Tania McLuckie: Sustainable spending – where can charities go from here?

03 May 2023 In-depth

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Why was 2022 such a tough year for investors?

Few investors will look back on 2022 with fondness. Conflict in Ukraine, surging inflation and dramatically higher bond yields created a year of volatility and negative returns that left investors few places to hide. Global balanced accounts suffered particularly as bonds and equities fell in tandem – the first time we have seen this on any scale in nearly 30 years. UK government bonds produced a return of -24% last year, while index-linked bonds failed to provide inflation-proofing and instead fell by -34%, and global equities declined by 8%.

Many investment managers, ourselves included, were wary of the inflationary effects of the pandemic, but almost nobody anticipated the consequences of Russia’s invasion of Ukraine. These two shocks in quick succession required central banks to raise interest rates sharply in a bid to contain inflation, marking the end of almost 15 years of central bank policies that had been highly supportive for equity and bond markets.

We estimate that the average charity portfolio lost about 20% of its value in real terms over 2022 and that there have only been five years since 1900 when real returns were worse: 1915, 1920, 1973, 1974 and 2008.

How has the investment landscape changed?

Last year was preceded by over a decade of strong investment returns driven by low inflation and falling bond yields underpinned by central bank policies and the deflationary effects of globalisation. Low interest rates and cheaper sources of labour – particularly in China and Eastern Europe – were good news for equity and bond investors. Our research suggests that many charities generated real returns of over 7% per annum over this period and had the opportunity to build up a significant real capital buffer.

The next decade is likely to be a decade of weaker returns: globalisation is reversing to some extent, the supply of raw materials, goods and labour is likely to be more constrained, and central banks are ending their supportive policies, which raises the cost of capital. Inflation is likely to settle at higher levels than we have been used to, but it may also rise and fall in waves. As a result, markets could be more volatile.

The good news is that after the trauma of 2022, bond yields are now materially higher than we have experienced in recent years, boosting projected returns from fixed income assets. At the same time, the returns from equities will benefit from structurally higher inflation, a more attractive starting yield and lower valuations than were the case 12-18 months ago.

How can portfolios be made more resilient?

In today’s environment of lower expected overall returns and more volatile markets, long-term investment success is likely to be found in active, responsive management and diversification across a wider range of markets and asset classes. Equally important will be good housekeeping – particularly in terms of income and how much is genuinely available to spend.

We believe that many charities would benefit from an unconstrained global investment approach, which both widens the investment opportunity set and increases potential for defensive diversification. The benefits of diversification apply to income generation as well: focusing primarily on the UK market, where approximately 54% of all dividends come from just 10 companies in a handful of sectors, results in an unpalatable level of risk.

We also recommend adopting a total return approach to maximise flexibility in generating returns while ensuring that spending is disciplined, such that savings are built up to support consistent spending during fallow years.

This year has brought a smorgasbord of opportunities – and risks. Markets are unpredictable and regularly make fools out of investors. However, a robust strategy that is well-diversified, evolves over time and is transparent in terms of income, liquidity and what one owns are all important elements in the formula for long-term success.

How much can a charity afford to spend over the next seven to 10 years?

Answering this question depends on the levels of investment returns that a charity has received during the good times, and how much of that it has already spent. However, while it’s difficult to forecast short-term market returns, our analysis suggests that longer-term trends can be more dependable. Given this, we are able to make some general observations based on historic returns since 2011 and our projections out to 2031.

Interestingly, the expected real return – and thus, sustainable spending rate – over this period is likely to be about 4% per annum, which is remarkably close to the very long-run averages.

So, if one had achieved average returns and spent the long-term sustainable average of 4% over the past decade, then – even after the torrid past 12 months – one should be able to continue to spend 4% per annum over the next decade. Across the whole 20-year period from 2011-31, one could end with a little more capital in real terms than when one started.

A word of caution is needed: spending 4% per annum might not leave much of a buffer for the next storm. We suspect that many trustees will prefer to reduce spending and only increase it again when their capital buffers have been rebuilt.

Tania Mcluckie is a specialist charity manager at Sarasin & Partners

Fast facts

Sarasin manages £8.2bn for over 490 charities* and not-for-profit clients

Charities represent nearly 45% of total business

*All figures as at 31 December 2022

What we do

Sarasin & Partners LLP is a Londonbased asset manager that manages £18.3bn* on behalf of charities, institutions, intermediaries, pension funds and private clients, from the UK and around the world.

Our goal is to grow and protect our clients’ capital in a way that secures tomorrow. We take a global, long-term, thematic approach to investing, with responsible investment at its core. We identify powerful trends that will shape the investment landscape for years to come, and embed stewardship into our investment process.

*All figures as at 31 December 2022 

This information is for investment professionals only. If you are a private investor, you should not act or rely on this document but should contact your professional adviser.
The value of your investments and any income derived from them can fall as well as rise and you may not get back the amount originally invested. Past performance is not a guide to future
returns and may not be repeated.
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Sarasin & Partners LLP is a limited liability partnership registered in England and Wales with registered number OC329859 and is authorised and regulated by the Financial Conduct Authority.
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