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CHARITY INVESTMENT ANNUAL 2017

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Page 1: CHARITY INVESTMENT ANNUAL 2017 · portfolio theory was gaining recognition. Robb Caledon was a shipbuilding company based in Dundee. Although effectively bankrupt, there was a nationalisation

CHARITY INVESTMENT ANNUAL 2017

Page 2: CHARITY INVESTMENT ANNUAL 2017 · portfolio theory was gaining recognition. Robb Caledon was a shipbuilding company based in Dundee. Although effectively bankrupt, there was a nationalisation
Page 3: CHARITY INVESTMENT ANNUAL 2017 · portfolio theory was gaining recognition. Robb Caledon was a shipbuilding company based in Dundee. Although effectively bankrupt, there was a nationalisation

Welcome

Professor John Kay Economist and Author

Huw van Steenis Global Head of Strategy Schroders

Alex Baily Portfolio Director Cazenove Charities

In this annual we pull together a collection of interesting articles that we believe are useful reading for long-term charity investors. We capture some of the current talking points and cover updates in regulatory and investment thinking that may be relevant to the management of your charitable assets.

Giles Neville Head of Charities

ContentsINVESTMENT THOUGHTS

Charity Investment Lecture 2016 2 Professor John Kay

5 things I learnt at Davos 5 Huw van Steenis, Global Head

of Strategy, Schroders

Active versus passive investing: the decision is not binary 8 Alex Baily, Portfolio Director,

Cazenove Charities

Investing sustainably: 5 myths debunked 12 Schroders, ESG

The foundations of investing  for tomorrow, today 14 Kate Rogers, Head of Policy,

Cazenove Charities

SECTOR THOUGHTS

Foundations and Society: Sliding Panels 16 Rien Van Gendt, Fonds 1818

UK Civil Society Almanac 20

Foundation Giving Trends 21

REGULATORY THOUGHTS

Common Reporting Standard: is your charity affected? 22

Charity Authorised Investment Funds 23

What you need to know about MiFID II 24

CONTRIBUTORS

Kate Rogers Head of Policy Cazenove Charities

Rien Van Gendt Fonds 1818

Tom Graves Head of Regulatory Change Cazenove Capital

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Charity Investment Lecture 2016

INVESTMENT THOUGHTS

In May 2016, the Royal Institution hosted the third annual Cazenove Charities investment lecture. We were delighted to welcome Professor John Kay, the renowned economist, author and regular contributor to the Financial Times. 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 Kay is fortunate to have three different perspectives to draw experience from; as an influential academic; an individual 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.

So how did defining risk as volatility become part of conventional wisdom? The answer lies with the evolution of portfolio management theory. Economist Harry Markowitz introduced ‘modern portfolio theory’ in a 1952 essay, for which he was later awarded a Nobel Prize in economics. His theory described

how, by combining assets, it was possible to benefit from diversification and get a better risk-adjusted return. In this authoritative work, risk was described mathematically as the volatility of the portfolio value. This model forms the basis of much of the current advice given to endowments. It is also the origin of the derivatives and asset backed securities markets; with the boom that followed their introduction eventually leading to the credit crisis; and the value at risk metrics that spectacularly failed the banks in 2007.

John’s first personal experience in share ownership came in the 1970s around the same time that the model portfolio theory was gaining recognition. Robb Caledon was a shipbuilding company based in Dundee. Although effectively bankrupt, there was a nationalisation bill going through Parliament which, if passed, would value the shares at £1. If the bill failed the shares would have been worth nothing. Applying his academic training to the dilemma, he estimated that the probability of success was 70%, suggesting a risk-adjusted fair value of the shares at that moment of 70p. John bought the shares at 40p each. He had followed the process of appraising risk; by defining the possible outcomes, attaching probabilities to each outcome and making a rational decision based on this information.

However, there was an additional reason that could have influenced John’s decision. If he had been fortunate enough to have other investments, the Robb Caledon shares could be held as a hedge, behaving differently

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CHARITY INVESTMENT LECTURE 2016

to the rest of the market. If the bill were to fail, then the current Labour government was likely to lose power to the more business friendly Conservative government. Robb Caledon shares would be worthless, but the market would likely rise. In the opposite scenario Robb Caledon shares would create value, when the rest of the market was falling. This demonstrates a valuable lesson, that risk should be looked at in the context of the portfolio as a whole. Although a single holding in Robb Caledon might be described as risky, owning these shares as part of a portfolio actually lowered the risk.

It turns out that the bill was passed (by a majority of one vote) and John’s first share ownership exploit was a happy introduction to the world of investment. But the theory that he had tested turned out to have a more limited application than he believed at the time. Models don’t relate very well to the real world, as they tend to be based on history rather than applied current knowledge or business sense.

There are many examples where models are of limited real life use. These included a Professor of Decision Science, who was unable to make an important investment decision because ‘this is serious’; or Markovitz himself investing his own investment portfolio.

“I should have computed the historical co-variances of the asset classes and drawn an efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.” Harry Markowitz, quoted by Jason Zweig, Your Money and Your Brain.

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 not achieving a sufficient return over the long term to meet the charitable purposes. 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.

For endowments looking for long-term returns above inflation, the key dilemma becomes focused on 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 short term volatility. So how to allocate? Using probabilities, and some of the conventional assumptions of asset allocation models, there is an approximate probability of 60% that real assets outperform safe assets over one year (or 40% that they don’t). 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 comes from unexpected events. As the Goldman Sachs banker David Viniar remarked in 2007, “we were seeing things that were 25-standard deviation events, several days in a row”. But that is not what actually happened. When flipping a coin, 100 heads in a row is an equivalent statistical

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anomaly, or perhaps it would be more accurately explained by something that wasn’t factored into the original equation.

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.

As a final example of how differing perspectives of risk can lead to opposite investment decisions, John talked about an office block in Washington State considered for the St John’s College endowment. The location of this office block is within the Cascadia subduction zone, an area at risk of infrequent but large tectonic activity with serious consequences. Evidence of the last earthquake in this region has been gathered from native American legend, which speaks of a quarrel between the land and sea dating from roughly the same time that a tsunami hit the coast of Japan in 1700. The average time between these tectonic events is 500 years, suggesting that another earthquake is likely in the next 200 years. Despite this, there are many companies that have chosen Washington State as their headquarters. This is perhaps explained by the statistics. The probability of tectonic activity occurring in one twenty-year period is just 4%. But over twenty-five, twenty-year periods the likelihood is much higher at 64%. Investors with shorter, 20 year time horizons, appraise the risk as low. The College with a time horizon stretching to many centuries gave consideration as to whether the risk was too high. 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. Relative outperformance is not an advantage if markets are falling. More important is long-term returns over inflation.

2 Concentrate in real assets. Viewing risk as volatility confuses certainty with security. This creates a bias in investment portfolios away from real assets, seeking to dampen volatility, but underemphasising the best investments for the long term.

3 Mind your portfolio risk. Don’t avoid risky investments, but build a diversified portfolio – both between and within wide asset class definitions.

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. Fees are the reason that there are no hedge funds in the St John’s endowment.

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.

Having set out to show how there are serious mistakes in describing risk in endowment management, John challenged us to take a long term approach unbiased by volatility. For us, as managers of charity investments, his thesis underlines the importance of understanding the individual circumstances of each charity client. Without that knowledge we are less likely to meet your objectives, or consider the right risks in appraising investment opportunities for you. Building up long term relationships and a close understanding of the organisation is key, and something we strive to achieve for all of our clients.

