Long term charity investors seeking perpetuity must manage a delicate balancing act. To meet the requirements of future beneficiaries, they need to preserve the real value of their investments over the long term. At the same time, they are seeking to make sufficient distributions to meet current spending needs.
This is not a new balancing act for trustees of foundations. It is increasingly also the case for family charitable trusts, which are now often set up to last into perpetuity. Parents want to pass on their legacy of charitable giving to their children – and see the activities of their family trust continued across generations.
Striking a balance between spending and capital preservation
Setting an appropriate spending target is a key component in getting the balance right. Spend too much and you may deplete the real capital value over time. Spend too little and you may be withholding precious funding at times of urgent need.
Typically, spending 3-4% of a portfolio’s value on an annual basis is considered to be sustainable. However, this means that up to 97% of the investments are not directly contributing to the charitable mission in a given year.
The good news: trustees can now maximise the positive impact of 100% of the assets by investing in a way that promotes positive social and environmental outcomes. Investing in line with the charitable mission – or "intentional investing" – has become widely recognised as a means of using investments to further charitable objectives. The same is true for “values-based investing”, which aligns investments to core values, targeting the areas of need that trustees feel most passionately about.
This article looks at some of the different ways investment can promote better social outcomes. Potential approaches include using engagement and stewardship to improve corporate behaviour, as well as investing to achieve a measurable positive impact.
The impact companies have on society is growing. As a result, the importance of “active ownership” is increasing. As a large share owner we can engage with companies to highlight risks and opportunities they may not have foreseen and encourage them to adopt more sustainable practices. It helps us protect and grow our clients’ capital, whilst also promoting better outcomes for society.
Our engagement focuses on key environmental, social and governance (ESG) issues. We want to understand a company’s impact on all its stakeholders across the ESG spectrum: employees, customers and suppliers (S); regulators and shareholders (G); and the environment (E).
Truly sustainable companies are best placed to deal with the seismic environmental and social change that our world is facing
For instance, is the firm adapting its operations to accommodate the transition to a lower-carbon future? Does its culture allow for unfair working practices or discrimination? How compliant are they with tax regulations?
We believe that companies should be focused on creating long-term value for all of their stakeholders, as well as the societies in which they operate. When we identify shortcomings, we will engage with a company and use our voting power to push them to make progress.
As an example, we believe that diversity at board level is important for a company’s long-term success, by encouraging debate and ensuring wider stakeholder representation. In 2018 we wrote to all our US holdings with all-male boards communicating our views.
We explained that if we fail to see evidence of change by their next AGM, we will look to vote against the chair of the nominations committee. This has led to constructive dialogue with a number of these companies and we have started to see some change. As of January 2019, three of the companies we wrote to have appointed a woman to the board.
These factors and many more can have a material impact on the long term success of a business. We believe truly sustainable companies are best placed to deal with the seismic environmental and social change that our world is facing. They are also better placed to maintain their growth and returns over the long term.
We work closely with our colleagues in Schroders’ award winning Sustainability Team to conduct research and engage with companies. The size of our firm supports our ability to influence corporate behaviour and push for progress. In recognition of its commitment to responsible investment, Schroders was ranked first out of the 40 largest European asset managers by ShareAction, a charity which promotes responsible investment.
Impact investing: social outcome bonds and other assets
While stewardship can be used to promote positive outcomes, we can also use our investments to actively target areas of social and environmental need. This includes investing in companies whose products and services provide certain necessities, such as social housing or renewable energy. Alternatively, we can invest directly in social initiatives, such as social outcome bonds.
While the former can be accessed through the listed markets, social initiatives often require capital to be locked away in illiquid structures for the life of the project. The return is often dependent on the success of the project. While this kind of investment remains a niche area, it is a fast-growing market. It requires specialist advice, which we are able to provide.
We apply strict criteria in our selection of impact investments and the people who manage them. We expect fund managers to be able to demonstrate the impact of the companies they are investing in. This could take many forms – but in all cases we would expect to see companies delivering measurable positive impacts in areas of unmet need.
For instance, an education provider could show how it is helping more pupils from low-income backgrounds secure qualifications. In healthcare, a provider may be able to demonstrate how it has improved access to affordable healthcare in underprivileged areas.
Our favoured impact funds often focus on smaller companies operating in developing countries, given these are areas of frequently acute needs. These investments can represent attractive growth opportunities – but by nature they can be volatile. For this reason, we recommend diversifying a portfolio between sustainably managed businesses and those targeting specific themes.
Through values-based investing, we look to align client portfolios with their core values and target the areas of social need they feel most passionately about. This typically involves avoiding controversial businesses, using active ownership to promote change, favouring companies with strong environmental, social and governance practices and investing in specific impact themes.
Case study: risk-tolerant investor looks to allocate £2.5 million to social impact investments
While sustainable investment is new to some of our clients, others have very clear ideas about the impact they are seeking to achieve with their wealth. Our experts are able to help develop portfolios that meet these highly individual requirements.
One of our clients is looking to allocate £2.5 million to social impact investments and is willing to accept a high level of risk. Our Sustainable Investment and Social Impact specialists developed a portfolio that satisfies their distinctive social and environmental goals.
Three quarters of the portfolio will be invested in funds which in turn own listed equities that have "social impact" at their core – for example, social housing providers. The remaining quarter of the portfolio will be allocated to unlisted investments. This includes lending money to social enterprises and charities by investing in bonds.
The return on these social impact bonds is linked to the success of the projects, and we have agreed to provide the client with impact reporting covering each of the underlying investments.