Covid cast a long shadow over many institutional investors. Yet despite the uncertainty caused during the dark days when the pandemic first took hold, the picture for the UK’s charitable foundations is now one of a steady movement towards normality.
This was the headline from Newton Investment Management’s eighth annual Charity Investment Survey. Uncertainty has subsided significantly, the survey found, but are charities feeling positive about their medium and long-term investments?
“We feel more certain about the future, but less positive,” says James Brooke Turner, investment director at the Nuffield Foundation. “In other words, our outlook is based on surrendering some of the returns that we have received over the past few years, whilst at the same time compensating for higher inflation.”
It appears the uncertainty that engulfed the institutional investment markets is lifting. “Following the unprecedented impact of the pandemic on UK charities, 2021 has been a story of resilience and recovery,” says Alan Goodwin, head of investment relationship management at Newton Investment Management.
Indeed, in 2020, in the midst of the disruption caused by the pandemic, 11% of charities stated that they did not know what level of return to expect in the next three to five years. This reached 13% of respondents over a 10-year horizon.
However, 2021 saw greater clarity with only around 5% of charities unable to estimate their returns between the next three and 20 years.
The pandemic has placed a greater strain on organisations specialising in philanthropy and social wellbeing, with 53% of trustees reporting an increased workload. It remains to be seen if trying to do more with less is sustainable.
Remarkably, just 20% of charities believe the pandemic has affected their investment strategy, down from 30% a year earlier, according to Newton’s survey.
For those reporting an impact from the pandemic on their investment strategies, a drop in income is the most prominent issue. This is followed by a re-evaluation of reserve policies and a significant drop in returns – but they are all less frequently reported.
Three-quarters of charities with affected investment strategies also report a drop in investment income – down from 88% in 2020 – with 31% re-evaluating their reserves policies and 19% reporting significant drops in investment returns, both are improvements on the responses given the previous year.
Meanwhile, 19% of charities with affected investment strategies have increased spending in their investment portfolios, up from 18% in 2020, with 6% postponing an investment manager review as a result.
Much of the past two years has been defined by the disruption caused by the coronavirus pandemic. However, what is revealing when looking ahead is that most charities do not see the effects of the pandemic having a lasting impact on their investment policies.
Just 18% anticipate that Covid will have a lasting impact, with 65% believing that it will not be negative for their investment policy over the long term.
The previous year’s survey saw levels of ‘don’t know’ responses increase dramatically when charities were asked to make pre- dictions about their future. It appears that a significant level of uncertainty remained in 2021 with 17% of those surveyed stating they do not know whether the pandemic will have a lasting impact on policy or not – almost the same number as those that think it definitively will.
Interestingly, the 18% of respondents who feel the pandemic will have a lasting impact on their investment policy see potential for significant shifts in the way they invest, with the pandemic and the disruption it has brought prompting a re-evaluation of a range of policy areas.
Almost half of charities that anticipate a long-term change in investment policy are currently reconsidering their asset allocation, with a further 40% re-evaluating their reserves policies: 27% of charities are revisiting the level of risk they could tolerate following a period of significant disruption that has seen many dip into their reserves, while 13% are considering a switch to a total-return policy, rather than relying on the income generated by their portfolio.
Around one in 10 of the charities surveyed anticipate that the pandemic will have a lasting impact on their investment policy and are currently reconsidering their asset allocation as a result. “This may represent a small section of the sample overall, but it represents a significant shift caused by the acute factors of a single event – in this case the pandemic,” reports the survey.
An alternative route
When it comes to the type of investments charities may look at, almost half (43%) of those reconsidering their policies due to the pandemic state they are looking at alternative investments. The same level are reviewing the role fixed-interest is playing in their portfolios, while almost a third of charities re-evaluating their asset allocation are looking to make their portfolios more global.
Following the low investment returns reported in 2020’s survey, charities saw their investments bounce back the following year, recording their most significant performance gains since 2017.
The average performance improvement more than doubled to 11% from 5% in 12 months, while 52% of charities reported gains of 9% or higher in 2021 – a 35% increase, year-on-year.
The flip side to infrastructure stocks is that many do not score well on an ‘E’ perspective as they have high carbon footprints, so this is something that needs balancing.Henrietta Gourlay, Grosvenor Family Office
On the gains made in 2021, Brooke Turner says: “Returns have been generally good but with occasional surprises, such as China or the permanence of inflation. Growing developments and interest in environmental, social and governance (ESG) has also been excellent.”
