Kevin Gardiner: The 'what and why' of charitable investments in the current economic context

30 Jan 2020 Expert insight

Trustee engagement is evolving

Life is not getting any easier for trustees when it comes to investing their charity’s funds. Of course, not all charities are lucky enough to have funds available to invest in the first place. But for those that do, stewardship of those funds – which in some cases could be a commitment lasting potentially into perpetuity – is not as straightforward as it was.

Some reassuring fixed points have disappeared from the investment landscape and some unfamiliar features have been added.

Trustees will recently have searched in vain, for example, for traditional sources of (relatively) predictable investment income. Meanwhile, even if they are not managing their charities’ funds directly, to decipher their external managers’ reports they have needed to familiarise themselves with concepts such as: quantitative easing and tightening; negative redemption yields; and customs unions and free trade agreements. Rather unhelpfully, those external managers are also quite likely to begin their commentaries with unsettling comments to the effect that “these are particularly uncertain times”.

Most recently, charitable aims themselves are increasingly under discussion, with secondary, incidental goals often being added to charities’ primary missions.

In particular, the manner in which investment returns are delivered is being questioned as environmental, social and governance (ESG) criteria are increasingly being considered. Because the implications are likely to be long lasting, important and wide-ranging, they need to be thought through carefully, adding further to the claims on trustee time and scrutiny.

An altered landscape…

As interest rates globally have stayed lower for longer than most of us would have imagined – including the central bankers whose job it is to manage investor expectations – safe investment income has all but disappeared.

Just in the last year, confident Federal Reserve-backed expectations of rising US interest rates, for example, have been replaced by equally authoritative expectations – and delivery – of falling rates, and typical yields are again below even today’s modest inflation rates. Here in Europe, yields on money market accounts and investment grade bonds are either negative or negligible even before (modest) inflation is taken into account.

The yields available from money markets and high-quality bonds are not the only sources of investment income, and even they are not completely safe. But they have traditionally been the most predictable and reliable sources of income for charities needing to use their investment funds to finance “business as usual”.

There are several possible explanations of why interest rates have all but disappeared from the investment landscape. The most obvious perhaps is that money markets may be pricing in an imminent deflation – a shift to negative inflation and a sustained and substantial fall in the cost of living, whether because of an approaching economic slump or for more secular reasons – before the rest of us have spotted it.

Another possibility is that society may collectively and implicitly have revised its time preference, its required reward for waiting and for postponing consumption – perhaps because today is deemed somehow to be (even) more uncertain than a relatively settled future.

It is also possible that the markets have been distorted by some of those recent additions to the investment lexicon – such as quantitative easing, and risk-parity and liability-driven investing. With central banks owning a big chunk of bond markets and many pension funds and life assurers buying bonds for non-economic reasons, prices have been squeezed higher, and yields lower.

Any or all of these explanations could be playing a role. A big deflation or altered time preference cannot be ruled out. We do face some novel challenges. US policy-making by predictive text is a new source of uncertainty; so too, at least in recent times, is a questioning of globalisation. And these things need to be considered in the context of the longest-ever US economic expansion, which in itself seems to suggest that some setback is overdue. Closer to home, the need to renegotiate UK-EU trading arrangements, for example – hence trustees’ homework on customs unions and free trade agreements – is also unprecedented.

However, tempting though it may be to agree with those manager reports, we are not convinced that the outlook is especially grim or uncertain. It is human nature to worry more about losses than gains, and it is a common conceit to think that we live in special times.

Certainly, there is more news these days, and it is presented more graphically and immediately. But much of the media – traditional and social – is there to sell advertising not to inform and the reality is that the future is always profoundly uncertain (it must have been or how could we have arrived at such an allegedly special departure point?).

Current circumstances feel special, but they often do. The political and economic backdrop was just as difficult in the 1970s. And the well-documented reality is that the average human being has never been better fed, clothed or housed – nor safer, healthier or longer lived – than they are today. This could change but it doesn’t have to.

And while the current business cycle is indeed looking old and tired, as we write there is still little sign of the next US recession – or, more importantly, of a pressing need for one. This has been one of the least-loved cycles in recent memory, but it has also been one of the most polite. Consumers – and consumer price indices (that is, inflation) – have to date been well behaved. So too, seemingly, have the banks.

In trying to explain today’s low and negative interest rates, then, we incline most towards the third of those possible explanations – namely the distorting effects of the special emergency measures introduced a decade ago, and ongoing monetary policy on both sides of the Atlantic that remains tilted towards generosity – overly so, perhaps.

If we’re right, something approaching normal service may yet eventually resume.

In the meantime, there are no short cuts for trustees. In the other big public market, the higher dividends available on stocks should not be taken for granted and stock prices can be scarily volatile. And the apparent stability of private markets is misleading. Private debt and equity markets look stable not because they are safe, but because they do not trade often: they are illiquid and among the highest-risk investments.

