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Charity investment: total return regulation

The Charity Commission has published its review of the Charities (Total Return) Regulations 2013. Although there are no major changes, we thought a quick reminder might be useful for trustees of permanent endowments who may be considering adopting a total return approach.

14/02/2024
Charity investment: total return regulation

Authors

Kate Rogers
Global Head of Endowments & Foundations, Schroders

Last year the Charity Commission published its review of the Charities (Total Return) Regulations 2013. They concluded that the regulations achieve the policy aims which were threefold; to facilitate the adoption of total return investment by charities; to decrease the regulatory burden - as permanently endowed charities don’t need the Commission’s authority to adopt this approach; and to introduce safeguards to ensure the permanent endowment is not misused.

For some, this is a missed opportunity for simplification as the regulations are perceived as over engineered in parts. This is noted in the Commission’s response but has not been prioritised ‘given the small number of charities that would benefit, the ability of those charities to access professional advice and pressure on our resources.’

So it seems that the regulations are staying as they are. Time for a quick reminder?

Permanent Endowment

Some charities have assets that are ‘permanently endowed’. That means trustees are legally obliged to hold these assets permanently - either to further the purposes of the Charity, or to generate an income. The income can be spent, but the capital cannot.

Most charities are not permanently endowed; although many wish to exist in perpetuity. Investing charities without permanent endowment restrictions can choose to spend income or capital to further their charitable purpose and will therefore invest to maximise their ‘total return’ irrespective of whether the return is from capital appreciation or income. Conversely, invested permanent endowments are only able to spend income which tends to bias investments towards income producing assets.

This difference has become particularly pronounced over the last decade; with interest rates and bond yields falling significantly. Permanent endowments seeking income have needed to focus their investment assets in higher yielding areas; restricting their investment universe and hampering diversification.

Total Return Investment

The Trusts (Capital and Income) Act 2013 added a new power to the Charities Act 2011. This power allowed trustees of permanently endowed charities to adopt a total return approach to investment, without having to seek the Charity Commission’s authority. The Regulations set out the rules that trustees must follow in adopting a total return approach and focuses on safeguarding the original permanent endowment.

Adopting a total return approach gives permanently endowed charities greater flexibility. Under a total return approach, the form in which investment return is received does not matter. Instead, 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, rather than on investments which will give the ‘right’ balance between capital growth and income. The trustees can allocate whatever portion of the total return they consider appropriate as income, which is then spent furthering the aims of the charity. The balance remaining is carried forward as ‘unapplied total return’.

1. Identifying the ‘original endowment’

Trustees wishing to adopt a total return approach must first identify the permanent endowment assets and their ‘original value’. This is likely to be the most important step, and may determine the tolerance of the endowment investment approach to volatility of capital value. For a permanent endowment, invested in long term assets, trustees will want to make sure the ‘original endowment’ value is significantly less than the current value, to provide a buffer for any short term equity market falls and to enable spending to continue in times of market stress.

This identification exercise can also be an administrative headache; particularly if multiple endowments exists. The regulations do talk about a ‘reasonable estimate’ and the fact that ‘trustees won’t be expected to carry out an elaborate tracing exercise’. In practise trustees adopt a range of approaches, and many take advice from their accountant, lawyer and investment manager. This original endowment value is referred to as the ‘investment fund’.

2. Passing a resolution

Once trustees have identified the original endowment, and therefore the current balance of ‘unapplied total return’, they must pass a resolution. They do not need to notify the Charity Commission, and the regulations don’t contain any specific instructions on its wording.

3. Allocating unapplied total return

The unapplied total return balance will vary according to the market value of the endowment. This should be invested in the same way as the ‘investment fund’. In order to spend unapplied total return, the trustees will need to allocate a portion of these assets to the ‘income fund’. Trustees can also allocate unapplied total return to the investment fund – to increase the value of the permanent endowment, and reduce the unapplied total return balance. This is less frequently used in practise. The regulations do also allow for the reverse; up to 10% of the investment fund can be released to the income fund for spending, although this is subject to recoupment.

Whilst the regulations do allow more freedom for permanent endowments and have undoubtedly increased the uptake without adding to the Charity Commission’s work, they do place further burden on trustees who must decide how to balance the needs of the current and future beneficiaries. These spending decisions can have a significant impact on the long term value and spending power of the endowment and trustees are encouraged to take professional advice.

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.

Authors

Kate Rogers
Global Head of Endowments & Foundations, Schroders

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.