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You are here: BAILII >> Databases >> United Kingdom Journals >> Charity Investment in the UK: Some Contemporary Issues for the 1990s URL: http://www.bailii.org/uk/other/journals/WebJCLI/1995/issue3/morris3.html Cite as: Charity Investment in the UK: Some Contemporary Issues for the 1990s |
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Copyright © 1995 Debra Morris.
First Published in Web Journal of Current Legal Issues in association with Blackstone Press Ltd.
The investment duties of charity trustees have been highlighted recently due to the termination of the investment function of the Official Custodian for Charities (who previously held investments worth about £1.25 billion for over 40,0000 charities) together with the increased awareness of trustee responsibilities generally. In April 1995, the law relating to charity investment changed so that now charity trustees are less restricted in their investment decisions. The Charity Commissioners have also issued a number of recent policy statements concerned with investment powers. This paper examines these recent developments and argues for an even less restricted legal regime.
Contents
The Charities Act of 1992 (s 29) terminated the investment function of the Official Custodian for Charities. This led to a major programme of divestment whereby all the investments (other than land) which had previously been held by the Official Custodian were transferred back to around 40,000 charities. At the outset of 1994, for example, the Official Custodian had responsibility for 700 different securities belonging to 21,216 charities. By the end of the year those figures were reduced to 64 and 1,877 respectively. The remaining divestment was expected to be completed by March 1995 ([1994] Ch Comm Rep 22). This means that many charities who had previously had free safe custody and administrative services, and who possibly never really gave a thought to their investments, now have to do so.
The collapse of Barings Bank in early 1995 and the profound effects on the charitable world also served to focus the concern of many charity trustees upon investment decisions. Charities suffered a double blow; one of the top 10 grant making trusts, Barings Foundation had its income reduced by millions of pounds, whilst many charities had investments with Barings Bank which were feared lost.
Recent statistics reveal a 2% decline in income amongst the medium sized charities (Saxon-Harrold and Kendall 1995, 137). Such charities are struggling to adapt to a more competitive fund-raising market where increased efforts must be made in order to attract substantial funding. Charities can no longer rely on legacy income and general donations. They must maximise their funds by sensible investment policies. The proportion of charities' investment income illustrates the central importance of maximising the returns to be made from investment opportunities. The total income of registered charities in 1991 was approximately £9,100 million of which £1,400 million (15%) came from investments (Saxon-Harrold and Kendall 1995, 23). It has been estimated that charities own in aggregate some £26 billion worth of investments, excluding property (Cambridge Market Intelligence 1995, 164).
Trustees are not necessarily immune from liability for breach of trust merely by showing that their investments are authorised. Having established the authority to invest in a specific investment, whether it be due to a statutory power or a power in the settlement, trustees are then under further duties. In Nestle v National Westminster Bank [1993] 1 WLR 1260 Dillon LJ approved the words of Lindley MR from a nineteenth century case:
"The duty of a trustee is not to take such care only as a prudent man would take if he had only himself to consider; the duty rather is to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide." (Re Whiteley (1886) 33 Ch D 347, at 355 per Lindley MR)
The principle remains applicable however wide, or even unlimited, the scope of an investment clause in a trust instrument may be.
The Trustee Investments Act 1961 (TIA 1961) also imposes upon trustees a general duty, in the exercise of their powers of investment, whether statutory or otherwise, to have regard to:
(1) the need for diversification of investments of the trust, in so far as is appropriate to the circumstances of the trust; and,(2) the suitability to the trust of investments of the description of investment proposed and of the investment proposed as an investment of that description.
Charities should draw up concise investment policies which are formally adopted by trustees.
In the absence of any extension of powers by the governing instruments, all trustees, including charity trustees, have the powers of investment conferred by the Trustee Investments Act 1961. Many older charities only have these statutory powers of investments. Express powers of investment are much more common in modern trust deeds.
Before the TIA 1961, trustees did not have the power to invest in shares, unless specifically given that power in the trust instrument. This became a significant restriction on the ability of trustees to make appropriate investments. The TIA 1961 (sched 1, part III) therefore gave trustees the power to invest inter alia in shares and debentures of large UK companies that have been paying regular dividends. Originally a liberating measure, the Act soon became a severe restriction, since, under it, only half of the value of the trust fund could be invested in these "wider range" investments (TIA 1961, s 2). In making the division, a valuation in writing from a person believed by the trustees to be qualified to make it (usually a stockbroker) is conclusive (TIA 1961, s 5). The other half must be invested in "narrower range" investments which consist of fixed interest securities, such as government stock (TIA 1961, sched 1, parts I and II). The Act contains other provisions whose aim is to ensure that the two funds remain divided (TIA 1961, ss 2(3) and 2(4)). There is, however, continuing debate concerning the exact maintenance of such a ratio once a charity is operating its investments - it is arguably possible to increase the value of the initial proportion which was directed towards equities, thereby shifting the ratio over time.