Professor John Kay CBE

John Kay is one of Britain’s leading economists. He is a distinguished academic, a successful businessman, an adviser to companies and governments around the world, and an acclaimed financial columnist. His work has been mostly concerned with the application of economics to the analysis of changes in industrial structure and the competitive advantage of individual firms. His interests encompass both business strategy and public policy. More recently he chaired the government’s Review of UK Equity Markets and Long-Term Decision-Making, and essential part of the post-crisis review of banking. Now a writer, lecturer and broadcaster, John contributes a weekly column to the Financial Times. He is the author of several books including Foundations of Corporate Success, The Business of Economics, The Truth about Markets, Everlasting Light Bulbs and The Hare & The Tortoise.

INVESTMENT THOUGHTS

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5 things I learned at Davos

Populism, automation, regime changes, future forecasting and long-term investing – Huw van Steenis, Global Head of Strategy, shares his perspectives from the 2017 World Economic Forum meeting

The mood at Davos was the most divergent in years. Some American bosses were notably bullish about accelerating economic growth and a regime change in fiscal, regulatory and trade policies. Others, particularly some European policy makers, were markedly downbeat. But whoever you spoke with, the intense political and economic challenges from populism, globalisation, disruptive technology, the migration crisis and inequality dominated debates. While consensus was less confident on how to navigate the risks, it likely acts as a catalyst to drive change.

Conversation was dominated not only by who was there, but by who was not. President Trump was the dark matter of Davos. Dark matter is not well understood but occupies 95% of the universe and has huge gravitational pull. The implications of Trump’s presidency reverberated around Davos.

5 THINGS I LEARNED AT DAVOS

1 Automation and jobs

I sense a step change in the perceived level of threat to jobs from automation and the fourth

industrial revolution. Consultancy McKinsey shared new research suggesting 86% of manufacturing job losses in US between 1997 and 2007 were a result of rising productivity, 14% because of trade. What’s more some 1.1 billion workers and $15.8 trillion in wages are associated with activities technically automatable today.

Take finance where bankers and insurance bosses who I spoke with are in earnest responding to low growth and low returns with concrete plans for greater efficiency. This year’s “Disruptive Innovation in Financial Services” roundtable was telling – as it had moved on from prior years’ future scoping of blockchain and digital identity to a practical session swapping notes on how best to automate and manage partnerships with tech

5

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companies. One forecast from the session was telling: regulatory technology or “regtech” may drive a 50,000 fall in compliance jobs. At Davos I took a straw poll of executives at financial institutions and a range of other professional services firms I met which suggested they are looking to automate 10-30% of activities in the coming three to five years.

The implications for white collar employment and lifelong learning are huge. But tech leaders, such as Google, Facebook, were far more upbeat about the enduring ability of entrepreneurs to create new jobs which we haven’t even thought of.

2 Populism

The impact of populism was the number one concern. How it manifests itself in the coming

years is likely to be one of the most important drivers of markets. But I was struck by the lack of consensus about the causes of the politics of anger, let alone the consequences. The stagnation in real incomes and multiple challenges to economic and national identity are complex to solve. It was striking that China’s President Xi gave the strongest defence of globalisation which has pulled millions out of poverty. So what does this mean for investing?

I suspect investing in Western markets is becoming more like investing in emerging markets – where a keen understanding of country risk and the political economy is important. Emerging markets also teach us populism is often inflationary.

Second, we need to invest through heightened uncertainty. The risk of tit-for-tat trade disputes was uppermost in many politicians’ and executives’ minds. There were understandably mixed views on Britain’s ability to forge trade links which are stronger than today.

But it’s not just about trade policy: the benefits of globalisation of financial markets continue to be reappraised. I came away thinking that the Balkanisation of banking markets will grow as countries put up financial walls. Whilst a more compartmentalised banking system can help seal off shocks, it likely to be negative for growth unless markets can fill the gap. The banking crisis taught us Europe sorely need more diverse funding markets for corporates and infrastructure, but my meetings made clear Capital Markets Union, a European Commission plan to mobilise and channel capital, is on hold until Brexit is resolved.

3Regime change

What does the regime change in policies mean for central banks and asset prices? The issue

was debated vigorously. While most agreed the reflation trade, particularly in the US, is the most important inflection for asset prices in years – and probably the end of the 30-year bull market in bonds – there was little consensus on how smooth the transition will be. Given that we reached the practical limits of monetary policy in 2016, with the dangerous experiments in negative rates, it is little wonder that investors are optimistic about inflections in fiscal, regulatory and trade policy. The impact on asset prices, market liquidity, emerging market (EM) economies and EM capital flows was uppermost among the concerns of central bankers, bankers and investors. While conclusions varied widely on the scale of regime change, a few themes emerged.

I found support for my view that as central banks reel in quantitative easing (QE), cross-asset correlations should fall dramatically. Wider distribution of outcomes and more divergence of assets, sectors and securities performance could also be positive for insightful active investors.

Next, we should be thoughtful about assets which have been buoyed up by QE, especially if US rates were to rise more quickly if the stimuli prove more inflationary. Whilst markets have become accustomed to dovish central banks and “lower for longer”, exiting the extraor-dinary monetary experiment is far from clear and likely to drive far larger re-pricing and rotations. In the corridors, the debate about peripheral European sovereign bonds was uppermost. Fiscal policy has been largely dormant in the eurozone and whilst monetary policy can ease the burden, it is not enough to resolve structural problems. As a result, financiers feel the most likely outcome is for the European Central Bank to be dovish and taper slowly and we could still be stuck with negative rates until 2019. But the re-pricing of US 10-year bonds may limit their ability to do this. On the positive side, a recent increase in German inflation and increasing global growth could lead to a much faster re-appraisal of  European rates.

My meetings with policymakers and bankers also suggested a change in the approach to bank regulation as European policy makers become aware of how constrictive the Basel IV bank regulation process could be to European growth. Peak regulatory uncertainty, however, is likely behind us.

INVESTMENT THOUGHTS

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4Long-term investing

The need to secure long term investments through the fog of heightened uncertainty has

shot up the agenda. One of the most interesting roundtables I joined was the meeting of “Focusing Capital on the Long Term” at Davos which brought together asset owners, investors and CEOs on how to promote more long-termism in investing. New draft research for the meeting suggested that long-termism could have added five million more jobs in the US and created $1 trillion of additional value. But uncertainty risks driving business decisions to be more short-term. Sir Martin Sorrell, Chairman of WPP, and Kevin Ellis, Chairman of PwC UK, debated this further on the BBC the day after (link below). For instance, in five of the last six quarters S&P 500 companies paid out all their earnings in dividends and share buybacks, rather than materially increase investment.

Practical and policy steps can be taken to reduce excessive short-termism, but two broader tensions in long-term investing kept coming up over the week. For the more bearish institutions, it was an underlying nervousness about what is the right risk premium one should place on a 10 to 30-year project given the heightened political and economic uncertainties? This was most acute in Europe and I had the opportunity to debate with the British Chancellor how best to help companies and investors look through what he called the “Brexit fog”. For the more optimistic investor, the concern was rather that as the global economy recovers and inflation increases there may be a far bigger re-pricing of interest rates, and so wanted to hold on for higher returns. But what bodes well for economies is the huge focus on companies capitalising on long-term themes – particularly tech and healthcare – and a far greater focus on the social impact of their investments.

