A total return approach to taking distributions from a portfolio gives stability and flexibility – and it also allows for wider exposure to attractive asset classes.
2020 was a year of "winners" (Tesla +718%, Zoom +380%) and "losers" (Lloyds -42%, BP -42%). A unique set of circumstances forced changes to how we live and work favouring a handful of sectors, predominantly in technology. The losers have tended to be industries with greater economic sensitivity, such as oil & gas and financials, or those which were effectively shut down by the pandemic such as hotels and leisure businesses.
The Covid-19 pandemic continues to have a profound impact. Many businesses in the most affected sectors have seen meaningful volatility in their share prices and have cut or suspended dividend payments to preserve cash and protect the viability of their businesses.
For charities following a traditional income approach to investment, 2020 will have felt particularly challenging. Income has declined dramatically, with dividend cuts of 41% in UK equities and 14% in global equities over the first nine months of 2020. This is causing a budgetary headache in many charity board rooms. So what can be done?
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 2020 distributions for the Charity Multi-Asset Fund and the Charity Responsible Multi-Asset Fund were -1.5% and flat respectively, compared to the end of 2019, which compares favourably to other investment asset income. 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.
An income focus would have traditionally led charities to a UK-biased portfolio. Over 2020, the UK equity market fell 9.8% compared to global equities which returned 12.9% in sterling terms. Income approaches have also underperformed with the IA UK Equity Income sector down 10.8% and the IA Global Income sector up 3.5%.
Part of the difference 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 5 years, the UK market has returned 28.5% whilst the IA UK Equity Income sector has only returned 16.1%. 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 do not 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 have been continuing to evolve to a fully global approach to equity investment, which means we have reallocated assets away from the UK towards international markets over the last few years. This allows 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.
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 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 fades. Lower real yields and supportive central bank actions reduces 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).
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.
The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.