular charitable service, a contract failing or general volatile economic conditions. Like a passenger on a train, the charity is reliant on others to get them to where they want to go.

A passenger may decide to give up on the train and jump in their car. Equally, a charity may decide it can manage itself and avoid the dependency of others. This might include managing physical property or making investment decisions, or working out the balance to hold in each. How do trustees know if they have sufficient expertise and resources to make these strategic decisions themselves? More often than not they do but they are often held back through a lack of confidence about what they are allowed to do or lack of experience. 

A common issue we see at present is charities that have enjoyed huge growth in assets but cannot work out how to translate this growth into a higher spend on their charitable objects. This is because they are locked into a world of only spending income. While it might seem prudent to save for the future, charity trustees who see their assets grow to new heights on rising stock or property markets, will all too often see this wealth as a sign of success, rather than one of failure. After all, it is their spending that makes them charitable, not their saving.

We have grudgingly become used to unreliable and overcrowded trains in the UK. Charities must not allow the public to take a similar view of them by ensuring their financial governance is robust to weather the highs and lows of their journey, without needing stop half way through to see where they’re going. 

 

 

Yoke is a year old. 10 things we have learnt about charities.

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Yoke and Company is officially one year old. The company founders are a lot older and we are amazed that the year has gone in a flash.  So what have we learnt and what has changed?

1.      Regardless of all the Charity Commission’s advice on financial governance, it remains normal for trustees to say ‘I don’t do money’. If it’s baffling, it is usually just because the issue has been badly explained.

2.      Being regulated means Yoke never hesitates about the investment advice we give, which goes beyond simply comparing managers; The FCA’s review on investment consultants having conflicts of interest or not being regulated highlighted many issues that have yet to be addressed.

3.      Charity decision making lurches from one quarterly meeting to another. They always have, and probably always will. Difficult decisions often get deferred. No decision is a decision in itself and it is usually the wrong one.

4.      Too many charities regard success as a growing pile of money. Surely this is a measure of failure because the money is there to be spent on charitable purposes.

5.      Charities tend to be cautious; trustees should take more risk for their beneficiaries, just as a parent would for their children. The parents don’t enjoy the rewards, but that’s not why they do it.

6.      Penny wise and pound foolish – investment managers can be expensive but not that different from each other. Getting your risk budget right is free and makes you most of your returns. Obtaining help in this area difficult to find.

7.      The rewards in winning new investment business are huge, so the industry is incentivised to get trustees to change managers frequently. Less change will provide better long-term results. 

8.      The public trust in charities has declined after successive years of media attention and bad practice from a few poorly run organisations. Kid’s Company is becoming a distant memory after Oxfam, but charities need to be less defensive and bolder about the great work they do.

9.      We continue to meet so many amazing charity executives who have passion and bold ideas. The problems manifest when these ideas are passed to the trustee board who struggle to share the confidence to take controlled risks with their assets.

10.   We keep looking for someone else offering independent financial assistance to charities, concentrating on the ‘upstream’ problems that concern the overall financial decisions. Combining this with regulated and totally independent investment advice to charities of all sizes. This currently makes Yoke fairly unique in the UK. 

 

Why are fund managers becoming insecure?

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The active fund management industry is going through an odd patch at the moment and showing signs of insecurity after a decade of confidence. 

Despite the economic crisis ten years ago, the fund management industry has generally ridden a prosperous wave as markets have been propelled ever upwards, with much thanks due to quantitative easing.  According to the Investment Association, the trade body for the fund management industry in the UK, assets under management have doubled to £8.1 billion by 2017. The FCA estimates that operating margins have on average been 36%, comparing favourably against the broader economy where the average operating margin for all UK listed companies, including asset management, was 16%. This is partly due to increasing AUM growing revenues much faster than costs, again improving margins.  

With the rise in profitability, the industry has seen a rise in regulation with MiFID II being introduced in January 2018 and the GDPR coming in May.

So as assets under management and profitability rise, with greater controls through regulation, why is there insecurity in the industry? 

There is a growing consensus from the fund management community that the decade long bull market in real assets may be stalling and returns in 2018 will be negligible at best. Peer group investment performance has narrowed as many fund managers appear to be making similar market calls. Market veterans have seen this before and long-term investors will digest the current hiatus with no more than a slight hiccough.

Does the insecurity exist because of what could be a crossroads of profitability and greater transparency on costs and performance? Research from Invesco PowerShares, a passive fund provider, suggested that 67% of institutional and sophisticated investors believe that MiFID II will result in increased use of exchanged traded funds (ETF) by institutional investors in Europe. The research cites transparency oflow costs and management fees being the top reason given for the expected increased flows into passive investments. 

It might feel insecure about the future and facing margin pressure, but the fund management industry must have the confidence to set out its views on the investment markets, no matter how painful it might seem. Active managers should not worry how they look compared to their peers or the passive competition, but to explain clearly the headwinds they are prepared for and the ones they will let go. They should also be more explicit about the positives of successful active management over passive or ETFs in terms of counterparty and momentum risk.

Clarity on costs and performance is good for investor confidence. Managers must demonstrate conviction on their distinctive investment approach, so clients can make a more informed choice between them. If they cannot achieve this, the managers’ profits will suffer as clients move their money elsewhere.