5 Forecasting

How to improve forecasting – in a series of workshops – was the surprise success of

Davos 17. At a time when the value of forecasting and opinion polling is under serious question, it was uplifting to have such an insightful series. This involved recognising and adjusting for biases, reducing group think and echo chamber effects, incorporating a wider range of novel data insights, and simply learning from errors. It reinforced by contention that central

banks made errors in part by assuming a frictionless economy free from credit booms and busts and ignoring banks and financial multipliers. Their models were, by construction, fair weather models and when the crisis hit they had no useful framework to turn to, and so had to turn to financial history. While some progress has been made, I am struck that one of the biggest policy mistakes of 2016 was negative interest rates, signalling that there is still plenty to do.

One of the speakers suggested that the problems in social sciences have come from over-emphasis on the advancement of complex theories rather than a focus on solving practical problems. As an investor, this chimed with me. Harnessing data insights to solve investing problems is critical to maintaining an investing edge. As we agreed: “no man or woman can beat a machine, but no machine can beat a person with a machine.”

Finally…

One can never do justice to the richness and breadth of the extraordinary debates and conversations in a postcard. I find the annual meeting of the World Economic Forum at Davos provides a good opportunity for an exchange of views on macro and micro issues. It deepens my understanding of the views that are embedded in asset markets and what’s on the minds of policymakers, investors, tech entrepreneurs, financiers and industrialists.

Huw van Steenis

Huw van Steenis is the Global Head of Strategy at Schroders and is responsible for helping Schroders develop and implement long-term goals and respond to the competitive financial services landscape. He joined Schroders in 2016 leaving his role at Morgan Stanley, where he was widely regarded as the top banking analyst.

5 THINGS I LEARNED AT DAVOS

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Active versus passive investing:

the decision is not binaryAlex Baily, Portfolio Director, Cazenove Charities

The passive market has grown exponentially over the past decade and in recent years, many investment columns have been devoted to the so-called ‘active versus passive’ debate.

Those in favour of actively-managed funds highlight that fund managers can take advantage of investment opportunities as they arise, in addition to those created by market volatility. In contrast, they claim passive funds have little flexibility to ‘swim against the tide’ and therefore guarantee underperformance (after fees).

The passive cohort, however, highlight the reams of academic studies that show a large portion of active managers underperform the market and there is the perennial question of fees.

In our opinion, it is not about choosing one side over the other. We believe the active versus passive debate is outdated because it is not a binary decision to invest in an actively managed fund over a tracker fund, or vice versa. For us, it is simply about selecting the most appropriate investment vehicle that will achieve the best outcome for our clients.

Initially, we make an asset allocation decision such as increasing exposure to a specific part of the market because it looks attractive. We then assess both the active and passive opportunities and carefully analyse the most suitable one for the client depending on their risk profile and objectives.

Finding the right tracker

Making a decision to simply ‘buy the market’ via an Index Tracker Fund or an Exchange Traded Fund (ETF) is not as simple as you might expect.

Like actively-managed funds, passive funds have their intricacies so it is important to look under the bonnet to ensure you understand what you are buying. Here are a few pointers to help with the process:

Fund or ETF?

In a particular quarter or year, passives will not completely replicate the performance of an index. This is down to the fact that they have different costs and structures, and are priced at different times of the day, so you can expect some degree of performance drift. An ETF is a listed security that can be traded through the day. In contrast, an index tracker is a mutual fund that is priced once a day, normally at noon. Fees can differ amongst providers.

What is being tracked?

When investing in a collection of markets, it is important to understand how the different exposures break down and be able to identify what is actually being tracked. This is especially true for emerging markets and Asia focused ETFs or index trackers, offering exposure to broad regions. The breakdown of how much is allocated to each country can vary from product to product, so it is important to make sure that the underlying exposures are appropriate and acceptable. In addition,

INVESTMENT THOUGHTS

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it is worthwhile confirming how often the portfolio is rebalanced to ensure that it does not drift too far away from the index.

Tracking bond markets passively can also prove challenging. If the aim is simply to track a bond index via a mainstream market cap-weighted product, the highest allocations will be to those countries and companies with the greatest amount of debt issuance. This may not necessarily be a sensible decision. In the high yield asset class the performance of the passive offerings has diverged significantly from the index at times.

How does it work?

It is important to distinguish whether a fund or ETF is physically backed by the underlying index it is tracking, or replicates the index using ‘synthetics’:

1 If it takes the physical route it means the fund buys all (or most) of the underlying shares in the index.

2 Synthetic replication works completely differently in so far as you are effectively buying a contract with a third party, normally an investment bank, to provide you with the same return offered by the index. The third party does not need to hold all of the shares within the index, but they should hold some collateral. This can be in the form of shares, although these may not necessarily be in line with the index you are seeking to track. It is important to monitor what shares are held.

Passive funds are a useful addition to our range of building blocks, and we often use them in Charity portfolios, as a way to get cheap exposure to a market. These funds sit alongside our favoured actively managed funds and we use the best of both approaches to construct the most appropriate portfolios for our charity clients.

Alex Baily

Alex is a Portfolio Director at Cazenove Charities, with 18 years’ investment experience managing portfolios for a wide range of charity clients.

Connect with Alex LinkedIn https://www.linkedin.com/in/alex-baily-396b0162/E [email protected]

ACTIVE VERSUS PASSIVE INVESTING

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5 Investing sustainably:

myths debunked Sustainable investing is growing in popularity, but many misconceptions remain Schroders, ESG

1 Sustainable investing is just avoiding “sin stocks”

The phrase “sin stocks” emerged to describe firms linked to industries perceived by some to be unethical, such as tobacco, alcohol or gambling.

Such funds will exclude these stocks, or screen them out. But each investor has views on what is and isn’t ethical, as the results of the Schroders Global Investor Study, published recently, demonstrates. See the full results on our website.

Rather than merely screening out certain stocks, sustainable investing is about closely evaluating a range of environmental, social and governance issues, known as ESG. This could be analysing a company’s track record on pollution from its factories, or how socially responsible it is in the communities it operates.

On corporate governance issues, it is a matter of judging how well the interests of shareholders, customers and staff are managed.

Put simply, well managed companies that care about the sustainability of the world in which they operate should have a better long-term future.

Sustainable investment is really about integrating ESG considerations into the investment decision-making process, with a view to enhancing returns.

2Returns will be hit if you invest sustainably

Isn’t there a cost to investing with a sustainably? There is mounting evidence to the contrary.

Studies by Friede, Busch & Bassen (2015) and Morgan Stanley to name but two, found that companies focused on ESG had, on average, enhanced financial performance.

A study by Empirical Research, which has been evaluating and monitoring 60 ESG factors since November 2014 for US stocks, found that those companies with better ESG scores outperformed those with lower.

By examining ESG issues investors gain a better understanding of not just what companies do but how they do it.

ESG analysis puts companies into a wider global context, and helps to identify which ones have the most resilient models.

Investors can choose investments based on moral beliefs and personal values, but that would be ethical investing rather than sustainable investing.

INVESTMENT THOUGHTS

ESG: Environmental, Social and Governance.

