Understanding investing: an introduction to asset classes

A guide for charities Understanding investing: an introduction to asset classes

A guide for charities

Contents Overview of asset classes 4 Cash 6 Fixed income 7 Equities 8 Commercial property 9 Infrastructure 10 The value of investments and the income from them Commodities 11 may go down as well as up and you may not get back Hedge funds 12 your original investment. Past performance should not Portfolio construction 14 be seen as an indication of future performance. Contact us 15

22 3 A brief overview Failure to grow a charity’s assets and surplus reserves ahead of inflation, will leave it steadily worse off and less able to of the main asset deliver on its charitable purpose. While holding some reserves as cash in the bank is usually necessary, cash generally earns classes that can a low return and its real value will be depleted by the effects typically be used in a of inflation over time. However, by investing, a charity’s reserves have a much better charity’s investment chance of generating income, growing in line with, or above, inflation, and potentially providing for the charity in a more portfolio. sustainable manner. Of course, it is important to remember that the value of investments and the income from them may go down as well as up and a charity may not get back its Investment portfolios are original investment. typically used by charities to It is possible for charities to invest in a variety of asset classes increase the value of their that offer varying levels of risk and reward. assets over time and guard The primary asset classes are: against inflation. — cash — fixed income — equities — commercial property — infrastructure — commodities — hedge funds.

An investment portfolio should generally be constructed using a mix of assets to meet a charity’s long-term objectives and attitude to risk. It is important to invest not just in a range of different assets, but to invest in a diversified combination of assets that behave differently.

4 5 Cash Fixed income

Cash and bank deposits, including overnight and fixed Fixed income investments, also known as fixed interest or deposits, offer very low risk and generally low interest bonds, involve investors loaning money to a corporation rates. Holding money as cash in the bank is unlikely to or government. The loan (bond) is tradeable, and provides beat inflation. two types of payment — the coupon (relating to interest payments) and the principal (which is the loan repayment).

Cash The return an investor realises on a bond is known as the yield. The yield can be influenced by the riskiness of the Pros Cons borrower, the expected rate of inflation and interest rates, Bank deposits are usually easily Cash and bank deposits offer low and the bond’s time to maturity. accessible, making them a useful way returns (via interest), if any at all. for a charity to keep a cash buffer There are a range of different types of bond, some more risky to meet near-term expenditure requirements. than others. The appropriateness of each type of bond for a charity portfolio will depend on its attitude to risk and the Bank deposits can provide a small The value of bank deposits is likely level of return it is seeking. amount of income through interest to be eroded by inflation. on savings.

Holding money in the bank Money in bank deposits is at risk if the Fixed income provides capital protection in bank fails, although most UK banks most circumstances, making it offer protection on up to £85,000 Pros Cons relatively safe. through the Financial Services Compensation Scheme. As the name suggests, fixed Issuers of bonds can default. income investments offer a predictable income.

Bonds usually have low risk or Inflation can erode the real value defensive characteristics, although of the fixed income. it’s important to distinguish between investment grade and non-investment grade bonds.

Fixed income investments can Fixed income investments offer be useful in providing portfolio limited or no capital growth. diversification.

6 7 Equities Commercial property

Equities, also known as stocks or shares, usually form the Commercial property refers to any property that is used largest part of a charity’s investment portfolio. In essence, for business purposes, such as offices, shopping centres, owning an equity (or share) of a company gives an investor retail warehouses, factories and can even include specialist part-ownership of the assets and profits of that company. property such as doctors’ surgeries.

Depending on the success of a company, equities can provide Like equities, commercial property provides a return through investors with income, commonly known as dividends, and a combination of income (from rent) and capital growth (from capital growth, as a result of increases in the share price. the appreciation of a property’s value over time).

Over time, equities have outperformed most other assets, Investors need to be selective in their exposure to commercial providing attractive long-term returns. However, equities are property, as the different types of property can be affected by also a more risky asset class to hold, and charities need to factors in different ways. For example, high street property consider the trade-off between risk and return when deciding has been negatively impacted by the rise in e-commerce, what percentage of their portfolio should consist of equities. while warehousing/distribution has experienced strong demand as a result of this trend.

Equities Commercial property

Pros Cons Pros Cons

Equities can provide attractive long- Capital values can be volatile Property can provide high and stable Rental income can fall, for example if term returns. and risky. income streams, enabled by multi- a tenant goes bankrupt. year rental agreements.

