Investment

The money garden

How can schools use their charitable investments and manage them to best effect? Ruth Murphy outlines some of the investment approaches and balancing acts available to schools when reviewing their options

The extent to which a school’s investments contribute to the long-term expenditure plans and annual budgets varies considerably across the sector. But whether the investments are there to fund bursaries, capital projects or make a contribution to the annual core costs (or all three), some of the same considerations and principles apply to all.

Independent schools with charitable status may invest their assets (cash and longer-term investments) in a range of ways, according to the school’s governing documents, such as a trust deed or Royal Charter. Everything the bursars and governors may do is dictated, in the first instance, by the legal status of the funds.

These funds may have varying legal status: they may be permanent endowment funds (where capital may not be spent and only the investment income expended) or expendable endowments (from which both income and the capital may be used); restricted funds (where income or capital may be spent for the furtherance of specific objects) or unrestricted funds where, perhaps, only the income may be spent.

In essence, the actual power to spend will depend on the terms on which a donor or grantmaker may have given funds to the school, or from a specific appeal run by the school.

Background to investing
Some funds with charitable status may be required for short-term measures. Other funds, to be enjoyed by current and future beneficiaries, should be invested with a long-term horizon, with current beneficiaries enjoying the annual income which, if not fully used, should be accumulated/reinvested (if allowed by the terms of the endowment deed).

In recent years, returns on investments have been the subject of considerable debate given the above-average volatility of markets, particularly at the beginning of the decade. Investors (and their fund managers) are mindful of the requirement to consider investment in the longterm context, while adhering to the commitments to current and future beneficiaries.

In years when a particularly high demand is being made upon their resources, trustees of the charitable funds may supplement the natural income they are earning from their investment with a withdrawal of capital growth accumulated in previous years, if permitted to spend capital. Capital projects are often funded in this way. Since the capital remains the long-term base from which the income is earned, maintaining its real value is important.

The balancing act
For schools, there are particular annual demands made on their resources to achieve their objectives. Aside from the annual budget for the management of the school and the delivery of its educational programme, specific bursary and scholarship programmes may generate more applications than can be met. A strong annual revenue stream is vital. Conversely, a capital project, such as a building programme, is likely to require a major capital withdrawal. But the principles of the long-term versus the short-term and of capital growth versus income are common to many.

When setting (or reviewing) their investment strategies, schools should design their policy to cater for current and future liabilities, desires for expenditure and establish a performance benchmark to enable them to assess whether their fund managers have achieved the intended aim. As trustees, governors have a duty to monitor their professional investment arrangements; a policy and benchmark must be in place for objective assessment to take place. Fund managers expect to have a dialogue with their clients to agree such criteria and to confirm that the school’s objectives are realistic.

Income, growth or both?
Historically, a balanced portfolio might have contained fixed interest stocks issued by governments or companies for the purpose of generating (above-average) income, while equities (shares), and sometimes property, were held to generate capital and income growth and to compensate for the erosion by inflation of fixed interest capital. Shares in UK companies produced a reasonable yield (income), but investment in overseas companies tended to focus on their growth potential and little annual income was expected, since overseas governments taxed income more highly than capital growth.

Things have changed in recent years, and in several ways. Overseas companies have begun to pay more impressive dividends and therefore are a source of both growth and income. The resurrection and growth of the property funds industry has resulted in a number of specialist property funds becoming available to investors seeking higher income and these may also have a natural place in a balanced charity portfolio.

Keeping the balance
One of the guiding principles of charitable investment is that of diversification; indeed, a key part of risk management is the consideration of how best to balance the assets to achieve the returns sought and to spread the risk. The old adage of not putting all your eggs in one basket applies here.

Equities remain the dominant part of most balanced charity portfolios, with bonds and cash held in smaller proportions. While equities are likely to continue to be a strong, long-term source of growth in capital and in income, they may prove volatile over the short-term. If the worry of seeing the value of investments fall significantly, if briefly, is unpalatable, or if some capital expenditure may be required over the short-term, then schools should consider spreading their money across a wider range of asset classes.

In recent years, there have been rising levels of interest in alternative assets. These include private equity, hedge funds and commodities. They each have differing characteristics. Investors should be mindful of the need to find cost-effective and transparent ways of investing in them and be ready to assess and monitor them. Given the importance of income to schools, it is also worth assessing the level of income (versus growth or protection) each type offers against the cost of investing.

Achieving the right balance to suit your school’s circumstances is as much about a decision for now as making a plan for the future.

This article is the view of Newton Investment Management Limited and should not be construed as investment advice. In addition, the information contained in this article should not be construed as a recommendation to buy or sell a security.

Ruth Murphy is director of charities business development for Newton Investment Management. Ruth can be contacted on ruth_murphy@newton.co.uk

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