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3It’s all about Green Investment

It would be easy to assume that the “E” of ESG dominates the other two. Most of the thematic

investment funds focus on environmental issues, from water shortage to new environmental technologies.

And environmental issues, especially in the wake of the COP 21 Climate Change talks in Paris last year are high up on investors’ minds. However, social and governance issues are of increasing importance.

Rising inequality and strapped governments has led to the introduction of Living Wages in a number of regions, putting pressure on costs.

Changing consumer tastes and new regulation has seen the introduction of sugar taxes and ongoing declines in sugary drink consumptions. CEO pay and boards are rarely out of the headlines.

Successful ESG investment processes take a holistic look at the changing world companies have to navigate, and assess the performance of their investment across a number of factors.

They engage where performance is lacking, pushing companies to improve their performance in ESG factors across the board accepting the need for continual improvement in these areas.

4It only works in the most developed markets

The bulk of ESG data that we have is disclosed by large companies operating in developed markets.

This does not mean that ESG considerations are not pressing for those in emerging markets.

A 2013 report by UBS, analysing the World Economic Forum (WEF) Corporate Governance Index and emerging market equities valuations, concluded that companies that score well on governance are valued more highly and have lower volatility.

Evaluating how companies manage stakeholders, and environmental and social change, is relevant whatever the market. With emerging markets, it may just take more digging.

5It only works for stocks

We tend to think mostly about equities, but it doesn’t end there. With bonds, for instance,

ESG analysis helps identify risks to a borrower’s ability and willingness to repay debts.

Put simply, a well managed company should be less likely to stumble into value-destroying disasters and be better positioned to repay investors who lend them money.

Conclusion

Investments do not operate in a vacuum; global industries face social, economic, environmental and industrial changes on a larger scale and faster pace than ever before.

The gap between the values of companies on the right or wrong sides of those trends may grow ever-wider as a result. By investing in sustainable businesses, investors may increase their chances of success.

Sustainable investing at Cazenove Charities

Our world is changing faster than ever, creating challenges and opportunities for investors. That’s why we seek to put responsible investing at the heart of all we do. From choosing the right assets to engaging with our investments, positive principles guide our actions.

5 MYTHS DEBUNKED

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Kate Rogers, Head of Policy, Cazenove Charities

Recently published research from the Donors and Foundations Networks in Europe suggests that there are almost 150,000 registered ‘public benefit’ Foundations in Europe. These Foundations have a combined annual expenditure of nearly Eur 60 billion, with 90% of this expenditure accounted for by Foundations in Italy, Spain, France, Netherlands, United Kingdom and Switzerland. The same report puts the total assets of these Foundations at over Eur 500 billion. In the UK, the top 300 grant-making Foundations have some £52 billion of assets1 with their investments representing over two thirds of UK charity investor assets according to the most recent NCVO Almanac.

Although definitions, laws and regulations vary across Europe, many of these Foundations share a common aim, to maximise their public benefit. They do this in two main ways, by spending on their projects today, or by investing for the future. In both cases Foundations are seeking to use the assets at their disposal to further their philanthropic purpose.

Finding the right balance

This raises two simple sounding questions for Foundation investors. What are the assets? And how can they be used to further the purpose through investment? The most obvious is the financial asset, but that is not the sole asset at a Foundation’s disposal. Foundations can also use their reputations to effect change by challenging the companies that they invest in to meet the highest corporate responsibility standards. They can use their people to find interesting and specific new investment possibilities, and they can use their long-term time horizon to take advantage of short-term opportunities.

The foundations of investing for tomorrow, today

1 ACF Giving Trends 2015

Trustees

Stable spending

Volatile returns

Maximisingdistributions

for today

Preserving capital for

futuregenerations

INVESTMENT THOUGHTS

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2 See http://www.acf.org.uk/policy-practice/research-publications/intentional-investing

THE FOUNDATIONS OF INVESTING FOR TOMORROW, TODAY

For the financial assets, investing to gain the maximum philanthropic benefit can be done through targeting a traditional financial return, to support spending; or through directly investing to bring about a desired social impact (social or impact investing). Increasingly Foundations throughout Europe are using a blended approach, considering both the financial and social return of any given investment choice, most frequently using responsible investment to reflect the aims and values of the Foundation in the investment strategy2.

Many Foundations are established to be intergenerational, as social problems persist from one generation to the next. One way this sense of being tied to future generations of beneficiaries has been expressed in the context of investment is through what has come to be known as a desire to achieve ‘intergenerational equity’. This isn’t a legal formula, but it is an influential idea first articulated in 1974 by James Tobin, the former Professor of Economics at Yale, in an article on endowment management.

Tobin said, ‘the trustees of endowed institutions are the guardians of the future against the claims of the present. Their task in managing the endowment is to preserve equity among generations’.

This places trustees in a difficult position, attempting to find the right balance between spending today, and saving for the future, whilst also hoping to translate a volatile return pattern into stable year on year expenditure.

Foundation investment strategies are designed to meet these challenges. Frequently Foundations aim to maintain at least the value of the investment portfolio in line with inflation; whilst also maximising the spending that they are able to support today. This translates into a long-term financial objective of inflation plus spending. Much research, including my own in partnership with Richard Jenkins, has examined how to find the ‘right’ balance of spending and saving, with history suggesting sustainable spending rates of 4% per annum.

However, today’s investment environment provides problems for Foundations seeking these real returns (adjusted for inflation). With interest rates at historic low levels and diminutive, even negative, bond yields; investors are being forced to take more risk than ever before in order to achieve their target returns. Over the last three decades the capital volatility of a portfolio that achieved inflation plus 4% has increased by over four times.

Asset allocation of an inflation plus 4% portfolio

Source: Cazenove Capital. Datastream. Total return in GBP over 10 years, Inflation rate UK RPI; Global equities, MSCI World (NR); Gilts, FTA Govt All Stocks; Cash LIBOR. Risk measured by standard deviation of returns.

Lower returns also promote a focus on costs, and ensuring that the fees paid to investment advisors are compensated for by the value that they add, over and above other passive investment approaches. This is a focus for us, as charity investment managers, so that our clients can effectively demonstrate the benefit that they gain for the cost.

1986-1995 1996-2005 2006-2015

Real return 4%Risk 4%

Real return 4%Risk 9%

Real return 4%Risk 17%

100%Cash

20%Cash

40%Gilts

40%Global

Equities

100%Global

Equities

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As we turn our backs on 2016, and look forward to 2017 we can reflect on a year that brought us two political earthquakes in the form of Brexit and Trump, but good investment returns for long-term charity investors. Unfortunately, the political uncertainty is far from over. For the UK economy and sterling, the Brexit negotiations will be a key determinant of sentiment and direction. For global markets, the implications of a Trump presidency will be closely analysed. Initial expectations that his policies are likely to be pro-business have supported the US equity market and dollar, raising short term US growth and inflation forecasts. His position on international trade is less clear, with the protectionist campaign rhetoric leading to concerns for markets exporting goods to the US. The anti-establishment theme could spread from the UK and US to provide Europe with some political shocks, with elections scheduled in the Netherlands, France and Germany in 2017.

