The Covid-19 crisis is having a profound impact on economic growth. Many businesses in the most affected sectors such as tourism, hospitality, aviation and retail have seen meaningful volatility in their share prices and have cut or suspended dividend payments to preserve their cash reserves and protect the viability of their businesses.

For charities following a traditional income approach to investment, 2020 will have felt particularly challenging. Income is expected to decline dramatically over the year, with dividend futures suggesting that UK and global equity income may fall by –40% and –15% respectively. This is causing a budgetary headache in many charity boardrooms. (More here on our views on the outlook for investment income). So what can be done?

A total return approach – reduced income falls

A total return approach gives charity investors greater flexibility. Under this approach, the form in which investment return is received doesn’t matter as both income and capital can be used to meet spending requirements. Investments are managed to make the most of the total investment return that they generate. This enables charities to focus on investments that are expected to give the best performance overall, rather than on investments which will give the “right” balance between capital growth and income.

For charities that adopt a total return approach, and smooth spending distributions over time, the impact of market and dividend falls is less significant. Our two charity-specific multi-asset funds, the Charity Multi-Asset Fund and the Charity Responsible Multi-Asset Fund, have been managed on a total return basis since launch. Both funds have a long-term inflation +4% target, with distribution units paying a total return distribution of 4% per annum, paid 1% per quarter smoothed over the previous 3 years.

This means that even in times of market volatility we can maintain a stable pattern of distributions. For example, the year-to-date distribution for both funds is only 1% lower than at the end of 2019. This is one of the key benefits of adopting a total return approach: it can provide a more stable and sustainable level of cash flow.

A total return approach – broader opportunity set

An income focus would have traditionally led charities to a UK biased portfolio. In the first half of the year the UK equity market fell –17.5% compared to Global equities which returned +0.5% in sterling terms. Income approaches have also underperformed with the IA UK Equity Income sector down –20.3% and the IA Global Income sector –6.2%.

Part of these significant dispersions can be attributed to the sector composition of the UK market and the more meaningful relative falls in dividends. However, this is not a new trend. Over the last five years the UK market has returned +15.0% while the IA UK Equity Income sector has only returned +4.7%. We believe these trends are likely to be more structural and persist.

Many structural themes have been accelerated as a result of the Covid-19 pandemic. We believe that technological disruption will continue and don’t believe that charity investment portfolios should be limited or biased towards a narrow UK universe. UK equities are also concentrated in resources and banks; both of which have significant challenges in the face of climate change and a shifting global economy.

We are evolving to a fully global approach to equity investment, which means we are continuing to reallocate assets away from the UK towards international markets. This will allow us to capture more investment opportunities from all over the world, including in sectors less well represented by UK listed stocks such as technology and healthcare. This move is a continuation of the changes we have been making over the last few years.

A total return strategy may also enable charities to make slightly higher withdrawals than strategies targeting an income-only approach. This is because equities produce real capital returns over the period and the investible universe will be broader. Additionally, a total return strategy ensures there is less danger of solely focusing on income targets and an increasingly concentrated list of higher yielding stocks.

A total return approach – diversification

A total return approach also provides the flexibility to increase diversification and access investment opportunities within alternatives that potentially provide little or no income, but that have the potential to achieve higher risk-adjusted total returns for the portfolio.

An example would be gold, which provides no income but warrants a place in portfolios as the attractiveness of bonds fade. Lower real yields and supportive central bank actions reduce the relative cost of holding gold versus bonds, whilst gold can be a useful hedge against growth, geopolitical, inflation risks and market stress.

If you would like further information on adopting a total return approach, the Charity Multi-Asset Fund or the Charity Responsible Multi-Asset Fund, please get in touch with your usual contact or James Brennan (020 7658 1183 / James.Brennan@CazenoveCapital.com).

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