Charities face increased interest and scrutiny related to potential conflicts between their investments and their charitable aims. By ensuring that their investment policies reflect their principles and purpose and are successfully implemented by investment managers, trustees can be confident that their mission and investment objectives are aligned and in the interests of beneficiaries.

Research undertaken in 2018 for Good Money Week by YouGov identified that 77 per cent of the UK public would be likely to withhold donations if they discovered a charity had invested in a way that was contrary to its mission. In addition, as the case of the controversial investment by the Church of England into payday lender Wonga has shown, conflicts between a charity’s values and its investments can attract negative media attention and cause longterm reputational damage.

For charities, a defined ethical or responsible investment policy can be a crucial element of their overall investment objectives. There is no legal requirement for charities to implement responsible investment considerations into their portfolios or to take into account pressing issues such as climate change risks. However, in March 2019, a coalition of UK charities with diverse approaches to responsible investment wrote to the Charity Commission seeking an urgent resolution to the question of “how charities are expected to align their investments with their objects and their commitments to wider society, including what to do about forms of investment which conflict with charitable objects, particularly in the light of climate risk”. This comes at a time when high-profile campaigners such as Extinction Rebellion and Greta Thunberg continue to mount pressure on governments to provide clear solutions and strong action on climate change.

Investors across the world are also actively integrating environmental, social and governance (ESG) issues in their portfolios. One reason for this is the growing body of academic evidence which demonstrates that sustainable investing does not require sacrificing financial returns. Selecting companies with strong ESG credentials can lower expected cost of capital, provide clarity on downside risk and enhance returns over the long term.

With this increased awareness and interest in ESG, how charities invest matters to a wider set of stakeholders beyond the investment committee and finance team, including employees and volunteers, institutional and individual donors and the media.

One solution to addressing this and avoiding investments that are in conflict with a charity’s purpose and values is to have an investment policy that takes into account material ESG risks alongside traditional financial criteria. If implemented effectively, this can both enhance and protect the organisation’s reputation, create better alignment with stakeholders and strengthen risk governance frameworks.

How can charities identify (and avoid) greenwashing?

Terms such as ethical, sustainable, responsible, ESG and impact are used frequently and often interchangeably and can be a source of confusion. The Charity Commission defines ethical investment as “investing in a way that reflects a charity’s values and ethos and does not run counter to its aims”. Ethical investing has long been a key area of focus for many charities looking to ensure that their investments are aligned with the core aims of their mission. However, given there are no universally guided principles, it is important that trustees have a good grasp on the range of terminologies and approaches. Without this, it can be difficult to fully assess investment products and services and ensure they are suitable for the aims of their particular charity.

ESG funds ratings can also be restrictive in the amount they reveal about what sits behind the label. It is important for charities to assess the true benefits of a fund claiming social or environmental enhancements by looking at not only the fund’s stated objectives but also its underlying holdings. ESG-labelled funds may appear similar in name, but holdings and screening approaches can widely vary. It is therefore important for trustees to understand the methodology and implications for stock selection. An example of greenwashing could be a thematic fund whose name suggests it is green, but which actually includes companies with questionable sustainability practices.

While most charities set materiality thresholds for screening out companies that derive a certain proportion of their income from what they consider undesirable activities, charities may still be exposed to those sectors either because the applied threshold was too low or due to exposure through another company’s supply chain.

Some investment managers have been subject to criticism for overstating their ESG capability. It is the responsibility of the investment manager to define and report on its approach to implementing sustainable investment, for example through corporate engagement and voting activities. Some ethical funds may hold companies that are positively rated by service providers but which may have exposure to significant ESG risks. Investment managers should accompany any headline scores with internal analysis to advise and conclude on the most material issues.

This highlights not only the need to have in place an investment policy that is not only intended to safeguard the best long-term interests of the charity but allows it to hold its investment managers to account. This can be achieved by putting in place the following steps.

An investment policy should:

• Outline what it wants to achieve from its investments and ensure this complements its charity mission;
• Be a live document that is regularly reviewed and can take account of evolving stakeholder interests;
• Outline ethical preferences that are driven by purpose and not by peers or external pressure;
• Act as a basis to hold its investment manager to account by asking challenging questions on how it upholds its investment policy through its investment decisions.

Why review the investment policy?

A recent report highlights that more than three-quarters of charities with an investment policy statement have a defined ethical approach to their investments. Although this number has increased from the previous year, once established, policies are often not subject to regular review. The Charity Commission recommends that the investment policy should be formally agreed by all trustees and reviewed at least annually. The requirement for regular or periodic reviews should apply equally to ethical or responsible investment policies.

With emphasis and public understanding on ESG issues escalating, trustees who regularly assess their policies will be better positioned to reflect current developments. The fact that a charity has avoided reputational risks in the past does not guarantee that it will not face controversies in the future. A change in internal leadership can act as a catalyst, prompting a review of the investment policy so that accountability sits with current board members.

Who is responsible for the policy?

Managing reputational and financial risks requires a collective response from the board, beyond any one individual. While the trustees are ultimately responsible for the charity’s investment policy, finance or investment sub-committees play an active role in scrutinising and monitoring the charity’s investments from a range of perspectives.

What involvement can I expect from my investment manager?

The role of the investment manager is critical to ensuring that investments align with policy. Charities can turn to their investment managers for advice and input on ESG issues. Skilled managers may have the expertise to facilitate forums to allow trustees to debate on the ethics of their investments, including which themes should be prioritised and provide advice on implementation and financial impacts, for example on diversification and divestment.

Reviewing your Investment managers’ capabilities

Good governance practice requires asking questions of the investment manager to ensure the charity stays true to its purpose. Investment managers who perform well in ESG can help identify risks beyond those found in the company’s financial statements. This will often involve using supplementary data from external providers and informing their own views of material ESG risks at portfolio companies.

The ESG performance and risks associated with investee companies can vary over time. Charities should expect their managers to communicate the rationale behind holding stocks on a quarterly or semi-annual basis. Only by understanding their exposure to underlying issuers are trustees able to identify and address potential reputational risks. In turn, trustees should ask searching questions of their managers about the methodology for incorporating ESG controversies into their investment decision making.

What should I consider when appointing an investment manager?

Changing or selecting investment managers provides an opportunity for charities to review the manager’s approach to responsible investment and how effectively they integrate ESG issues into stock selection. Charities should consider the experience and resourcing of the investment firm or team. Not all managers will have in-house responsible investment expertise which enables them to manage charity investments in a way that contributes to their overarching mission.

There is no best practice for charities to factor ethical issues into their investments. Charities can chart their own course to meet their financial and ESG objectives but, as discussed, these should reflect the changing needs and views of their stakeholders in the present environment. Trustees who confirm their commitment to updating their investment philosophy and review their investment managers’ capabilities are more likely to be better placed to protect and potentially enhance their charity’s reputation and long-term returns for their beneficiaries.

Terry Gyorffy is head of charities at Barclays Private Bank

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