What does this mean for our investments? The change in inflation expectations, accelerated by the US election result, is likely to have marked an important turning point for bond markets, with yields now adjusting upwards and prices falling. Inflation is not good news for Foundations holding on to cash, or for bond markets, so I’d avoid having too much exposure to conventional bonds in portfolios and take opportunities to invest excess cash. There is an unusually wide range of economic forecasts for the next few years, reflecting ongoing political and economic uncertainties and underlining the need for diversification. I expect this uncertainty to trigger volatility in equity markets, and would favour active management to take advantage of opportunities that any potential oscillations throw up.

Foundations are well placed to rise to these challenges. They benefit from a long-term time horizon; so unlike other institutional investors, corporates or individuals, Foundations are able to look through short-term capital volatility, accepting this as a necessary trade-off for long term inflation protection.

Successful investment strategies consciously tie the investment objective to the aims of the Foundation. For those seeking intergenerational equity, a long-term financial objective of inflation plus a spending rate could

be appropriate. For Foundations seeking to achieve their aims more directly through their investment assets, the strategy may encompass responsible or social investment. The ‘right’ strategy will undoubtedly be specific to each Foundation, but sharing the common challenges and opportunities only serves to enhance our collective investment intelligence and hopefully our future philanthropic performance.

Kate Rogers

Kate is Head of Policy at Cazenove Charities, focused on managing assets for Charities, Foundations and Endowments. Kate is responsible for sector engagement as well as co-managing a charity investment fund. She has sixteen years investment experience, is chair of the Charity Investors’ Group and has co-authored a number of Foundation investment research reports, published by the Association of Charitable Foundations.

Connect with Kate LinkedIn https://uk.linkedin.com/in/kate-rogers-0a705281 Twitter @katerogcharity E [email protected]

INVESTMENT THOUGHTS

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Rien Van Gendt Lecture 2016Foundations and Society:

Sliding PanelsAnd finally, foundations can influence debate. In short, apart from being organisations that provide funding, foundations can also serve as game changers in society.

To be more explicit, the development we are currently witnessing takes foundations away from the role of funding a swing in the local park, via funding the park as a social investment using public and private money, to funding the park as a meeting place for parents from different cultures, thereby contributing to social integration. It is a transition from charity to strategic philanthropy.

Factors that are increasing the importance of foundations

First, we have a government that is more inclined to take a back seat; it makes cuts in the hope that foundations will step in and make up the shortfall. This is a complex problem. Take Fonds 1818. The foundation obviously wants to uphold good relations with its municipality during the regular discussions it holds with the official and political authorities in The Hague, including with the Mayor. I have to admire Boudewijn de Blij (Executive Director

Rien Van Gendt is a phenomenon. We, at Fonds 1818, got to experience that closely. For nine years he was a member of our governing board. He played an important role as chair of our Investment Committee. He was responsible for shaping the diversification of our investment policy. Under his guidance the foundation started with socially responsible investments. Rien did not limit himself to “accounting” or “financing”. At Fonds 1818 he was committed with heart and soul to philanthropy, which, in the Netherlands is still not a very well-known concept. Like no other he argued for philanthropy’s value in society.

Rien left the Fonds 1818 Board at the end of 2015 as his tenure came to an end. The Board decided to offer him a biennial lecture – called the Rien Van Gendt lecture. This lecture will always address the societal value of philanthropy in its broadest sense. Naturally we invited Rien Van Gendt himself to kick off this series of lectures. I have always appreciated Rien’s contributions in our board meetings. I hope you will do so too.

SECTOR THOUGHTS

Changing role of foundations in society

In my presentation, I will examine the role and position of foundations in society, and the changes I have detected in this respect. I will concentrate on private foundations, which include many different types: family foundations, corporate foundations, lottery foundations and community foundations. I will not be looking at other manifestations of philanthropy, such as private donations or corporate social responsibility.

We usually equate foundations with grants, with donations. But nowadays, foundations are taking on another role, namely that of determining the content of public and political debate. This is about ‘agenda setting’. Foundations can also act as ‘convenors’, bringing together the various social parties considered relevant to solve a particular problem. Foundations can be ‘knowledge institutes’ with experiential knowledge. Foundations sometimes play the role of ‘advocate’ and can serve to challenge politics.

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of Fonds 1818) for his stance during these discussions: ‘If the municipality cuts its funding to an organisation because it assumes that Fonds 1818 will step in, we pull the plug on the partnership.’ Strong words, and with good reason: we are not here simply to subsidise local government budget cuts. But how does this work in practice? The municipality of The Hague decided to close a number of libraries; we had to decide whether to step in. Our initial reaction was: ‘no way’. But then we realised that it was not only libraries that would be closing, but also the youth clubs and community centres in the city. The municipality was actually closing meeting places at a time when we were trying to promote integration and mutual understanding. As it happens, this latter aspect is an important part of the mission of Fonds 1818. In this particular case, should we have stayed with our original position: we will not step in and make-up the shortfall left by government? Would it be true to say that we never fund anything that used to be funded by government? No, it wouldn’t. This shows the complexity of this matter and how easy it is to cling to the principle of ‘not filling the gaps left by the government’. Sometimes, we have to learn to step beyond our own ego. This is exactly what Boudewijn and the staff at Fonds 1818 (authorised by us, the Board) did. We took over the funding of the public library function, but we didn’t continue the traditional format. Instead, we did it on our terms. We deployed IT, not necessarily using qualified staff and not necessarily in the existing library buildings.

The increasing importance of private funding for public objectives, i.e. the importance of foundations, is also

evident in the fact that foundations are growing both in number and size. New types of foundations are joining the familiar family foundations and private foundations, among them corporate foundations and community foundations. All in all, foundations are becoming more visible. There is also heightened public, media and political interest in philanthropy. The growth and increased visibility of foundations is not only due to the more prominent role they have taken on, but also because they are contributing to a role that has itself become more significant. It’s a chicken and egg argument, but growth in the sector and the importance of the sector are certainly reinforcing each other.

The importance of foundations in the context of social development is also growing, due to the shift from donation to investment. These days, foundations are more willing to think not only in terms of donations, but also in terms of promoting development through loans, financial participation in social capital and guarantees, and being a partner in social investments. This gives the significance of foundations in society an extra dimension. The mission related investments of Fonds 1818 have undoubtedly contributed to boosting the role that this particular foundation plays within its own geographical area. In short, various factors are raising the profile of the foundations’ role in society. Society expects more of foundations, and foundations are keen to comply.

Before going into a number of factors that will always limit the role and significance of foundations (known as counterforces), I’d like to comment on the fact that regardless of whether the part played by funds is growing or

SECTOR THOUGHTS

shrinking, the nature of philanthropy has changed. The Bernard van Leer Foundation was founded by will after the death of Bernard van Leer. These days, most foundations are established during their founder’s lifetime. In fact as a result of this development, approximately half of the current endowed foundations in the Netherlands (in the region of 2,500) were established while the founder was still alive. The founders are therefore very much involved. They want to do more than provide funds; they also want to offer their expertise, their networks, and they want to be actively engaged. They’ve even come up with a term for it: ‘venture philanthropy’. It sometimes reminds me of The Emperor’s New Clothes, because I come across so many so-called traditional foundations, which are highly innovative without any sign of a living charismatic founder (example: Fonds 1818, Bernard van Leer Foundation). At the same time, I also see ‘venture

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philanthropy’ foundations that are run by founders who are still very much alive but keen to practise risk-avoidance. But I digress…

Let me return to my argument about the majority of foundations being established during the founder’s lifetime. Although I may be a slightly critical about making a distinction between traditional foundations and ‘venture philanthropy’, the fact that wealthy private individuals/entrepreneurs set up foundations has certainly contributed to the dynamics of the sector and its professional development.

