The fallout from the BP oil disaster has had serious consequences for charity investors, says Lynne Lamont.

Few UK charity investment portfolios will be without exposure to global energy giant BP, and investment managers and charity trustees alike have been following the media and political frenzy following the catastrophic explosion on the Deepwater platform. Aside from the uncertainty over the potential outcome of the spill in terms of capping the flow, compensating those impacted and dealing with the environmental consequences, the share price has been plunging and it has been announced that no dividends are to be paid to investors for the remainder of 2010.

The dividend income from such stocks is particularly important to charity investors for whom the main priorities are generally to maintain the real value of the capital over the long term whilst also generating income. Traditionally, many charitable funds were set up as permanet endowments restricted to spending only income by their governing documents, whilst others believe that it is prudent for the longevity of their trust to operate in this manner.

Historically, it has not been hard to generate reasonable income streams as cash rates and government bonds, perceived as low-risk assets, have been significantly higher. Today with interest rates at 0.5 per cent and the Uk government bond yield at 3.5 per cent, the outlook is bleak for income investors, particularly with inflation (CPI) sitting at 3.4 per cent. With the loss of the tax relief on Uk dividends, cuts in external funding and pressures on fundraising, charity investors are frantically attempting to maintain the income levels to which The fallout from the BP oil disaster has had serious consequences for charity investors, says Lynne Lamont. They have become accustomed and reliant upon. the average yield on the UK FTSE all share index is currently 3.5 per cent. Within this however, a small number of companies are paying yields in excess of 5-6 per cent, which together with the opportunity for real capital growth has enticed income-hungry investors.

The recent financial crisis has highlighted this with the downfall of UK financial stalwarts such as Royal Bank of scotland and Lloyds. The demise of these popular, highyielding equities hit charity investors hard in terms of loss of capital and suspension of dividends. This was disastrous for those within charities trying to manage cashflows where there were demanding income targets. This also further emphasised a situation where a handful of companies were paying a large proportion of the overall available income. BP is one such company as £1 in every £6 paid in dividends last year came from BP.

In the current low-interest-rate environment, the desire to generate income has led to charities being enticed into an increasingly smaller range of equities in order to achieve demanding income targets which may lead to an increased level of stockspecific risk. The extreme importance of taking professional advice and having a well diversified portfolio has never been more pressing, in terms of the type or the range of asset types held and the geographic spread of the underlying holdings. The inclusion of investments such as overseas equities, corporate bonds, property and infrastructure funds allow for necessary diversification of income streams. Other investments such as absolute return funds, hedge funds and gold regrettably pay little income and thus it is difficult to justify their inclusion where the generation of income is a priority.

In an attempt to ensure greater diversification, many charities have taken the move to adopt a total return approach where the income generated within the fund can be supplemented with capital gains in times of plenty. This can certainly help to lower overall risk through allowing for a wider range of assets to be held but would require collaboration with the regulator or a lawyer to effect the change.

So what of BP, the share price and the likelihood of future dividend payments? Political pressure has resulted in BP agreeing to pay $20bn into an Independent Claims Facility to cover the cost of all claims associated with the oil spill.

In order to assist the financing of this, the company has announced that no dividend will be paid in 2010. This is bad news for charity investors. Income estimates from investment portfolios form the basis of cash flow forecasts and spending plans for many organisations and there is no easy answer to replacing the lost dividend. The extreme fall in share price is hard to justify and to sell now is to give up on the potential for the capital value of holdings to recover. As the oil continues to flow from the leaking well, charities across the country are left counting the cost of yet another blow to their income 

Lynne Lamont is head of charities in Scotland & Northern Ireland at Brewin Dolphin