In the sector press
The wrong risk
Kate Rogers, Portfolio Director and Head of Policy at Cazenove Charities shares her thoughts on issues faced by the charity sector in Third Sector Magazine every other month.
Taking more out of investments in good times is a good idea - but only if you take less out in more difficult market environments, writes Kate Rogers
A few weeks ago, I had the privilege of listening to Professor John Kay, the renowned economist, author and regular contributor to the Financial Times speaking at the annual Cazenove Charities investment lecture. His talk followed two main themes; investment uncertainty and long term decision making in endowment asset management, with his thesis challenging the perceived wisdom and suggesting that 'we make serious mistakes in describing risk in endowment management'.
John is fortunate to have three different perspectives to draw experience from; as an influential academic; someone involved in shaping public policy debates and as a Fellow and long term member of the investment committee at St John's College, Oxford. He believes that describing risk as volatility of capital value is bad for beneficiaries and for the economy. This mistaken conception has driven financial regulation and therefore the approaches of most providers of investment advice. In his view many advisors are overly focused on short term volatility, thereby skewing portfolios and investment decisions.
People make decisions based on what is important to them. Risk is not objective or a number that is the same for everyone, but it is subjective and personal and should be defined as failing to meet your realistic objectives.
For endowments the main investment risk is failing to achieve a sufficient return to meet the charitable purposes over the long term. For a saver, the risk might be that the money doesn't stretch to a deposit on a house. For a fund manager the risk might be short term underperformance curtailing their career. Different investors have different perceptions of risk, creating an opportunity to trade with each other to mitigate your own personal risk.
Many charity investors are looking for long term returns above inflation and as a result the key decision is how much to entrust to real assets. Safe assets such as cash and bonds are classified as low risk by their limited short term volatility. Real assets are likely to be more risky, according to volatility. Real assets outperform safe assets over a single year about 60% of the time. However, extend this time horizon to 25 years and there is a 99% probability of real asset outperformance.
It is also clear from history that significant periods of real asset underperformance come from unexpected and unpredictable events. We can't know what future will hold, and we can't be sure of the outcome, but the longer the time horizon the more likely we are to generate returns from real assets.
To conclude John gave six pieces of advice for successful endowment asset management
1. Think of risk as it affects the endowment and the beneficiaries.
2. Concentrate in real assets.
3. Mind your portfolio risk. Don't avoid risky investments, but build a diversified portfolio.
4. Think for the long term. Although herd mentality creates correlation in the short term, endowments have the luxury of time which provides opportunities.
5. Pay less and minimise intermediation. Costs reduce returns.
6. Don't pull the plant up every few years to see how it is growing. Find a good manager and let them get on with it.
This article first appeared in Third Sector in June 2016
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