Are there any disadvantages to this development? Yes. Let me mention two of them very briefly. The mentality of some entrepreneurs when it comes to solving social problems is: ‘we’ll fix it’. They have earned their wealth dynamically and now, in this new world of philanthropy, they are thinking in terms of exits, with all the dangers this entails. I’m told that venture capitalists always enter a room walking backwards so that they can see the exit before they go in. It doesn’t work like that in the world of philanthropy. Realising social change is a matter of organic development rather than ‘we’ll fix it’. A second point that warrants special attention is that of the new, up-and-coming foundations that operate on the international stage with absolutely no idea or experience of contextual differences. They do not seem to realise that you can’t simply transpose a solution or strategy from one country onto another; they have no concept of cultural sensitivity. Let me illustrate this point with an anecdote based on reality. There are huge differences between the Netherlands and Belgium in terms of cultural and national characteristics.

to replace government in this respect. This is not a role that we can, or more importantly, would want to play. What sort of country would this be if public goals were financed solely (or almost solely) by private funding, and donors were able to say what the money should be spent on and how? However, we do respect ‘donor intent’, the will of the person giving, and quite rightly so. One of the unique features of a government is that it is accountable to the public for what it does. Activities and initiatives are the result of democratic processes. The unique feature of a private foundation on the other hand, is that there are no democratic processes governing what it does. Private foundations specialise in using this lack of democratic accountability to their advantage. Foundations are able to fund controversial public objectives that your average man on the street would never support, but which definitely cater to the diversity of preferences among the population. Foundations can play the wildcard, be innovative, facilitate social experiments and take risks. We can adopt the role of ‘social venturing’, because there is an adequate government to take care of the rest. To my mind, we can only realise strategic philanthropy because we have a public sector, and because we are not too dominant. If the role of foundations were to become too prominent, we would be forced to introduce mechanisms that would destroy the very essence of why we do what we do. We would be forced to act like a government. The act of using private money for the public good would self-destruct; we would become victims of our own success, and find ourselves compelled to form a quasi-government. So all in all, it is better if the role of foundations

If you are not aware of these differences, you can go horribly wrong. The difference in management style between a Dutch and a Belgian foundation is a prime example. In the Netherlands, it is common for the director of a foundation to plan extra time into a decision-making process to consult staff before changing a strategy or making far-reaching organisational changes. The atmosphere is usually informal. This participational approach with the aim of reaching consensus about vital decisions is held in high esteem by staff working in Dutch organisations. In fact, some would say that the Dutch value consensus in the same way that people in other countries value sex. But a colleague working for a Belgian foundation once told me that asking staff to participate in making a vital decision simply does not work in Belgium. If a director in Belgium asks the staff for their opinion on a weighty problem, the reaction is usually: ‘Oh help, the boss is confused, he’s out of his depth, he doesn’t know which way to steer the organisation’. In fact Belgian staff might even say: ‘the future of the organisation is obviously at stake; we’d better start looking for another job’. That’s how important culture is.

Factors limiting the importance of foundations

First of all, the sector and the amount of money involved will always be relatively small compared with the government and the level of public funding. We must not get above ourselves or cherish a secret desire

“Realising social change is a matter of organic development rather than ‘we’ll fix it’.”

FOUNDATION AND SOCIETY: SLIDING PANELS

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remains reasonably limited. It is the only way to ensure that they can continue to support pluralism and focus on innovative, high-risk activities.

A second factor that limits our role is the fact that foundations do not provide structural funding to activities for general public benefit. Although I would like to see foundations funding projects for longer periods than they do at present (they tend to stick rigidly to a period of three or four years, mainly choosing sexy projects), and despite the fact that I would also like to see them funding the organisation behind the project (which usually means committing for a longer period), I do understand that we must continue to earmark money for innovative projects, from which we are free to withdraw. Thus, the role of foundations, however important it may be, will always be limited.

Another reason for the sliding panels and relatively limited role of foundations concerns the low-interest-bearing environment in which they operate. Expenditure levels of 3.5 to 4.5 percent of capital were par for the course until a few years ago, but this is no longer feasible. The Dutch Association of Foundations (FIN) regularly focuses attention on this important issue. To maintain their level of expenditure in a low-interest-bearing environment, foundations must either take more risks or, the more likely option, reduce their spending. This assumes that they want to be there in perpetuity (i.e. want to continue their operation on

activities on location, but also that foundations are at risk of self-censuring in order to remove the sting from their naturally critical attitude. But you would be wrong in thinking that the ‘shrinking space’ only exists in far-away countries (although I did mention Hungary). In the UK, for example, it recently became obvious that the Common Reporting Standard (CRS) of the OECD, which imposes strict administrative obligations on financial institutions, will also affect foundations. The UK tax administration (HMRC) considers foundations to be financial institutions. As a result, future recipients of donations made by foundations will be treated as account holders. The ‘shrinking space of civil society’ is evident in the Netherlands too, prompted not by government but by the banking sector. Compliance rules imposed by banks make it difficult for organisations focusing on human rights in the Middle-East, for example, or refugees from the Middle-East, to open or keep an account.

Importance of partnerships

If we combine the factors that serve to increase the importance

the basis of realistic spending power). But this is not necessarily the case; some foundations are considering the possibility of setting themselves a time horizon. But the most direct effect of a low interest-bearing environment is a drop in expenditure and as a result, in the importance of foundations.

And now we come to the final aspect that limits the role of foundations. This is known as the ‘shrinking space of civil society’. In recent years, many countries, from China and India to Israel, Turkey and Hungary, have been undergoing developments whereby the government tries to silence social organisations, including foundations. This is not only making it difficult for non-profit organisations to operate freely in those countries, but also for foreign foundations (such as Dutch foundations) to transfer money into these countries. The atmosphere is tense and private foundations are seen as potential criticasters of the government, something that is not tolerated. The restrictions imposed by these countries (by means of permits, compulsory registration and complex administrative procedures) do not only mean that there is less money available to fund worthwhile

“The most direct effect of a low interest-bearing environment is a drop in expenditure.”

SECTOR THOUGHTS

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of foundations with those that limit their importance, we arrive at the argument for creating partnerships, both between foundations themselves and between foundations and other social partners. Some partnerships evolve due to a reduction of money available for donations by foundations. This was the case after falls on the stock markets in 2008 and 2011. We also see foundations collaborating because they are taking on a challenge that would be impossible (or almost impossible) on their own. But in other cases, collaboration becomes necessary not because of a reduction of money available for donations, but because of too much money available for donations. Research currently being carried out in the USA is examining ways in which foundations can reserve more money by working together than they can by working individually. And guess what? The ‘Pledge’ made by Bill Gates and Warren Buffet (appealing to living American billionaires to invest at least half of their fortune in a foundation during their lifetime) has resulted in more than a hundred new foundations in the USA, each boasting capital of at least $1 billion. The USA imposes compulsory expenditure of 5 percent as a condition for the tax-free foundation status. This pressurises foundations into spending ($10 million per working day for the Gates Foundation). Against this background, the research is examining partnerships as an instrument for reserving large amounts of money every year as philanthropic donations to major present-day issues, such as climate, poverty and migration. However, I think that for now, it would be better if partnerships were to develop based

European foundations through the European Commission is a good example. In Italy, Berlusconi wanted to give the government a say in the running of private foundations. Mass protests vented through the European Commission forced Berlusconi to withdraw his proposal.

