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Economic Doldrums?

What an Olympics London had in August, with 44 world records, 204 nations competing, USA finishing first and the UK having one of its biggest medal hauls of all times! Top that off with sensational opening and closing ceremonies and similar success in the Paralympics, and the world feels a better place... or does it?

Economic news is still not great, manufacturing down, China slowing, India has infrastructure issues, Europe ... well let's not go there! After the euphoria of the Olympics it seems that we have all come back down to earth with a bit of a bump!

However, there does seem to be some direction starting to take shape, and in the UK there is a confusing picture that says a) we are in a double dip recession but b) employment figures are improving! So where does that leave the average not-for-profit organisation when considering how to structure its investments?

At Mark Freeman & Associates, we have been looking at this closely for the past six months and taken soundings from a number of different sources. What we are finding is that there is a very mixed view out in the market place.

Some asset allocators are of the firm view that you should set your long term asset allocation based on extrapolation from past results, and stick with this allocation. Others are of the view that a 50/50 approach of equities to bonds is a sensible place to be until clarity of direction reappears. Whilst others are very bullish that equities are the place to be, as bonds now potentially can't keep up with inflation - and that this is likely to continue for some time.

So where on earth do you turn to determine the best way to invest your not-for-profit funds?

The starting place must be your investment objective, understanding how it was developed and what is important to your organisation. It is very easy to see the attraction of longer term growth but what might be the short term cost in capital value due to volatility?

So, when looking at the investment strategy/policy do be sure to consider these areas:

• Is capital preservation more important than growth?
• Is capital preservation more important than income?
• Do we need income for my day-to-day operations to continue or can I use excess capital?
• Over what period of time can we cope with a loss of 20% of capital value?
• What element of certainty do we need that income or cash will be available from the investments?

Some would say that these types of questions should be asked at the time of setting up the investments policy and asset allocation - but what we are finding in today's climate is that these questions need to be re-examined by organisation at least on a annual basis not every three to five years.

Why so frequently? Unfortunately the world that we now invest in has dramatically changed, and the constant or sustained growth of the stock markets is now not certain... in fact it is very uncertain! The fact that we are seeing bonds delivering a negative real return makes it harder to find places to earn income as well as preserve capital with any degree of certainty. Cash, once the safe bet, is now itself showing negative real returns.

One approach that we are seeing organisations adopt increasingly is a balanced approach to investing which harks back to the late 90's, that is, 60% in equities 30% in bonds and 10% in cash and other. So why adopt this traditional approach in these volatile times? Well the appeal is varied:

• It balances the present and the future, allowing for risk, but not to the point of devastating an investment if the market turns down for a period of 18 months or so. But it also balances the upside if the market does start to grow with consistency (depending on your idea of consistency!)
• It allows for an element of capital protection through the bonds, always remembering that the real return will be impacted by the current trends in the bond market.
• Finally your 10% (assuming that it is liquid) allows for tactical moves - so if the equity markets begin to rise you can allocate more to this.

I have a client who asked me the other day "So, why doesn't this happen, when you look at the evidence supporting this view?"

Quite simply it comes back to the investment strategy/policy and the asset allocation set at the time. When implemented by an investment manager (depending on the style the house has) they can rarely move more than a few percentage points either side of the 60/30/10 model. How can you tell that this is the case? Have a look at your past eight quarters, and if it has moved less than 5% then your investment manager is working to the long term objectives of the policy - which in the current and foreseeable future may not be in your best interests.

The other clue to asset allocation is to look at how often it is discussed in meetings with the investment manager, and what alternative asset allocations could be employed to achieve the results that you are looking for (depending on the answer to the five questions above).

What you may find is that you discussed the merits of the Euro, and that equities are yielding better than bonds, but you had no real discussion on strategic asset allocation and its lack of movement.

So how do we get over this hurdle?

There is a need to be engaged not only with the long-term objectives of the investment strategy/policy but also be very aware of the short-term impact of the markets we are operating in.

That means keeping abreast of what is happening in Europe, Asia, China and America and how this may impact on the objectives of the investment. Now, your investment manager will be doing this as well as looking at performance against benchmarks, but to be prudent, every organisation should consider this independently of their investment manager and take soundings from different sources to be able to:

a)   develop a view on the market
b)   assess what might happen and the impact this may have on performance
c)   identify possible alternative strategies

And, here are the questions you should be exploring with your investment manager: 

• What would happen if we did this?
• What level of risk/volatility does the portfolio contain and how could it be reduced?
• What tactical moves would assist the short term without damaging too heavily the long-term objectives?
• Within an asset class does the asset allocation make sense? (e.g. the split between global and UK equities)? 

In the end the lack of direction given by politicians, the reaction of the markets, and retrenching of the economies means that there is a lot more work to do when looking after investments! It is not something we can do in Olympic style every four years and then forget about it - we all need to adopt the Jessica Ennis approach and put in the hard work every day during the four years!

If you are concerned about how your investments are performing and would like to discuss this, Mark Freeman & Associates provides an investment monitoring and review service and we would be happy to meet you, initially at no cost, to discuss your investment strategy and recent results and explore what improvements can be made.