Trustees seeking investment income thus have to be very patient, then, or willing to take a degree of risk that may be qualitatively higher than they are used to. Many charities are of course happy to hold risky assets and, indeed we think, stocks are the natural long-term investment for far-sighted trustees to hold. But they are not the best repository for rainy-day funds.

… and a less direct journey

If the investment landscape looks unfamiliar to many trustees, so too do the proposed journeys through it. Environmental sustainability and social justice are moving up the investment agenda, and such concerns increasingly have to be addressed.

Sustainability has long been a worry. Malthus suggested as long ago as 1798 that a growing population would not be able to feed itself; the seeming precariousness of human existence was brought to us afresh in 1994 by Carl Sagan’s Pale Blue Dot (a picture of the earth seen at a distance of six billion kilometres from Voyager 1). However, it has become more pressing as the evidence of man-made climate change has become more convincing (see, for example, the UN IPCC’s fifth assessment report).

Social justice is hardly a novel idea either, but interest in it has revived in the aftermath of the global financial crisis. Objective data is more difficult to come by: the extent of any recent increase in inequality in incomes and wealth is much more difficult to pin down than the evidence of climate change. The economic data is simply not good enough to answer the questions we’d most want to ask in this respect. The widespread belief, for example, that the average US household’s living standards have stagnated since the 1970s may be mistaken. However, the political pendulum likely swung too far towards market forces in the last few decades, and there is no doubt that the public mood has hardened against them.

In September, even the US Business Roundtable, a group of chief executives from some of America’s largest corporations, suggested that managements need to consider other stakeholders alongside owners. This contrasts markedly with the post-1970s mantra of shareholder value.

As a result, trustees find themselves increasingly needing to articulate their positions on environmental, social and governance issues, and to ask themselves whether they should explicitly incorporate such positions in their investment policies.

It is not an easy question. In the environmental debate, the big natural resources companies – oil and mining groups – are easy targets. Their methods may be improving, however; some of them are at the forefront of the search for alternative energy sources. And where should trustees draw the line? If oil, armaments and tobacco are to be shunned, what about their suppliers or their suppliers’ suppliers?

In the social arena, how do we identify best employment practice or social awareness? What if many workers are happy with zero-hours contracts, or if technology and social media giants pay such low tax rates because of bad (or competitively designed) national legislation? Are workers in developing countries worse off for being part of a globalised production line? Should ESG policies proscriptively avoid bad behaviour or prescriptively seek good?

The companies that compile the big stock market indices and the increasing number of consultants who advise in this area are helping trustees in their search for a more socially aware investment journey. They are providing more objective data and rankings (MSCI’s ESG ratings, for example), and making it easier to see what happens if we include or exclude certain companies and characteristics from various benchmark indices.

The G part at least of an ESG-aware investment policy is pretty straightforward. Best practice for corporate governance – regarding board structures, executive remuneration and investor protection, for example – is relatively easy to define and monitor, and arguably should always have been one of the things that investors considered to begin with.

But some subjectivity and arbitrariness in this area are unavoidable, and trustees need to consider carefully what exactly they are trying to achieve.

A charity’s investment fund exists to further the mission of the charity, not the beliefs of its trustees. If the charity’s objectives are clearly aligned with ESG issues – if it is providing relief for communities exposed to rising sea levels, for example – then an investment policy shaped explicitly with sustainability in mind is clearly in line with the charity’s mission if not mission critical.

In some cases, however, we can imagine conflicts of interest. If, say, a socially aware investment policy were to result in a worse investment outturn, then the ability of the charity to do its day job, as it were, is harmed. And in many cases, the founders of a particular charity are no longer with us, so cannot be asked to update their original aims in line with today’s thinking.

To be clear: this does not mean that sustainable, socially aware and well-governed investments are not good things in themselves. But it does suggest that trustees need to think carefully about their priorities.

Milton Friedman, the influential US economist who did more than anybody to popularise free enterprise back in the more collectivised 1960s and 1970s, argued that profits are the only legitimate goal for company managements. This is not a tenable public stance today, but there was logic to it.

He was focused on agency and efficiency. He saw managements as the agents of owners, and inequalities and externalities as being most easily addressed by taxes and the price mechanism.

Similarly, it could be argued that trustees are the agents of their charity’s mission, and other concerns – no matter how important – are best tackled by the politicians who can do most about them. The key thing, perhaps, is for trustees to have the debate – and, perhaps as importantly today, to be seen to have had it, whatever they decide. Why are our charities there – to what end?

Kevin Gardiner is chief global strategist at Rothschild & Co Wealth Management

Charity Finance wishes to thank Rothschild for its support with this article

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