But the government is not the only party that must respect the independence of foundations; we too must ensure that our independence remains high on the agenda. Or as the Americans put it: ‘You are either at the table or on the menu’. This doesn’t mean that we can’t work with the government. On the contrary, this partnership can be very productive in areas where foundations aim to have an impact on the more complex issues affecting society. The activities of the Major Alliance I mentioned earlier are a good example. But foundations must also act as a thorn in the side of the government, a criticaster. This adds to pluralism in society. It means that we have to think carefully about when to work with the government and when to criticise. Independence is not just about taking a critical stance; it also involves a willingness to take risks in what we do and how we do it. We must be prepared to play the wildcard.

To keep pace with the sliding panels, we must ensure that our own accountability is a permanent item on our agenda.

Fonds 1818

Fonds 1818 is an endowed charity that supports socially relevant projects in the Netherlands, investing both money and knowledge. Find out more on their website http://www.fonds1818.nl/content/about

on the magnitude and/or complexity of certain social problems, rather than because of a surplus of money.

Partnerships do not only exist between foundations; they also exist between foundations and other social partners, such as companies and government. The Major Alliance is a great example of the willingness of foundations, government and the corporate sector in the Netherlands to join forces and work on complex problems, such as refugees and migration and providing a safe, healthy start for young children.

Despite changes in the world of foundations, certain essential features must be upheld

Philanthropy entails private money being spent on the public good so one of the essential features we must uphold is our independence. It goes without saying that this must be respected by the government. It would be truly devastating if the Dutch government – and it cannot be ruled out – were to abolish the tax deduction on gifts (to my mind an integral part of our civilisation), and replace this particular tax benefit for donating private money to public objectives for instance with a system whereby private donations are matched by government funding. At some point, the government would inevitably introduce conditions for providing these matching grants. The idea is reprehensible and strikes at the roots of civil society.

Fortunately, the philanthropic community in the Netherlands and Europe unites and swings into action if governments try to limit the independence of private foundations. The successful campaign mounted a few years ago by Italian and other

FOUNDATION AND SOCIETY: SLIDING PANELS

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162,965voluntary organisations

827,000paid workforce

66% female

34% male 62%

full time

38% part time

£12.2bncontribution to the UK economy

£19.4bntotal income from individuals

£15.0bntotal income from government

£41.7bn

total current spending

Fast facts:

UK Civil Society Almanac Cazenove Charities was delighted to sponsor the 15th edition of the NCVO Almanac. As the most comprehensive compendium of voluntary sector trends and statistics, the findings are an important reminder of the sector’s breadth and its impact on society.

In this edition, it is pleasing to see that an increasing number of people are employed in the voluntary sector and that its contribution to the UK economy has risen to around £12.2 billion per year. In a typical month, 27% of the population report that they volunteer and 44% of adults reportedly give money to charitable causes. These are impressive figures and we believe that the Almanac provides essential publicity in support of the sector.

Although investment represents only a relatively small part of the sector’s overall income, as the largest investment manager of charitable assets this is the area where we

can have most impact working with our clients. Investment income has remained stable over the past few years, despite lower returns from cash and government bonds.

SECTOR THOUGHTS

Source: NVCO UK Civial Society Almanac

This partially reflects a greater use of other investments by charities, but also some growth in the dividends paid by both UK and overseas companies.

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Foundation Giving TrendsKey facts and figures on giving, income and assets in the top 300 UK Independent Charitable Foundations

The Association of Charitable Foundations’ report,Giving Trends, shows that grant spending by the top 300 foundations in 2014/15 reached a record £2.7 billion, finally overtaking the £2.5 billion spent in 2008 before the credit crisis, although the level hasn’t yet recovered in real terms. Nonetheless, the overall trend over recent years is for foundation spending to grow, despite an underlying ‘bumpiness’ in their finances over the same period, with dramatic swings in the annual growth of voluntary income, and asset growth slowing with the economy, following two years of rising values. In sum, with grant spending growing more steadily than income, the results suggest the helpfulness of the ‘total return’ approach taken by some foundations, taking advantage of capital growth as well as investment income to support grants.

The value of the combined net assets of the Top 300, largely comprised of investments, reached a new high of £54 billion in 2014/15. Assets are concentrated, with a few large foundations controlling a large proportion of the sector ‘wealth’ (see diagram). Asset values have steadily grown over the last 5 years from £42 billion in 2010/2011. The report also provides analysis of 16,500 grants, to show where the money goes, and presents evidence that education and training receives the lion’s share of all grant-making, followed by health and arts and culture.

The role of family and corporate foundations are also highlighted as growing sources of income for the sector.

Wellcome Trust (Sept-15)

Children’s Investment Fund Foundation (Aug-14)

Garfield Weston Foundation (Apr-15)

Leverhulme Trust (Dec-14)

City Bridge Trust (Mar-15)

Henry Smith Charity (Dec-14)

Esmée Fairbairn Foundation (Dec-14)

Health Foundaton (Dec-14)

Wolfson Foundation (Apr-15)

Paul Hamlyn Foundation (Mar-15)

£million

Top 10 foundations by net assets

17,125.30

10,852.58

2,622.43

2,143.76

1,151.60

838.80

836.68

831.55

728.64

659.87

Source ACF, 2016

SECTOR THOUGHTS

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The definition of discretionary management does not

include investing in unit trust where the trustee retain the

decision making responsibility

THEN: Classified as an Investment EntityIF AND

>50% incomefrom investments

Investments managedon discretionary

basis for last 3 years

Charitable Trustor Unincorporated

• Due diligence required on grantees and settlors

• Reporting obligations for any grantee or settlor with tax residency in reportable jurisdiction

Charitable company or CIO

• Less affected

• Due diligence required on debt or equity interest holders

• Reporting obligations for any debt or equity interest holder with tax residency in reportable jurisdiction

Consider your due diligence and reporting obligations

Investment entities have due diligence and reporting obligations. They must identify their ‘account holders’, carry out due diligence on these account holders and fulfil their reporting obligations to HMRC.

For charitable trusts or unincorporated charities these account holders include all grantees and settlors. Due diligence requires tax residence data to be collected on all grantees and settlors, and to report any who are tax resident in a reportable jurisdiction to HMRC.

REGULATORY THOUGHTS

If your charity gets more than 50% of its income from investments then you may well be affected by the Common Reporting Standard (CRS), and have reporting obligations to HMRC (by 31st May 2017).

The Common Reporting Standard is the result of the drive by the G20 nations to develop a global standard for the automatic exchange of financial account information, aiding the tax authorities in participating jurisdictions that reduced tax evasion. Although it came into force at the beginning of last year, HMRC have only this week finalised the guidance for charities, after a long period of consultation with a working party which included Kate Rogers, Cazenove Charities’ Head of Policy.

Determine whether you are an investment entity

The regulation is aimed at ‘financial institutions’ which include banks, custodians, depositaries, insurance companies and investment entities. It is the latter that includes some charities and foundations. If your charity derives more than 50% of its gross income from financial assets (over the last 3 calendar years) and if any of the investments are managed on a discretionary basis then you are likely to meet the definition of an investment entity.