Equities can preserve real value by Equities can be negatively impacted Property has historically provided Capital values can go down as well as delivering returns ahead of inflation. by inflation over the short term. protection from inflation and overall up, and returns can be volatile. returns — both income and capital They are positively impacted by Equities are negatively impacted by growth — have been attractive. economic growth and improving recessions and worsening investor investor sentiment. sentiment. Property can provide portfolio Physical buildings can be expensive diversification as it has slightly to maintain, repair and upgrade. different sensitivities to most other Dividends are relatively predictable Dividends are not guaranteed. investments held within a portfolio. and typically provide reliable and growing income. Individual buildings are unique, and can be illiquid, particularly in times of stress.

8 9 Infrastructure Commodities

Infrastructure, which refers to the basic structures and Broadly speaking, commodities are raw materials. This facilities required for the operation of society or enterprise, overall classification covers a range of sub-sectors and asset is a relatively new investment asset class. types, including agriculture and livestock, precious metals, industrial metals and energy. It can be split into two main types: social infrastructure, including facilities such as schools, hospitals and prisons; Commodities can be very volatile, and the different types and economic infrastructure, including assets such as behave very differently. The principal commodity used by airports, roads and power generating facilities. most investors is gold.

The various types of infrastructure have different characteristics and can behave quite differently, so their Commodities risk and return profiles can also vary considerably. Pros Cons

Gold is a portable store of wealth. Gold provides no income — ­holding gold comes at the opportunity cost of Infrastructure holding an income-producing asset.

Pros Cons One of gold’s most desirable Gold can be difficult to value as, aside characteristics is its tendency to from its use in jewellery, it has limited Infrastructure can provide stable and These assets and their income provide protection in periods of real world application. attractive levels of income. streams are not immune to economic and political stress. global events. Gold can provide protection against The price of gold can be heavily inflation, as well as portfolio influenced by investor sentiment, Returns are typically government- Debt levels can be high in diversification. which is difficult to predict. backed and are therefore infrastructure investments, which relatively reliable. can create profit volatility. Gold has, historically, delivered While returns have been positive, positive returns across rising markets. they tend to be relatively low. Infrastructure revenues are often Infrastructure offers limited capital index-linked and can protect growth potential — it is predominantly against inflation. an income investment.

Infrastructure assets behave There is an element of illiquidity to differently to equities, so can provide these assets, similar to commercial portfolio diversification. property.

10 11 Hedge funds

A hedge fund can invest in a wide range of assets and trading Hedge funds strategies in order to produce good risk-adjusted returns over time. These funds are able to profit from identifying Pros Cons both overvalued and undervalued assets and, in so doing, Hedge funds have investment Similar to gold, hedge funds typically can produce returns that are uncorrelated to global equities. powers allowing a greater degree provide no income. As their name suggests, these funds were originally designed of flexibility in how they produce returns and manage risk. to hedge portfolios and provide protection. These funds have the ability to Due to their complex investment There are a number of different types of hedge fund, typically make positive returns in falling strategies, hedge funds can be more markets, which is a potentially expensive than other assets and defined by their strategy for investing. Strategies include appealing profile. often have performance fees. macro, relative value, merger and acquisition arbitrage, This can hinder returns over time. trend following and equity long/short. Hedge funds are focused on risk- Given the nature of some of their adjusted returns and are mindful of strategies, hedge funds can be illiquid Hedge funds’ investment strategies are designed to produce capital preservation. or opaque. positive returns in all kinds of markets, and are able to profit from both falling and rising asset prices. By providing returns Hedge funds provide portfolio In some cases, hedge funds have less uncorrelated to equities, hedge funds can provide portfolio diversification. regulatory oversight than other assets — thorough due diligence should be diversification while contributing to returns over time. conducted before investing in this asset class.

12 13 Portfolio construction To find out more about Rathbones’ approach to The range of asset classes discussed in this guide can be combined in varying degrees in order to provide the returns portfolio construction a charity is seeking, within an acceptable level of risk. and investing for charities, An understanding of how different assets behave, particularly please contact: in times of stress, helps to construct truly diversified portfolios which manage risk and provide long-term returns. Natalie Yapp [email protected] The fundamentals of investing

This guide accompanies one of our charity investment training webinar series: An introduction to asset classes. You can watch the full webinar by following this link.

Our training webinar series is designed to provide trustees and senior finance staff with an understanding of the fundamentals of charity investment.

Please visit: rathbones.com/charities to find out more about the training series.

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Unless otherwise stated, the information in this T3-ChGuide1-02-21 document was valid as at February 2021.

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