A portfolio for the next decade
Charity investors have enjoyed a profitable last decade as the global economy has shown continued gradual growth and asset prices have been boosted by liquidity from loose monetary policy. A long term endowment portfolio is likely to have generated returns of around 100% over the last decade, as compared to inflation of 23% (UK CPI). This means that after spending, many Charity investors will have ended the decade having experienced significant real portfolio growth.
Having enjoyed this growth, we think it is the right time to review and refresh our charity investments and have four recommendations to ensure our charities portfolios are fit for the next decade.
1. A global approach in equities
Equities represent the most significant asset class in most long term charity investment portfolios (70%1). In the past UK charities have had a bias towards UK equities for three reasons: the income premium, the alignment of currency and the global nature of the UK equity market. Whilst we can understand these from a historical perspective, we now recommend a global approach. Let’s look at each reason in turn:
The UK equity market does provide a yield premium to the global equity market (4% vs 2.5%). However, the Charities Total Return Regulations first introduced in 2013 (and amended in 2018) mean that charity investors, even if permanently endowed, are not restricted to spending from income alone. In our view, biasing portfolios towards UK equity income will limit the return opportunity over the next decade.
Alignment of currency?
It is true that UK equities are priced in sterling. However, any comfort that is gained from this is largely an illusion. The largest 100 companies in the UK equity market (representing 80% of the total) have only 23% of their revenues in sterling. In other words 77% of FTSE 100 revenues are subject to currency risk. As we saw post the EU referendum, large swings in currency markets can have a real impact on the value of the UK equity markets.
A global UK equity market?
The statistics above show that the UK equity market is made up of global companies; deriving much of their revenue elsewhere in the world. However, does it represent the global equity market; or indeed give us access to the areas of growth?
The last decade has seen a rise in the technology giants. In the last 10 years a combination of Facebook, Apple, Alphabet and Microsoft have added a total of $4.3 trillion in market cap to the US market; this is more than the value of the UK market and nearly as much as the Chinese mainland stock market.
The rise of technology
Then and now, 1999 and 2019: today's superstars are all technology firms
Source: Datastream, Refinitiv, Cazenove Capital
We have little exposure to the technology sector in the UK listed market. While the UK has had a number of very successful technology companies, such as Arm, Misys and more recently Sophos and Just Eat, many have been taken over by their larger international listed rivals depriving UK focussed investors of the future growth. We believe that technological disruption will continue to be a theme for the next decade, and do not believe that charity investment portfolios should be limited or biased towards a narrow 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.
Sector composition matters
Why we want more global exposure for portfolios
Sector composition of major equity indices
|UK||US||Europe ex UK||Japan||Pacific ex Japan||Emerging Markets||MSCI World|
Source: Bloomberg, Cazenove Capital
Our portfolio for the next decade takes a global equity approach at its core, and by doing so allows our charity investors to access the exciting growth potential of companies all over the world.
In order to deliver this approach successfully, we believe it is not enough to rely on UK based investors alone – we must use the huge global investment resource of Schroders, drawing on more than 750 investment professionals in 19 countries for investment ideas and insight.
2. Looking for alternative sources of return
The last decade provided bond markets with a strong monetary tailwind. This reduced yields and pushed up capital values.
Sources: Datastream, Cazenove Capital. Past performance is not a guide to future performance.
This has been a global phenomenon. At the turn of the decade the 10 year UK government bond yield stood at 0.8%, having fallen from 4% in 2010.
It is clear that bond yields cannot fall a similar extent over the coming decade, meaning that capital returns are likely to be low, if not negative. Our seven year forecast for bond markets shows a negative real return. This is unlikely to be attractive for charity investors seeking returns that protect their investments against inflation and generate excess returns to support spending.
Having benefitted from strong bond market returns; our portfolio for the next decade moves away from bonds, with only a small allocation for diversification, and instead seeks alternative sources of return. These alternative assets include property; infrastructure, commodities and other diversifiers. We are also asking our charity clients with long term investment horizons to look at private assets.
Including private assets
Schroders’ latest survey of global institutional investors shows that private assets comprise around 10-15% of institutional portfolios. However, most expect the allocation to rise over the next three years. This makes sense to us. At a time when macroeconomic and geopolitical concerns are increasingly on investors’ radars, private assets can offer meaningful diversification and compelling returns.
