Given the heightened levels of volatility seen in all asset classes over the past three years, many charities are rightly reviewing their investment approach and questioning long-held assumptions. The re-emergence  of inflation has made ‘inflation  plus’ an uncomfortable investment target for numerous UK-based endowments. This is particularly so when a transient phenomenon demonstrates the signs of being something more stubborn.

The underlying investment goals for most long-term charity endowments inevitably incorporate a tension between the short and long-term. Drawing cash from the endowment to support charitable causes whilst also protecting the real value (after inflation) of the endowment for the long-term is simple enough in concept. In practice, setting an appropriate spending rate while maintaining the value  of an endowment in real terms can be fraught with complexity, particularly when set against short-medium term timescales. The post-COVID world of heightened inflationary pressures, increased economic uncertainty and responsible investment make for a foggy backdrop compared to the relative stability of the past decade.

A light through the fog? 

For many decades, perceived wisdom has been that a spending level of 3% to 4% of the value of the endowment is compatible with protecting the value of the endowment. Does the ‘inflation plus’ target provide a light through the fog?

In practice

At the end of 2021 and midway through the pandemic, an audit of typical (if there is such a thing) charity endowment returns revealed a decade of robust endowment performance with markets having benefited from  a period of falling interest rates and central bank market intervention without any significant provocation of inflation. Simultaneously, many endowments had produced a decade and more of cumulative investment returns that were significantly ahead of the ‘inflation plus 3%’ yardstick.  

Fast forward just eighteen months, and the picture would appear to  have altered dramatically. Many Endowment Investment Committees will be looking at returns significantly below the inflation plus 3% target on  a five-year cumulative basis.

Lifting the fog

Given the complexities and uncertainties now facing charity investors, in our view charities and their investment committees should reassess their investment objectives, policies and strategy. Traditional  bond/equity structures have served many endowments well over the last decade, but recent experience for our clients indicates a broader investment exposure is appropriate and can offer benefits in the current environment.

We saw this work to good effect through 2022 when a number of our endowment clients enjoyed more resilient returns than the average charity balanced fund, having taken our previous advice to allocate to alternative asset classes with strong inflation-linked income. Their investment income also held up well through 2022, reducing the need to draw down on hard-hit equity and bond investments.

We haven’t stopped there though. 2023 brings new challenges and opportunities: higher interest rates, US equity valuations at all-time highs, a stronger Pound and most recently the Charity Commission’s new investment guidance. We’re working with our clients to address these factors including reviews of:

• income yield for treasury and short-term reserves
• foreign currency exposure
• responsible investment policies
• active versus passive equity allocation. We believe an investment  target of inflation plus 3% to 4% remains appropriate and achievable for our clients with long-term endowments. But given the significant shifts in markets, in many cases this will need charities to review their asset allocations  to ensure they remain on target.

We would be happy to help you navigate the fog of uncertainties. Please feel free to contact us for an informal chat about how we can help.