Fiona Gillespie details how charity trustees can manage their investments during times of uncertainty
Covid-19 sent markets into meltdown in March, leaving investors, companies, and the economy to cope with the spectre of volatile markets and tumbling revenues.
Charities will have seen their investments take a hit at the start of the pandemic, and while some markets have recovered, it’s likely to take some time for a widespread return to pre-pandemic levels. It is important to remember though, volatility is not a new phenomenon: markets have fallen sharply and risen rapidly from time to time for decades. Economic recovery after the Covid-19 crash may be slow, but it’s still predicted to normalise eventually.
As individual investors will know well, it’s hard to hold your nerve when markets are falling even if you know pulling out can be highly detrimental. Here's three top strategy points to keep in mind when managing investments during times of market volatility.
1. Cash requirements
When investing, charity trustees should have good understanding of their cashflow over the coming few years, both in terms of potential inflows but also cash required for expenditure, which may need to be sourced from the investment portfolio. Trustees need to be sure they have enough cash held separately to cover their operational expenses or any future projects. Cash reserves help to improve tolerance, flexibility and provide a buffer from market volatility.
2. Time horizons
Investment horizons (how long a charity can stay invested) play an important role in defining investment strategy. If there is a likely need to liquidate some or any of the portfolio, trustees will need to consider roughly when this is likely to take place and how long the remaining sum needs to stay invested. If time horizons vary, it’s worth considering investing in separate portfolios which follow their own individual strategies.
A charity’s strategy should also be focused on financial sustainability. While a private investor’s main goal could be outperforming the market, a charity is more likely to be focused on beating inflation and so there is much less need for charities to focus on short-term portfolio volatility. Generally speaking, volatility is smoothed over time, protecting the portfolio from extreme short-term ups and downs. Ideally, the minimum length of time to invest in equity markets is five years; most investment managers will be reluctant to manage portfolios for any shorter period.
3. Absolute or relative returns?
Charities must consider exactly what their financial requirements are as this will impact the way in which the portfolio is invested. These tend to be an absolute or relative approach. There is no ‘right answer’ to this question, but it is up to trustees to weigh up the respective advantages and disadvantages, and then make an informed decision having considered their charity’s specific requirements.
The absolute return approach typically involves investing in a relatively ‘unconstrained’ manner where the investment manager retains the flexibility to invest wherever they see the best potential for returns and typically alters the structure of the portfolio in reaction to, or anticipation of, certain market conditions. In this approach the manager is looking to generate strong returns, while protecting against absolute loses over an agreed period of time.
The relative return approach is less heavily reliant on ‘manager skill’. The benchmark for a relative returns investor will tend to be biased towards assets classes which tend to offer investors capital growth over the long term, and protect against the impact of inflation. This approach can also be compatible with an income-only approach for those charities who prefer to maintain their capital and use the income generated to fund their activities.
When the market is highly volatile, an investment manager can be instrumental for charity trustees in steering a steady course through challenging times, particularly if the trustee has limited market knowledge. They play a crucial role in reminding the trustee that volatility is natural within markets and that, provided the charity has a well thought out strategy, it is the long-term performance that matters.
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Fiona Gillespie is Head of Charities, Scotland at Rathbone Investment Management
