Article

Endowments can help charities deal with soaring costs

As costs rise sharply and investment income falls, how should trustees at endowment-based charities change their financial plans?

| 8 min read

It’s not easy being a charity trustee at the best of times. Trustees give generously of their time and skill to help the many beneficiaries of a charity’s work. They need to keep up to date with the changing patterns of investment, regulation and charity best practices. It has been particularly difficult over the last three years, with a pandemic followed by a European war, alongside a nasty resurgence of inflation.

Rising prices and costs are worrying for charities. If a charity lives from its endowment, it is difficult keeping up with the inflation from investments in bonds and deposits that will see their worth eroded by inflation. If the endowment takes more risk with real asset investment, that too can still be subject to falls in values as the authorities take tough measures to curb the price escalation. If the charity depends more on current donations, trustees will worry that, at a time of a substantial cost-of-living squeeze on real incomes, people may no longer have as much money to be generous to their favourite charities.

Cost bases are soaring

Any consideration of how best to protect a charity’s finances today needs to start with thinking about prospects for inflation. Our base case assumes we will see the worst of the inflation in the US, UK and EU this year, with sufficient action taken by central banks to bring the rate of price rises down substantially next year.

This really needs to happen, as inflation is running at around 8% in the major advanced countries of the west. At such a rate, charities need to plan for a substantial increase in the cost of employing people, delivering services and buying-in goods. Typical endowment investment portfolios are unlikely to keep up with such a pace of rise – and may well lose money all the time the uncertainties persist about how high and how long inflation will go.

There are some signs that wages are not chasing prices into an inflationary spiral – and some indications that we will see the worst of the price rises in food and energy this year. Next year may not see either of these crucial markets return to normal but is likely to be an adaptation to the new realities in such a way that means no further rapid push upwards in the price of petrol and wheat are likely. The US is largely self-sufficient in these items. The UK can grow most of its own grains and still produces half its own gas. The more that can be done to boost output in safe countries the better to tackle the supply shortages.

Central bankers finally act

The Bank of England stopped creating new money and buying up bonds at the end of last year. The US stopped at the end of March. These were the essential first steps to getting price rises back under control. Now the European Central Bank has made its first move. Many other central banks around the world have also raised interest rates to control demand and deter too much credit. Whilst we keep a scenario where inflation embeds through a price/wage spiral, this bearish scenario looks less likely the more action the central banks take.

Trustees would be wise to assume a lower rate of return on their endowments than they have enjoyed in the long bull market era that lasted from the end of the banking crash in 2009 through to the end of 2021. That era was made possible by ultra-low interest rates and by heavy
buying of bonds by authorities to keep the interest rates low. Where some of those gains have been banked it would be prudent to add a bit to the reserves. Spending needs to be budgeted to reflect the reality of lower total returns going forward. The good news is that charities will be able to earn a bit more return by low-risk investments such as keeping money on deposit or in relatively safe, shorter-dated bonds as interest rates rise.

Any consideration of how best to protect a charity’s finances today needs to start with thinking about prospects for inflation.

Charities also need to adjust to the large social changes emerging from Covid-19 and the consequent lockdowns. This accelerated the digital revolution that is sweeping through company and family life. Charities can benefit from offering online as well as in-person events, using social media, and from contacting a wider range of potential supporters and donors through the new digital services.

As employers, charities will adapt to hybrid working – negotiating flexible packages with talented people who want to do some of their work from home. The return of in-person events will be widely welcomed, but they will often be advertised using the new social media and may have hybrid elements to their delivery. More of the content that charities publish will also be available as stored video for others who could not be present or who did not read it the first time it was published.

ESG comes with risks as well as rewards

As investors, Trustees will be expected to make difficult judgements about environmental, social and governmental issues (ESG). There is increasing interest in ESG investing, where a buyer of shares or bonds asks questions about the practices and attitudes of the companies and governments concerned.

Some charities seek to ban certain types of investment from their portfolios. Others encourage the investment managers to take an interest in ESG matters and to use their investment to urge better performance from the companies. We rate our investments using one of the external services to assess individual investments in relation to their ESG performance, and we can implement a strategy for ESG investing tailored to charity trustees’ wishes. It is important for trustees to think through what they wish to achieve, and to appreciate the way in which so many companies are enmeshed in a wide range of differing activities. If you invest in a bank or insurance company or advertising agency or a business services supplier, you may well indirectly be earning revenue from fossil fuels, weapons manufacture or tobacco. It is
usually a matter of degree. It may also be the case that trustees are happy to allow investment in companies that are themselves on a journey to better ratings under ESG metrics.

It is an unusual year when an investment manager gives charity trustees the bad news that the endowment that funds their good work has been hit by falling equity and bond values, whilst the costs of undertaking the charity’s work have risen sharply. The last decade has, for many endowment-based charities, been good years. Asset values rose well ahead of price rises, giving charities scope to do more and build prudent reserves. However, the light at the end of the tunnel is that this should be the worst period for this financial squeeze. Markets will adjust to higher interest rates and authorities will grapple inflation down – albeit at some cost to incomes, output and profits.

This year trustees should use the opportunity to “smooth” and build up reserves if they can.

Next year, if all goes well, inflation should be lower and markets able to offer positive returns once more. A bad year does not disprove the wisdom of having an endowment fund. It reminds us why endowments are a good thing when you can create reserves in good years to smooth the bad years.

Many charities use the idea of spending that part of the endowment income and capital gain that looks safe over the long term. This year trustees should use the opportunity to “smooth” and build up reserves if they can. There will be more opportunities to invest on better terms as markets adjust to the world economy’s current tough problems.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Endowments can help charities deal with soaring costs

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