The TIA 1961 (s 6) also requires that trustees should obtain and consider expert advice before investing in either wider range investments or the narrower range investments requiring advice. As is always the case with trustees, although they should be guided by the advice given, the final decision is theirs. They should consider the advice and not follow it blindly.
As investment practices have changed over the years, the powers given in the TIA 1961 have for long been considered to be unsatisfactory. For example, the Act has been described as:
"tiresome, cumbrous and expensive in operation with the result that its provisions are now seen to be inadequate. Furthermore, careful investment in equities is perhaps more likely in the long run to protect and benefit both income and capital beneficiaries than is investment in fixed interest securities." (Law Reform Committee 1982, para 3.17)
The Deregulation Task Force on Charities and Voluntary Organisations published their proposals for reform in July 1994 and, in relation to the TIA 1961, said:
"The Act interferes unwarrantedly in trustees' exercise of their discretion, and prevents them from maintaining the real value of their assets and investment income. The loss in under- performance of investments since 1963 has been estimated at £450 millions per year." (Task Force on Charities and Voluntary Organisations 1994, p 22.)
The Task Force recognised four main problems with the Act: it is bureaucratic; it is costly to administer; it is arbitrary in its controls; and it goes beyond what the state ought to regulate. The principal issue has been the stipulation that a charity must maintain a basic 50/50 split between wider range and narrower range investments in order to minimise the risk to charitable investments.
Clearly, charities bound by the provisions of the TIA are at a significant disadvantage. Yet, whether trustees are bound by the Act is entirely a matter of chance as to whether or not a trust has been created with wider investment powers. There are still many areas that need to be addressed to bring the investment powers into line with present day market opportunities. Why is it, for example, that direct investment in the USA and Japan (the two largest markets in the world) is excluded, whereas investment in the European area is now authorised? Trustees can now invest directly in the emerging markets of Greece and Iceland. Also, there is a restriction which only allows investment in companies with a five year dividend history. This excludes all the recent privatisations together with many new companies, such as Vodaphone and Abbey National. Yet, many of the largest corporate failures - shares in Maxwell Communications, Polly Peck and British & Commonwealth Holdings - were acceptable investments immediately before their collapse.
Trustees may apply to the court to widen investment powers under various statutory provisions. For example, in the case of Trustees of British Museum v Attorney-General [1984] 1 WLR 418 Megarry VC sanctioned a very wide investment power and in Steel v Wellcome Custodian Trustees Ltd [1988] 1 WLR 167 Hoffman J approved a Scheme giving trustees power, subject to several safeguards, to apply a fund (worth more than £30 million) in the acquisition of any property whatever as if the trustees were absolutely and beneficially entitled. Similarly, the Charity Commissioners may grant wider powers of investment by a Scheme. They have recently announced (Charity Commissioners 1995, p 22) that unrestricted powers of investment without the requirement for any division will be conferred only in very exceptional cases and where the property available for investment is very substantial, normally in the region of £20 million. Restricted wider powers of investment will only be considered generally for a fund worth at least £1 million. This means that the powers granted in these cases are simply not available to smaller charities. For this reason, inter alia, the use of common investment funds is particularly appropriate for smaller charities governed by the TIA 1961.
CIFs are established by Schemes made by the Charity Commissioners (under Charities Act 1993, s 24) for the exclusive benefit of charities. They can afford a solution to many practical problems associated with investment management and can provide a sound basis for charities' investment needs. All charities are given the power (under Charities Act 1993, s 24(7)) to invest in a CIF, unless the governing instrument specially prevents this. As "special range" investments, all CIFs (irrespective of whether they are equity based or fixed interest based) sit outside the narrow/wider range division of the TIA 1961, with the result that a charity can invest any proportion of its funds in special range assets without the requirement to make a division. This allows charities greater exposure to equity related assets than is possible under the Act's division, which is thereby side-stepped (with the active encouragement of the Charity Commissioners).
CIFs enable the funds of otherwise unconnected contributing charities to be pooled and invested in a large and diversified portfolio of stocks and shares. Units in the CIF equivalent to the sum invested are allocated to each charity. The funds are actively managed by professional fund managers. CIFs give advantages similar to those of a unit trust. The benefit of expertise and the ability to spread the investment portfolio over a wider range of investments than may be available to individual charities should secure a safer balance of risk and growth than individual trustees could achieve.
