Realise the potential of your charity's investments

 By Chelsea Traver and Mike Ross

The trustees who govern trusts have specific duties and considerations to ensure funds are appropriately managed and support the charity’s specific cause. While charitable trustees and board members generally have the best of intentions, it’s not uncommon for them to inadvertently fall short of their obligations to the charity and its beneficiaries.

There is debate as to how to practically apply these obligations, so we’ve put together a checklist of considerations based on our experience investing for charities.

Know the duties of a trustee

The Trust Act 2019 states that trustees have a ‘Duty to invest prudently’. It states:

“When exercising any power to invest trust property, a trustee must exercise the care and skill that a prudent person of business would exercise in managing the affairs of others.”

Plainly, that means a trustee must ensure the trust’s funds are invested by a person with the appropriate skills, and in a manner that a reasonable person would expect.

Document a clear investment strategy

The number one investment priority for charitable trusts is a clearly documented investment strategy that is appropriate for the trust’s goals, timeframe and cash flows. This might be an official Statement of Investment Policy and Objectives (SIPO) or just a general investment policy statement. It should be designed as the foundation for current and future investment decisions and clearly lay out the:

1. Objectives of the trust
2. Investment governance and management framework
3. Investment philosophy and strategies

This document provides accountability at board meetings and can be given to new board members or interested parties to inform them of the trust’s investment strategy. It can also provide guidance for future decisions.

Melville Jessup Weaver principal, Mark Weaver has a step-by-step guide on how to create a SIPO and he includes useful examples of a SIPO in practice.

“Once trustees have updated their SIPO they should be in a good position to answer any question that might arise in regard to the trust and management of the investments. An example of this occurred during the GFC. It was a very difficult and challenging time for trustees with markets falling and uncertainty as to the future value of investments held. Those trustees who had a complete understanding of the aims and policies of their trust were able to make better decisions while retaining more confidence in the future.”

How much risk can a trust take on? 

Balancing risk and return is the most important investment decision the trustees of a charity will make. If the charitable trust takes on more diversified risk, it can likely earn a higher return which will provide more funds to support its charitable causes. Conversely, too much volatility might not support the stable distributions the trust desires.

There are two primary considerations when deciding how much risk is appropriate for charitable trust investments:

1. Timeframe
2. Cash flow

Timeframe

Investing in a manner that is consistent with the charity’s time frame is a key consideration when deciding how much risk is prudent. For most charitable trusts the overall time frame is perpetuity, meaning there is time for negative years to be offset by positive ones. Other charities are designed to gift all of their funds within a certain time period.

Cash flow

The other consideration is the expected cash flow activity. It’s important to know the answers to these questions:

1. What are the regular gifting outflows?  Is this based on need, investment income, or overall expected return? How flexible are these withdrawals? Should the gifting increase with inflation?
2. Are there any significant future expenses or commitments?  For example, a new building. When should these funds be set aside from your primary investments?

Generally, charities want to preserve their capital so they can gift into perpetuity. To do this, the trust may be designed to gift only income from the investments. However, during low-interest rate periods, this may not be sufficient to support the beneficiary cause. It can also lead to a significant build-up in capital which may not match the purpose of the trust. Therefore, it’s important for the charity to ensure its income strategy is appropriate for the changing investment landscape.

Conservativism can cost your charity

We often see boards and trustees who want to invest very conservatively. Their rationale for taking a low-risk approach is meeting their duty of care obligations. But it’s important to remember that a trustee’s duty is to invest prudently which means investing in a manner appropriate for the trust’s goals, timeframe and cash flow requirements. We have seen charities miss out on significant growth and support because of an overly conservative investment strategy.

Ensure a strong investment framework

Diversification is an important way to mitigate risk

Diversification is a key tenet of all investing. It involves spreading investments across companies, countries, and asset classes so the portfolio is not exposed to unnecessary risk. If the portfolio is overexposed to companies, or even countries that have a down year the portfolio could be dragged down as well.

It’s important to review the diversification of your investments and any term deposits and savings accounts as well. Even undiversified cash assets can leave the trust exposed to unnecessary risk. ie. Are they just with one bank? Do all the term deposits have a similar maturity?

Fees

Initially, it's important to have a clear understanding of what the charity is paying in fees. Here are some that might apply:

• Fund manager fees
• Adviser or consultant fees
• Administration and custody fees
• Transaction fees (brokerage, fund spreads, foreign exchange costs)

The second step is to make sure your charitable trust is getting value for your fees. Are the fees you’re paying in line with or well above the industry average? Are you paying high amounts in poorly structured performance fees?

Align money with the mission

Integrating ethical investing into a charitable trust’s investment strategy has important benefits for the charity. :

• It supports both investment and gifting objectives of the trust.
• It’s an approach that resonates with donors.
• It negates the reputational risk of investing in harmful industries.

Up until recently, some trustees have argued that investing responsibly could mean forfeiting a higher return, resulting in them falling short of their prudential duties. However, there is a growing body of evidence that suggests investing responsibly doesn’t have to mean giving up returns.

In fact, there is international legal precedent that confirms environmental, social and governance issues are now a part of a charitable trustee’s role.

Thirty years ago UK courts ruled that it was appropriate for the Church of England to limit their investment in companies with links to South Africa.This ruling established that it was permissible for trustees to bring in ethical considerations for investment decisions and provided three possible justifications:

1. If an investment would conflict with the aims of a charity.
2. If it might impact its work either by making beneficiaries unwilling to engage with it or by alienating beneficiaries, donors or supporters.
3. If there would be no financial detriments.

In 2021 a Jersey Royal Court confirmed that there is an evolving meaning of ‘benefit’. This meant that the term ‘benefit’ was not limited to financial benefit but could also encompass social and educational benefits for the beneficiary in question.

Another pro of investing ethically is the ability to target key investments that support the charity’s cause. For example, a charity that provides scholarships for young women can invest in funds that advocate for gender diversity.

Charitable Investment Checklist

• Does the trust have a guiding investment document (SIPO?)
• Are the investments suitable for the timeframe and cash flow?
• Are the investments appropriately diversified across asset classes, sectors and countries?
• Are the term deposits diversified across banks and maturities?
• What fees is the trust paying and are they good value for money?
• Is the portfolio responsibly invested? Are there any specific areas of ethical investment that the trust could target?

Trustees and board members of a charitable trust are in a unique position to chart the course of future charitable giving. By having a strong investment framework and the appropriate expertise for ongoing management they can ensure that their charity thrives.

 Not sure if your charity's investments are reaching their potential? Schedule a free no-obligation consultation. 

 Disclaimer: This article is general in nature and does not constitute financial, tax or legal advice in any way. Should you require such advice, please contact Evergreen Advice or a suitably qualified professional.