Common Reporting Standard:

Is your charity affected?

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The definition of discretionary management does not

include investing in unit trust where the trustee retain the

decision making responsibility

THEN: Classified as an Investment EntityIF AND

>50% incomefrom investments

Investments managedon discretionary

basis for last 3 years

Charitable Trustor Unincorporated

• Due diligence required on grantees and settlors

• Reporting obligations for any grantee or settlor with tax residency in reportable jurisdiction

Charitable company or CIO

• Less affected

• Due diligence required on debt or equity interest holders

• Reporting obligations for any debt or equity interest holder with tax residency in reportable jurisdiction

Incorporated charities (including those established by Royal Charter or Acts of Parliament) are likely to be less affected, although still have to report any equity or debt interest holders resident in a reportable jurisdiction. Please note incorporated charities may still hold assets in trust (e.g. permanent endowment) and may therefore have additional reporting obligations.

Richard Jenkins, the Head of Policy at ACF, has prepared some useful material available on the ACF website – including a flow chart to help you identify how your charity is likely to be affected.

As a financial institution ourselves, we will be required to identify our own ‘account holders’ and so will be in touch with our clients to ask for information in due course. We are unable to give tax advice, but if you would like a general discussion on the Common Reporting Standard and its implications for charities then please do get in touch. For more information please see the HMRC guidance for charities www.gov.uk/hmrc.

Charity Authorised Investment FundsGiles Neville, Head of Charities

Following a number of years of work by the Charity Investors Group, led by our colleague Kate Rogers, the new Charity Authorised Investment Fund structure was launched in October 2016 in conjunction with the Charity Law Association, Investment Association, Charity Commission and Financial Conduct Authority. We believe that this is good news for UK charity investors and intend to convert the Cazenove Charity funds into the new structure, subject to gaining the required approval from the regulators.

The structure is available exclusively to Funds established for charitable purposes, which will be registered as charities and regulated as such by the Charity Commission for England and Wales. As authorised funds they will also be regulated by the FCA under the Financial Services and Markets Act, offering protection for the investing Charities.

The Charity Authorised Investment Fund structure replicates the main benefits of the existing Common Investment Fund structure presently administered by the Charity Commission. The new structure preserves many of the specific characteristics of Common Investment Funds; including the tax benefits of being a registered Charity; the ability to smooth income to aid cash flow budgeting for investing Charities and the ability to have an independent advisory committee to represent charity unitholders. Additional benefits include improved regulatory oversight, and an exemption from VAT on investment management fees.

We will be in touch with investors in our charity funds over the coming months to complete the transfer to the new structure.

REGULATORY THOUGHTS

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REGULATORY THOUGHTS

WHAT YOU NEED TO KNOW ABOUT MiFID IITom Graves, Head of Regulatory Change, provides an update on what we can expect from the new rules and regulations of MiFID

What is MiFID?

The Markets in Financial Instruments Directive (MiFID) is a European Directive which was implemented on 1st November 2007. MiFID affects how firms carrying on investment business and ancillary activities organise their internal systems and controls, as well as how they conduct business with their customers both in and across Europe. The key objective of this initiative was to integrate Europe’s financial markets, enhance investor protection and attract new investors to the EU capital markets.

So what is MiFID II?

MiFID II is a fundamental review and enhancement of the previous directive with a renewed focus on investor protection for clients and market transparency. Firms must implement the required enhancements by 3rd January 2018.

At face value, the impact on UK firms looks fairly modest, as, since 2007, our UK regulator (the Financial Conduct Authority) has been very active in the investor protection areas covered by MiFID II including:

· Governance and organisational structures

· Product governance

· Independence

· Suitability of advice and due diligence

· Appropriateness

· Costs and charges

· Conflicts of interest

· Safeguarding of client assets

Suitability and appropriateness

MiFID required investments to be categorised as non-complex or complex. Currently, firms will need to consider the complexity of investments when recommending them or buying them on behalf of clients. The key difference is that many more investments will be categorised as complex. For clients purchasing without advice, financial organisations need to document that the client has sufficient knowledge to understand the investments that they purchase (known as “appropriateness”). The impact of more investments being categorised as complex will increase the number of occasions when “appropriateness” needs to be assessed.

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WHAT YOU NEED TO KNOW ABOUT MIFID II

Costs and charges

For portfolio management, the key change is (in addition to the cost of the service provided by the firm providing the portfolio management service) the firm must now illustrate and show the costs of the underlying investments within the portfolio. At the start of the relationship, assumptions on investment returns will need to be made and the effect of the total costs will need to be illustrated. Furthermore, at the end of a reporting period the actual total costs will need to be disclosed.

Regulatory reporting

In addition to investor protection requirements, financial organisations are required to report trades by the close of business the following working day to the regulator. These reports are to assist the regulatory authorities to identify market abuse such as insider trading. Therefore, both the scope of instruments to be reported and the depth of information will dramatically increase. One key impact for entity clients (for example investment companies and larger trusts) is that, unless they are only invested in open-ended collective vehicles, they will need to obtain a Legal Identifier Number. Without this number financial institutions will not be able to trade on behalf of clients.

Industry implications

Whilst the UK regulatory regime is advanced in the areas impacted, the volume of work required and associated cost should not be underestimated. The UK rule book is being re-written and firms need to conduct detailed analysis. Client agreements will need to be updated with additional information, and increased disclosures will need to be provided to clients. Financial organisations

will be required to exchange more information with both their counterparties and their regulators. The increased information disclosures and exchanges will require firms to significantly upgrade their IT systems in several areas.

The impact to Cazenove Capital and our clients

Our firm is not immune to the impact of MiFID II on the industry. We are, however, well positioned as we are of a sufficient size to effectively manage the changes; we started planning early and have ensured adequate resource is in place to manage the challenges. Over the next 12 months we will communicate the changes that will affect our clients from January 2018 onwards.

These changes will include:

1 Valuations must be issued quarterly rather than every six months

2 We will formally notify you if your portfolio falls 10% in a quarter

3 We will be reviewing the structure of our charges for some clients

4 Our website will detail information relating to our best execution policy

5 We will be liaising with clients with holdings in listed equities and bonds to obtain Legal Entity Identifiers (LEIs) in order to help fulfil reporting requirements

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cazenovecharities.com

Important information

Past performance is not a guide to future performance. You should remember that investors may not get back the amount originally invested as the value of investments, and the income from them can go down as well as up and is not guaranteed.

The opinions contained herein are those of the authors 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 Management 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 Management has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Issued by Cazenove Capital Management which is a trading name of Schroder & Co. Limited, 12 Moorgate, London, EC2R 6DA. 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. K16039.

Giles Neville Head of Charities

Tel: 020 7658 6975

Alex Baily Portfolio Director, Charities

Tel: 020 7658 1108

[email protected]

Kate Rogers Head of Policy, Charities

Tel: 020 7658 2480

[email protected]

Lucinda Napier Portfolio Director, Charities

Tel: 020 7658 1106

[email protected]

[email protected]

CONTACT US

Nicholas Orr Portfolio Director, Charities

Tel: 020 7658 3285

[email protected]

Tom Montagu-Pollock Portfolio Director, Charities

Tel: 020 7658 3726

[email protected]