Individual CIFs differ both in their investment portfolio and in the balance between capital growth and income. They do tend, however, to concentrate on either equity funds or fixed interest funds. There is now even an index tracking CIF. It is also possible for CIFs to invest solely in overseas equities but the Charity Commissioners advise that no more than 20% of a charity's portfolio should be used in overseas investments (Charity Commissioners 1993).
The administrative advantages to charity trustees of investing in CIFs are considerable. The investment process is simple and the cost of making investments and withdrawals is low. Transactions can generally be carried out for any amount and without the need to act through a stockbroker. Holdings in CIFs are registered in the name of a charity rather than in the names of individual trustees, which avoids the need to re-register new trustees on any changes in trusteeship occurring. Finally, because CIFs hold only charity funds, dividends and interest are remitted gross automatically, thus avoiding the need to claim any tax relief due.
One disadvantage of CIFs (as with unit trusts) is that investors may not entirely appreciate the nature of their shareholdings. In May 1995, several high profile charities were embarrassed to discover (through the media) that they were investing in firms that were banned from their portfolios. For example, the charity, Imperial Cancer Research Fund, through its investment fund manager, had money invested in two CIFs which had around 5% of their investments in tobacco companies.
The Charity Commissioners have always regulated CIFs on the grounds that they are subject to charity law. However, since their primary function is that of an investment vehicle, it was one of the Deregulation Task Force's recommendations (Task Force on Charities and Voluntary Organisations 1994, p 24) that their regulation should be passed over to an appropriate self regulating organisation, to be governed by the Financial Services Act 1986. The Home Office response was that the matter is under review. If the proposal is implemented, it is possible that new types of CIFs would be created more quickly and easier than in the past, as an SRO, with its broad investment experience, may be more willing to allow new types of funds, compared with the traditionally conservative Charity Commissioners.
The increased significance of CIFs as practical and effective investment vehicles cannot be underestimated. It is likely that, in the future, their role will develop even further. The Barings experience has taught investers to diversify. The CIF facility is, therefore, a considerable boon to the charitable sector - minimising risk by maximising the spread of investments.
The Commissioners will not confer any general power upon charities to participate in the derivatives market, even with a limitation as to the amount which they can hazard (see Charity Commissioners 1995, pp 25-26). However, they do now concede that there may be individual cases in which the use of a particular form of derivative may be of advantage to a charity. The Commissioners' approach is a cautious one. They are willing to consider each such case on its merits and then may authorise each individual action by an Order under Charities Act s 26, rather than by way of a Scheme conferring a general power.
The responsibilities of charity trustees have been highlighted over recent years, following the enactment of the Charities Act 1992 and the On Trust Report in 1992 (NCVO/Charity Commission Working Party on Trustee Training, 1992) which revealed that many trustees take on trusteeship with insufficient understanding of their responsibilities. Since then, much has been done to impress upon trustees their important role. However, in the area of investment, it seems as though trustees are still not sufficiently trusted to make appropriate unrestricted decisions. This does not fit comfortably with current trend to encourage trustees to shoulder their responsibilities.
No matter how wide their authorised powers of investment, trustees will never be absolved from the necessity to obtain professional advice, to ensure that there is a reasonable spread of risk and, above all, to avoid investments of a hazardous or speculative nature. The changes in April 1995 were enacted 34 years after the passage of the original Act. It is hoped that less time will pass before charities are given complete freedom to invest where they choose.
Cambridge Market Intelligence (1995) Charity Finance Handbook 1995 (London: Cambridge Market Intelligence)
Charity Commissioners (1984) Fund-Raising and Charities, Leaflet CC20.
Charity Commissioners (1993) Investment of Charitable Funds, Leaflet CC14.
Charity Commissioners (1994) Decisions of Charity Commissioners, vol 2.
Charity Commissioners (1995) Decisions of Charity Commissioners, vol 3.
Law Reform Committee (1982) The Powers and Duties of Trustees, 23rd report, (London: HMSO)
NCVO/Charity Commission Working Party on Trustee Training (1992) On Trust: Increasing the Effectiveness of Charity Trustees and Management Committees, (London: NCVO)
Task Force on Charities and Voluntary Organisations (1994) Proposals for Reform: Deregulation Report, Deregulation Task Force.
Saxon-Harrold, S and Kendall, J (eds) (1995) Dimensions of the Voluntary Sector 1995, (Tonbridge, Kent: CAF)
Warburton, J and Morris, D (1991) "Charities and the Contract Culture" 55 Conveyancer 419.
