Designing the Charity’s Portfolio

Every charity is different and will have its own risk tolerances and expectations of return. So, as wealth managers we design portfolios for each charity as a unique entity. Each charity will almost certainly have several financial goals and each one needs to be analysed before it can be integrated within the overall investment strategy. We have a simple process to do that, revolving around the four dimensions of investment:

• TIME: What is the time frame over which the charity is investing – when is the charity likely to need some or all of the capital from the portfolio?

• RISK: To what extent are you prepared to see the returns fluctuate in the short term? What probability do you want to attach to meeting the charity’s long term goal?

• RETURN: What return, from both income and capital growth, do you expect over the charity’s chosen time frame? How much money will the charity need at a date in the future?

• TAX: What allowances and reliefs can the charity take advantage of to enhance its returns?

These questions form the first part of the investment process – setting objectives – and need to be answered in terms that can be measured if they are to have any value. We approach each part of the process in a similarly objective manner. As a result, you can be confident you have identified the right strategy for the charity’s circumstances and that our investment decisions are based on reason rather than on the latest fashion.


The Right Mix of Investments
To achieve the right mix of investments you need to:

• Understand the risk and return characteristics of different asset classes
• Know how and when to use diversification
Correctly align the charity’s tolerance for risk with its return profile

Building Blocks
There are two core asset classes that can be used to create a portfolio: fixed-interest securities (bonds) and equities. There are also alternatives to fixed interest and equities, as shown in the table below. We can add these alternatives to your portfolio to increase diversification and potentially smooth the pattern of the returns over the longer term. Each asset class has a different risk and return characteristic. By blending asset classes together we can create a profile that suits your charity’s needs.

More information on these types of funds can be found in our glossary

Each asset class has a different absolute level of expected risk and return. In addition, each asset class responds differently to economic and political events so each will have a different pattern of returns over time. By combining two or more classes together, this can significantly reduce the short term volatility of returns on the overall portfolio. Diversification across different asset classes can thus raise the level of return you can expect for any given level of risk.

Our goal is to ensure that you have a degree of diversification that is commensurate with your charity’s tolerance for risk and provides as much protection as possible against the uncertainties of the financial markets.


Aligning Risk and Return
By modelling the past performance of different combinations of assets, we can quantify returns over various time periods so that you can understand the risk and return potential of different portfolios.

The table below shows historical worst-case returns, for varying time periods, as a measure of risk. We believe a useful measure of the potential return on an asset class is the average total return (income and capital) above inflation that has prevailed in the past. Whilst past returns are no guarantee of future returns, these measures can assist you to form an opinion as to the mix of asset classes that is likely to suit the charity’s needs. By reading across the table, you can easily align your risk tolerance with your return expectation.

This analysis is based on facts and contrasts with the typical approach of describing risk as simply ‘low, medium or high’ and returns as ‘income, balanced or growth’.

1608 Risk Return

1608 Risk Return Key

The returns in the chart above are total return, gross of fees.

Worst Case: Thomson Financial Datastream 1983-2016. Real returns: Barclays Capital.
Equity-Gilt Study 1950-2016.

Alternative Investments Can Reduce Risk
We can overlay the alternative asset class on to this mix of bonds and equities to increase diversification further. Adding commercial property, hedge funds and commodities to a portfolio has reduced the volatility of returns over the past 30 years, whilst leaving total return more or less unchanged over this time period.

Since we can’t foresee the future, we can’t know what the best asset allocation will be. However, by incorporating a variety of asset classes that perform differently in any given economic environment, we can construct an allocation that should do reasonably well under a wide range of circumstances.

The risk reduction benefit of alternative investments is most pronounced in portfolios with a higher proportion of more volatile assets, such as equities.

The benefits of alternatives

1608 Alternatives

1608 Alternatives RW

Probability of Achieving Your Charity’s Return Objective
The purpose of investing should be to achieve some goal. That might be to cover short-term emergencies or to provide for longer-term liabilities. We can help your establish the likely return, after inflation, that your charity needs from its investments and make sure this is properly aligned with the charity’s tolerance for losses.

However, the returns shown above are long-term average returns so there is no certainty these average returns will actually be achieved. We therefore show you what the probability is of your charity achieving its goal, as the chart below demonstrates. By monitoring the actual return, we can then help you keep track of the charity’s chances of meeting its final goal and adjust the investment strategy as necessary.

Regular Income
Income is generated from interest on the bonds and / or dividends on the equities. We can pay this on a regular basis. If your charity requires more income than the portfolio provides, we can arrange for capital to be released to supplement the income. Alternatively, you can select a different mix of assets that provides a higher income, although this will change the risk and long term return profile of the portfolio. Either way we will explain the implications and help you to decide on the strategy that best suits your charity’s needs.