Goodwin is just as upbeat. “It is positive to see that while charities continue to suffer significant disruption from the coronavirus pandemic, this year’s survey reveals a more positive outlook for the majority of charities in their investment strategies,” he says.
So, from a specific investment focus, along with the bounce back in investment returns, another big issue for charities is the attention placed on ESG investments coming even further to the fore thanks to Covid – with an even bigger focus on cli- mate change.
“Both have struck strong chords with us because of our charitable purpose in promoting the wellbeing of society,” Brooke Turner says. “We have begun a process of upgrading managers to ones where ESG is more central to their offer.”
On a more concerned level, Broke Turner adds: “I worry that whilst interest in the E will be pretty constant from here, the S will wane. Both are important.”
The commitment to climate change stands out in the research, with 82% of charities believing it is their responsibility to tackle the issue – a figure which has risen 18% in two years. In fact, charities have never felt it more important that ESG is a factor in the management of their investment portfolios.
In 2021, 85% of charities felt that ESG factors are either very or quite important in the management of their portfolio. This represents a 3% rise year-on-year, but more striking is the growth over the longer term. Between 2015 and 2021, the proportion of charities that felt ESG factors were important jumped to 85% from 61%.
Furthermore, a stark statistic is that half of the charities questioned in 2021 stated that they are prepared to accept compromised levels of return in exchange for sustainable, responsible investment practices.
“Wider societal concerns that have become increasingly prominent over the eight years of the survey have become more important, and more nuanced, in 2021,” notes the survey. There has interestingly been a significant shift to divestment from engagement when it comes to ensuring that climate change factors are considered in the management of portfolios.
Between 2019 and 2021, the proportion of charities who considered engagement to be their preferred approach fell to 54% from 70%, while the proportion believing divestment is the best approach jumped to 35% from 24%.
While the level of charities with ethical exclusion policies appear to have plateaued, the nature of these policies is becoming increasingly broad.
Tobacco remains the most barred investment, forbidden by 87% of those with an exclusion policy. Armaments, gambling and pornography are also each avoided by most policies, while 48% now exclude fossil fuels, up from 36% in 2020.
2022: A year of differing outcomes
So, given the challenges of Covid, what is the outlook for 2022? “We’d expect continued inflation, lower than needed rates and a slow grind onwards – until there is a trigger event which we will probably come out of left field,” Brooke Turner says. “Be prepared for a range of outcomes remains our watchword.”
Henrietta Gourlay, investment manager at the Grosvenor Family Office, which looks after the Westminster Foundation, is also positive on most markets, apart from fixed income. “Yes, inflation is here and is starting to look persistent, and this will inevitably result in central banks putting up rates. However, any rate increase will be from a low base and likely to be small increments.”
Europe is in more of a conundrum, with Covid infection rates surging. “This could encourage them to extend their quantitative easing program past March 2022,” Gourlay says. “But, with inflation likely to be at a 30-year high in November, there will be much debate about this, I’m sure.”
In terms of markets, Gourlay is not optimistic about fixed income, believing that government bond yields cannot go lower in the face of this inflation. “Which means they will likely have negative returns – particularly if the European Central Bank terminates its quantitative easing program in March, as that has been a huge buyer of sovereign bonds to date.” She adds on the inflationary environment outlook: “Credit spreads are tight and investment-grade credit is unlikely to give a positive real rate of return in an inflationary environment.
“High yield credit spreads are also tight and there is not a risk-adjusted return at this point in time.” Gourlay notes that many investors are worried about equity valuations. “I have less concerns, as inflation is good for equities as long as they have pricing power and can pass through their cost increases,” she says. “Obviously not all companies have this luxury, but a good investment manager should be able to act on this.”
For Gourlay, financials should do well in a rising rate environment – as they will become more profitable. “Infrastructure should do well, as cashflows will be linked to inflation.
“The flip side to infrastructure stocks is that many do not score well on an ‘E’ perspective as they have high-carbon footprints, so this is something that needs balancing. Commodities should do well, but again there are ‘E’ considerations.”
The investment challenges evident here, especially for ESG-aware charities, are balancing where the best returns are with a commitment to ESG. “Oil majors and tobacco are super cheap, super yieldy, with steady growth and pricing power, but generally are no go areas if you are trying to look good from an ESG perspective,” Gourlay says.
The 2022 outlook and challenges for charitable foundations, and other institutional investors, will, therefore, not be on the same level as the past year, but will, nevertheless, contain challenges.