What does a charity trustee need to know for their organisation’s investment portfolio in 2023?

“Trustees are the people who exercise control over, and are legally responsible for, the management of a charity,” according to Guidance for Charities Trustees, from the Charities regulator. Therefore, all charity trustees are collectively responsible for the charity’s investments and need to understand what is happening in the organisations portfolio(s).

The current environment is providing several challenges for charity trustees, with market conditions markedly different to those prevalent in recent years. Inflation is at its highest level in more than a generation, causing central banks to pursue aggressive measures in an attempt to rein in persistently above target price increases. Other major developments this year include the Russian invasion of Ukraine, rising energy costs, supply chain constraints (ongoing Chinese Covid-19 lockdowns) and the fear of recession.

This backdrop provides a timely reminder of the importance of monitoring investments to ensure the portfolio sits within the parameters set and reflects the charity’s desired ethos – a consideration of utmost importance for charities.

As a result, bond yields and cash failed to offer returns that provided the required level of inflation protection and therefore trustees were forced to consider a higher exposure to real assets, such as equities and property, to maintain the real purchasing power of these reserves. This necessitated an increase in the risk profile.

Now bond markets are finally showing signs of value however, although the impact of rising rates has been keenly felt by those holding bonds prior to the turn of the year. Traditionally this has been an asset class in which charities typically allocate a relatively larger proportion of their portfolio due to perceived reduced level of risk and liquidity reasons. This has left them particularly vulnerable to the sizable declines in bond markets year-to-date. To highlight how quickly and significantly market conditions have changed, at the start of 2022 the yield on a US 10-year Treasury bond was around 1.51%, by the end of December it had more than doubled to around 3.88%.

The size of the increase has been a similar situation for core eurozone government bond yields. The German 10-year bund ended the year yielding 2.57%, over 200 basis points higher on the year, having spent recent years in negative territory. In July the European Central bank delivered its first interest rate increase in more than a decade, hiking by 50 basis points, before upping the ante and announcing a 75 basis point rise at its two subsequent meeting. The root cause of the move has been rising inflation and therefore trustees should be aware of other assets that have historically outperformed bonds during inflationary environments.

ESG Developments

The rapid increase in awareness and application of responsible investing in recent years has meant investors are increasingly interested in whether their portfolio represents their ethos – this can be especially important for charity trustees. Environmental factors are progressively attracting a greater amount of attention, while the conflict in Ukraine has brought into sharp focus how strongly many investors feel about social factors. The outbreak of war has also shone a spotlight on some of the challenges associated with incorporating social factors into investments, raising complex and nuanced questions such as what are the social implications for investing in defence companies? Are they always “bad”? Or just “bad” if they sell weapons to the wrong people.

The impressive strides forward in the awareness and analysis of these issues have been welcome, and arguably long overdue, but they have also brought about potential pitfalls. One of the main areas of concern that has arisen is “greenwashing” – the practice whereby a company is perceived to be misrepresenting its ESG (environmental, social and governance) credentials. There has been a clear increase in demand for reporting on ESG metrics and factors, but this increased reliance on data brings its own danger and can paradoxically provide a murkier picture of the performance of a portfolio in relation to ESG factors. The absence of a global framework for data providers, means each interprets information in different ways and each will have different biases as to how they weight factors behind a score. Ratings are a static figure, a one-dimensional rating whereas considering ESG factors involves much more thought.

The proliferation of interest in ESG factors in recent years has resulted in varying degrees of competence among those claiming adherence to these principles. Effective governance is the key here and trustees should be on the lookout for clear and timely reporting along with for example, additional disclosures on your investment manager’s approach to this.