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“Since the GFC and the appearance of more and more hybrids there has been a lot of interest in investing in them and in the last couple of years particularly there has been an increasing amount of examination of hybrids by non-profits.
According to ABS data, charities in Australia have around $32bn that they need to invest and with many of them relying on products directly linked to the cash rate, they are staring down the barrel at diminishing returns. A new piece of research just published by Sydney-based Koda Capital estimates that the Australian non-profit sector has seen its returns dwindle by almost $900m each year since 2011. The conclusion drawn is that ‘safe as houses’ term deposits and cash accounts may no longer be the most appropriate investment strategy for many leading non-profits.
David Knowles, head of philanthropy and social capital, at Koda Capital has a wealth of experience in helping Australian non-profits come to grips with the new economic realities of securing acceptable returns in the face of falling rates.
In part, the issue centres on the decision-making process within charities in terms of asset allocation. “There are a lot of different aspects to asset allocation,” says Knowles. “The standard process for the larger organisations with a reasonable amount of funds to invest is for them to organise their investments either through their board or through a subcommittee. Typically they will put out a tender about every three years and typically they will expect to appoint a manager/adviser for a three year period.”
Choosing a manager/adviser will inevitably involve some form of beauty parade in which shortlisted potential advisers will be allowed to present their investment proposal to the committee. “Typically once they have appointed an adviser they would meet to review their portfolio, their strategy, their policy and everything else and review whether the whole reason that they are investing is still valid, every three months,” says Knowles. “If they are very active the committee might meet once a month. Some might only meet every six months but typically it will be every three months. Often they will call the adviser or the manager in and they will have to account for themselves, their performance and give an update and help feed ideas into the committee.”
Naturally, the overall level of investment knowledge and competence will vary considerably from one non-profit to the next but few are so well-versed in dealing with different types of market environment that they could not do with a little extra help from the professionals. “There are a number of non-profits that are very conservative and that is appropriate for them,” says Knowles. “But there is another group where they are very conservative but where this is not in the best interests of the organisation, particularly for the long-term investor. If capital volatility is not the most important thing for them, then they can afford to explore other ways of investing. One of the challenges is that the investment committees are often volunteers and no one want to blow up the reserve or the endowment on their watch so people have a natural bias towards being extremely conservative, particularly if they are dealing with money that has been raised from the public or received from government. So you need to overcome those challenges and get them to look at their portfolio in a proper and strategic way and be brave enough to do the right thing.”
It is here that the pitfalls of simply piling everything into term deposits and cash accounts become evident. “A lot of people are not doing the right thing and so they are in cash and possibly they shouldn’t be,” says Knowles. “You can see the way that markets have gone over the last four years and a lot of people would have started off saying, there is no problem with cash, it has a great return, there is no risk, guaranteed by the government and all of a sudden it is a very different scenario.”
A savvy investment committee with supply their adviser/manager with a set of parameters within which they will have to operate and indeed this is one of the most basic requirements in terms of compliance. “They should always have a comprehensive, written policy and that policy document should state the parameters within which the manager can operate,” says Knowles. “There should be risk profiles, risk tolerances, asset allocation restrictions, return expectations, income expectations. You name it. It should all be there and it should be there to help them do their job and make sure that we are all singing from the same song sheet but it should also be there to be given to the adviser and it always is and that becomes your mandate and tells you what you are expected to deliver and what you can and cannot do. If an organisation does not have one, then the very first job is to make sure that they produce one.”
Non-profits investing without a policy run the risk of projecting an image of a body where it is not clear who is making the decisions and from which framework are they working. The danger signs are when decisions are made purely on personal views which makes it very difficult for the organisation to track what is going on and why.
What sorts of products should non-profits be looking at as an alternative to TDs in low-rate environments? It is important that the advisers are impartial, independent and do not have an axe to grind. “At Koda, we are independent and we have a charter that says to clients that we have no perceived or real conflict or remuneration conflict,” says Knowles. “We don’t have an interest in recommending one product over another. We don’t have a suite of products. We are not a product manufacturer and we have no restrictions on the products that we recommend. In terms of suites of products, lots of non-profits who have not restricted themselves to cash have gone first of all into fixed income securities, then they can look at hybrids and then they look at blue chip Australian equities especially ones that pay fully franked dividends because then they reclaim the imputation credit and get a cheque which is further income for them. We think that should be part of their strategy but it should not be the whole thing.”
Do they come and ask specific advice about new hybrids whenever they are announced to the market? “Absolutely,” says Knowles. “Since the GFC and the appearance of more and more hybrids there has been a lot of interest in investing in them and in the last couple of years particularly there has been an increasing amount of examination of hybrids by non-profits. Was it what we thought it was? Was it riskier? Is the price more volatile than we expected? Does it look a lot more like an equity than fixed income? That has been a big issue.”
Overall, it seems that charities and non-profits are becoming increasingly sophisticated and increasingly demanding of their advisers. According to Knowles, “In terms of asset allocation, most organisations will take a lot of input from the adviser. Sometimes it’s an asset consultant if they have enough money, but they will take a lot of input and we will try to tell them that we think that an appropriate asset allocation for them is. Some of the more sophisticated groups, the ones with really sophisticated investment professionals on their committees will often come to you and say, ‘This is what we think we want.’ And they are the ones that will say, ‘There’s a hybrid coming out in the market, what is your view?’ These are the ones that are sophisticated investors themselves and they are onto this kind of stuff so they are asking you and they are probably asking two or three other people and their own private adviser. They can be quite sophisticated, but it depends on the quality of the person that they are lucky enough to get to sit on the committee.”
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