Adopting a Total Return Approach to Charities’ Permanent Endowments

Hillier Hopkins LLP

Chartered Accountants & Tax Advisers

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Approaches to investing have altered considerably in recent decades, not least due to the financial crisis. New rules were bought in for charities with permanent endowments at the beginning of 2014 to help them accommodate modern investment approaches in the form of the Charities (Total Returns) Regulations 2013. From 1 January 2014 charities with permanent endowments have been able to take a total return approach to investing without the permission of the Charity Commission.

Trustees of charities with permanent endowments must seek to balance the somewhat competing interests of current beneficiaries with those of potential beneficiaries in the future. In order to do so, the permanent element of the fund must be maintained such that future spending power is not lost through inflation while income is produced for beneficiaries in the here and now.

The changes brought in by the new rules offer greater flexibility towards meeting those dual requirements in the context of the modern investing landscape.  

Total Return Investing v Capital Growth and Income Investing

The nature of the investment universe has evolved over the last few decades and the variety of investments available to charities with permanent endowments and other investors has proliferated enormously.

One of the primary forms of investment, equities, have also changed significantly in the nature of their investment characteristics. In the early 20th Century, many listed companies paid dividends with strong yields; in the early 21st Century by comparison this has generally not been the case. As a consequence, companies have retained more of their earnings and displayed greater capital growth. Similarly, yields on bonds have suffered in the low interest rate environment that has existed since the financial crisis.

Modern investment managers have responded to this trend by targeting total returns, the combined return produced by capital growth and income that a company produces over a period of time, without discriminating between the two. Income can thus be generated from dividends or coupons or by realising gains from capital growth. To do so has required the introduction of regulated vehicles through which the tax implications can be managed accordingly.

Although charities have been able to elect to adopt a total return policy previously with consent from the Charities Commission, the introduction of the Charities (Total Returns) Regulations 2013 attempts to give all charities with permanent endowments the same flexibility.

Total return policies should open up a wider universe of investments than traditional approaches. Under normal rules only ‘income’ assets, i.e. high yield assets such as dividend stocks and coupon bonds, can provide the income to be used by the charity whereas the gains realised through total return can be effectively treated as either income or capital gains.

Considerations for a Total Return Approach to Permanently Endowed Charities

At this stage it is unclear how many charities with permanent endowments have adopted total return investment policies and there are various considerations that must be made before doing so.

The main consideration is whether a total return policy is in the best interests of the charity. In addition, the assets that made up the original permanent endowment must be identified in order that they can be effectively maintained. Finally, a total return policy should only be contemplated if the potential benefits outweigh the risks.

Detailed guidance is available for charities with permanent endowments.