Charity investors have watched the ebbs and flows of the stock market this year with more anxiety th...
Charity investors have watched the ebbs and flows of the stock market this year with more anxiety than most. Conservative by nature, many charities are wary of investing their money in stocks and shares. Troubled by the perceived risks of such investments, trustees worry they might jeopardise the future of the charity and its good works.
Fortunately, trustees today have a much greater knowledge of the markets - largely thanks to financial trade journals and financial advisers - and understand there is a trade-off between risk and return.
Charities are therefore benefiting from the adoption of more flexible investment policies and casting off the straight jacket of being tied to bonds and deposits.
It also looks like the proposed repeal of the Trustee Investment Act (1961) will enhance trustees' powers of investment, including their ability to use discretionary fund managers and gain greater exposure to a wider selection of equities.
While deposits are a good way of investing funds that may be needed at short notice, trustees increasingly appreciate that inflation poses the greatest threat to the purchasing power of a charity and its ability to increase the value of its reserves. This, in turn, undermines its capacity to achieve future objectives.
Nowadays, charities, like other investors, are having to accept that volatility is an increasingly integral part of the financial system.
Daily swings of 100 points or more in the FTSE 100 index are now commonplace. Such volatility can be a short-term drawback to investing in the stock market.
Shares, on occasion, suffer from severe, short-term corrections but these are the counterparts of booms and are an inevitable feature of an economy's cycles. Investors should remember, however, that even quite severe stock market setbacks have, over the last 15 years, been relatively short lived and the average decrease has lasted for only 14 months.
For example, the infamous 'Black Monday' in 1987 was an ugly day for investors but the market still managed to end the year at 1,712, or 2% higher than at the start of the year.
Part of the volatility 'problem' is that markets often come down considerably quicker than they rise and so tend to grab newspaper headlines with clichés such as 'billions wiped off share values' (why are billions never wiped on shares?). Volatility should not be a signal for panic, but for opportunity.
If the FTSE was to fall to nearer 6,000 in the coming months many investment managers would view it as a long-term buying opportunity. The important thing for charities is to have an experienced fund manager with a consistent investment strategy.
More pressing for charities in today's low-yield environment is concern over their future income streams. Charities' long-term income, over one third of which is derived from investment, is under threat as low interest rates, falling yields and the phased abolition of advanced corporation tax (ACT) all take their toll.
These dilemmas also mean the traditional low risk strategy of keeping funds on deposit is no longer a viable option for charities. An element of equity investment is therefore recommended
Although the phased removal of ACT credits has reduced the attractiveness of UK equities - because less net income is left in a charity's hands - UK equities should still form a major part of an investment portfolio. UK equities now provide a considerable range of robust, cash generative companies with good records of paying increasing dividends.
Having been in the doldrums for some time, many cyclical blue chip stocks in the service, transport and construction sectors look attractive.
Furthermore, the UK economy looks healthy with inflationary pressures muted by the Monetary Policy Committee's early interest rate increases cooling 'hotspots' and limiting the need for too many subsequent rises. Equally, the housing market has come off the boil and consumer spending has slowed down.
It is inevitable that some diversification away from equities will be necessary in order to maintain net investment income. Indeed, a variety of methods should be employed.
Some commentators suggest that corporate bonds are the panacea to income investor's woes. High quality corporate bonds do provide a widened yield 'pick up' over gilts.
Many are yielding 6.5% to redemption whereas equivalent dated gilts are yielding only 4.8%. Exposure to corporate bonds may be the sensible course of action for charities requiring the highest possible immediate income, but against that is the limited long-term potential for income and capital growth.
Similarly, the chase for income can bring the danger that investors will be tempted by 'junk bonds' - or debt in companies that have a high credit risk and are subject to extreme volatility - which should be avoided.
Corporate bonds are not risk-free investments, although defaults by top rated companies have been low historically. Corporate bonds are a specialist area and so charities should turn to specialist advisers and investment managers.
Charity investors in search of income might also consider income shares in split capital investment trusts or convertible loan stock as routes to preserve a desired income flow. Once again, though, trustees should not rush into appropriate action but should be guided by the advice of experts.
The question is what the future holds. As always the answer depends on the time frame. The bull market is not over but is pausing for breath.
Looking to the next few years, equities may not give the same actual returns as in the past but will probably continue to show the same relative performance to bonds and inflation as they have in the past.
The key, though, will be to select those industries and the companies, both domestic and international with the best growth. For example the telecoms, pharmaceuticals
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