Charity

Understanding the numbers

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The second Trustee Charity Finance Competency Survey 2019 produced by MHA and the Charity Finance Group starts by reminding us that the 2017 Charity Commission research on trusteeship “Taken on Trust” demonstrated that 93% of charity trustees “regard their role as important or very important to them”. The report points out that “most [trustees] would be truly shocked if they understood their performance is holding back their charities’ impact on beneficiaries.”

Findings indicated by the respondents show that about 60% of their trustees had the necessary financial skills or knowledge, or that they had a good enough understanding of the charity’s financial governance to undertake their duties well.

This means that 40% of trustees, not far off half, aren’t confident about their charity’s finance. This doesn’t sit well with the Commission’s core duties for trustees set out in CC3. The report doesn’t attempt to suggest why this might be, although training and support is a welcome suggestion that will always help at the margins.

There are probably more fundamental problems including the increasing complexity of charity and length of accounts including gems such as pension deficits, accruals and contingent liabilities, all of which impact at a relatively low turnover of £250k, as opposed to much simpler cash accounting.

 MHA’s welcome report should add grist to the Charity Commission’s review of how the SORP is governed and to what end if it is to help close the gap between what trustees need to understand and what is reasonable to expect them to understand.

Reputational Risks

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‘Don’t wash your dirty laundry in public’ is an old and established piece of advice, and like old established advice, it contains much sense.

However not flouting one’s dirty washing is quite different from denying it exists. Recently and too often charities have been caught out seeking to protect their reputation by covering up a scandal, and in the end inadvertently creating a far worse reputational problem than before.

Reputation management is always high on a charity’s risk register but the mitigation should be consistent with the charity’s values. Reputation is an external attribute – it is what other people think. There will be times when what others think, and what a charity thinks, are different and in those situations the charity must be true to its own values and be prepared to explain its reasoning to those who disagree.

Sometimes the popular thing to do will not be the right thing to do. ‘Responsible investing’ means just that – decisions that are thoughtfully considered and the balance between harm and benefit carefully weighed. This is the story of the Sackler Trust gifts. That’s why it’s so hard to do well and so easy to become overwhelmed. Everyone starts with small steps.

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.

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.

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.

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.