And it is not a new asset class for charities – private assets have been a key driver of returns for the very largest foundations and endowment portfolios for decades.
Case Study: The Yale Endowment, $29.3bn
Over the longer term, Yale seeks to allocate approximately one-half of the portfolio to the illiquid asset classes of leveraged buyouts, venture capital, real estate, and natural resources.
The heavy allocation to non-traditional asset classes stems from their return potential and diversifying power.
The Endowment’s long time horizon is well suited to exploit illiquid, less efficient markets such as real estate, natural resources, leveraged buyouts, and venture capital.
The twenty-year time weighted return of Yale’s venture capital portfolio is 24.6% p.a.
Source: 2018 Endowment Update
Once the preserve of the richest charities only, we are pleased to be able to offer private asset to our clients. In his paper Adding return and lowering risk with private assets, Duncan Lamont, our Head of Research and Analytics, highlights the four ways in which private assets can potentially add value – higher returns, broadening access, reducing risk and diversifying portfolios. Where charities can tolerate illiquidity, we believe that an allocation to private assets can help our clients meet their investment objectives for the next decade.
3. Investing sustainably
In 2009 just 23% of charity investors had a policy that linked their investment strategy to their charitable aims. Now more than three quarters of charity investors seek to align their investment approach with their charity’s aims – both avoiding conflict and seeking positive impact.
The increasing number of charities aligning mission and investments
Source: Cazenove Cappital, Intentional Investing (2014). 2019 data based on practice
There are a number of explanations for this change. From the need to protect reputations and build public trust; to the increasing evidence that a focus on sustainability enhances returns.
Compelling academic evidence...
...shows it makes financial sense
- Firms with significant environmental concerns pay higher credit spreads
- A well-governed firm can have an equity cost advantage between 0.8 to 1.32%
- Good corporate governance can lead to a 1.8% reduction in cost of equity
- 88% studies showed a positive relationship between sustainable companies and operational performance
- Rating agencies tend to give better ratings to issuers with good ESG policies
Sources: 1From the Stockholder to the Stakeholder, Smith School of Enterprise and the Environment, University of Oxford and Arabesque Asset Management, September 2014. 2Sustainable Investing, Establishing Long-Term Value and Performance, Fulton, June 2012
Our portfolio for the next decade integrates sustainability into the investment decision. Going forward, all of our charity investment strategies will integrate environmental, social and governance factors and we will continue to use our influence to push for progress – standing up for what we believe, improving futures.
We can help individual clients find alignment between their investments and their values, and measure the effect of portfolios on people and planet.
Investing sustainably is no longer an option, it is an essential.
4. Focusing on value for money
The last decade has brought about an increased focus on costs, as austerity and greater scrutiny ensure that trustees are committed to demonstrating value for money. There has also been a significant reduction in the cost of investing passively, with the cost of a UK equity tracker fund falling by 80% since 2010, from 0.5% to 0.1% today. This has rightly led to questions over the cost of active management; and challenge from charity investors to deliver investment portfolios at lower levels of total cost.
The total cost of our investment approach has also fallen over the last decade as we construct portfolios with budgets in mind. We have already established that global equities form the main part of charity investment portfolios. We think there are two, cost effective ways to invest in global equities:
- 1. Direct investment - which avoids the costs associated with pooled funds, to reflect specific responsible investment policies and to benefit from our global investment resource; or
- 2. Pooled investment – combining low cost passive approaches with specialist active managers to generate excess returns and benefit from diversification of manager and style.
Our portfolio approaches
Investing with budget in mind makes sure that we analyse every penny we pay in fees, to ensure value for money. That doesn’t mean we won’t pay up for a great opportunity, a new asset class or a strong performance track record, just that we need to be convinced that the potential benefit is worth the cost.
Our portfolio for the next decade
Designing a charity investment portfolio for the next ten years and beyond means four things to us:
- A global approach in equities
- Looking for alternative sources of return
- Investing sustainably
- Focusing on value for money
Combining these into a new charity investment approach gives us confidence that we can meet your charity investment objectives whatever the next decade might have in store.
 Source: Teknometry CIG Charity Fund Universe, 30th September 2019 – 1,298 portfolios of total value £12.4bn.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 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. For your security, communications may be taped and monitored.