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How trustees should be achieving investment oversight

ANDREW IMPEY, a director and portfolio manager at OLIM offers a guide to charity trustees for meeting their investment responsibilities.

At a time when the world is changing at an unprecedented pace, the role of the charity trustee is becoming increasingly complex, including the delivery of reliable, long term investment returns and stable income.

Macro-economic and political events dominate the news headlines, fuelling uncertainty exacerbated by short termism. Charities must look past this noise by focusing on well structured, well governed investment portfolios which deliver enduring investment solutions. Here are the factors that trustees should consider to achieve this objective:

Investment committee

Charity trustees have overall responsibility for the investment of their funds. They can delegate the management of their investments to those with relevant professional experience, whether internal or external, and pass oversight of portfolios to a finance or investment committee. This committee must report to and advise the trustee board, but trustees should be aware that they are ultimately responsible for any decisions made.

The committee could be formed of the whole board of trustees. However, in the interests of efficiency and to ensure that relevant knowledge and experience is brought to bear, many charities decide to form a separate investment sub-committee to advise the trustees and to oversee an agreed investment policy.

The added advantage of this approach is that other appropriate internal appointments can be made, such as staff dealing with finance and budgets, on a more frequent basis. In addition, external advisers can be included to offer specific investment or legal experience, which may come from involvement with other charities, bringing an informed yet independent perspective.

Investment policy

A written investment policy provides the framework for making informed decisions. It helps trustees manage their resources effectively and at the same time demonstrates good governance. Regardless of size, charities with investments must have a policy, which must be agreed and signed off by the trustees and reviewed periodically.

The policy must take into account how trustees intend to manage the assets. The size of funds available for investment may steer a charity in a particular direction. For example, investment managers generally have a minimum value that they will manage in a segregated fund. For large sums, charities may wish to appoint more than one investment manager, covering different areas of specialisation.

The policy must also reflect an appropriate investment horizon for return generation. Clearly endowments have a long term horizon. These funds lend themselves to investment in “real assets” (e.g. equities and property) which offer the potential for capital growth or inflation. However, other funds exist to provide liquidity or funding for a known purpose. These assets should not be put at risk and need to be readily available, and such funds should be invested in “financial assets” (e.g. bonds)..

A good investment policy should also balance a charity’s requirements, such as capital preservation and income, with risk tolerance. An investment policy needs to serve two masters – providing income for the present, and providing for the future by ensuring assets at least maintain their value in real terms. Trustees who fail in this last regard are likely to see the income from their investments fall.

A strong investment policy will define a charity’s strategic asset allocation and provide the flexibility for tweaks on a more granular, tactical level in response to short and medium term market trends.

Asset allocation

Charities’ investment portfolios should be suitably diversified across asset classes to match their liabilities. Diversification is useful for reducing specific risk such as too large an exposure to a single sector or stock. It can be viewed from several angles, such as the number of asset classes selected or the holdings within each class. In addition to core instruments like bonds and equities, other classes such as alternatives can be included. Each of these can be further subdivided down into different geographies, currencies and strategies.

This does not mean that charities must hold a diverse range of assets if one asset class, such as equities, is appropriate. Few individual managers have proven experience in every asset class and investing with more managers could significantly increase costs. Diversification should be properly scrutinised – more holdings do not always deliver greater diversification, but can prove complicated, opaque and expensive.

Charities must also decide how they want to split their investments across financial and real assets. Financial assets, such as bonds, can provide security of capital and income, but offer no protection against inflation or rising interest rates. Real assets, such as equities and property, can provide capital growth and income growth, but are considered to be higher risk.

Asset allocation and diversification must be carefully assessed on an ongoing basis. Past investment cycles have shown us that the values of bonds and equities normally move in the opposite direction, providing useful diversification. This was particular true before 2008, the depth of the financial crisis. However, from 2008 to 2014, while smaller moves were in opposite directions, the general trend for both asset classes was upwards. From 2014, both the trend and shorter term fluctuations have been synchronised upwards.

As one asset class has not provided a foil for the other recently, the mix of assets between bonds and equities has been less effective in reducing the overall volatility of an investment portfolio. The implications are particularly interesting when considered in conjunction with income generating potential.

For long periods, UK government bonds (gilts) have yielded more than equities and so were the core income generating part of a portfolio. However, since the financial crisis, equities have yielded more than gilts. We are now in a relatively unusual situation where equities not only provide prospects for capital preservation, but also offer a higher current income.

Manager selection

Once charity trustees have determined strategic asset allocation, they will often pick professional investment managers to manage all, or sections of, the portfolio. Good manager selection is key as many fail to outperform the market. It is therefore essential to examine the organisation that a manager works for: Does it have a good reputation? Is there a house investment style? Will you have direct contact with the portfolio manager(s) or solely with relationship managers?

Trustees should also research and get to know individual portfolio managers and the way they work. Do they have integrity, skill and experience? What is their long term performance like? What is generating their performance? How is performance relative to a benchmark and/or peers?

Trustees must also consider a manager’s investment process and approach to managing risk. Does it make sense? How are stocks selected? How is the portfolio constructed? How is risk measured and controlled?

Oversight standards

It is vital for trustees to ensure that monitoring and reporting are up to scratch. Managers’ performance should be assessed against appropriate benchmarks. This may be as simple as a single index such as the FTSE All Share Index for a 100% UK equity portfolio, or a mixture of recognised indices in a proportion that reflects the strategic asset allocation. Charities with a 70% equity/30% gilt portfolio might have a blend of 70% FTSE All Share and 30% FTSE Actuaries UK Conventional Gilts All Stocks, for example.

There are two ways in which an active manager can add value. One is via stock selection and the other by tactical asset allocation around a charity’s strategic benchmark. However, charity trustees may wish to exercise some control over how far a manager has discretion to move from the strategic asset allocation. This can be done via benchmark bands, which might limit discretion to move 10% either side of the benchmark without consulting the investment committee.

In terms of reporting, trustees must also decide how much information they want from managers and how often. An appropriate solution may be a quarterly valuation and report which summarises transactions, income and other portfolio data for that period. This can be accompanied by a written report detailing what has occurred during the period, what action the fund manager has taken and why, and an outlook for the months ahead.

Personal meetings

It is also important that trustees meet fund managers in person on a regular basis to ask questions and obtain any necessary clarifications. Trustees and managers must have a consistent reporting process in place and review holdings versus the charity’s investment policy. Most importantly, the charity’s trustees and investment committee must demonstrate an ability to adapt to changing circumstances and take recommendations which can improve stakeholder outcomes to the trustee board.

If you would like more information about OLIM please email us at or call Sarah Chadwick on 0207 367 5660.