Thought leadership  

25/07/2017

Brexit can no longer be ignored by a troubled charity sector

charities_Intranet-M.jpgYet the implications of Brexit are profound and have already had an impact on the sector’s finances and on the demand for charitable services.  So it is interesting to see that many commentators are now calling on charities to lobby loudly around their issues. 

 

For example, many universities lament a decline in applications from the most gifted of European students and lecturers, while scientific and research organisations similarly fret about a loss of intellectual capital, alongside funding.  Meanwhile, environmentalists worry about the eventual withdrawal of EU agricultural farming practices, which currently serve to protect certain natural habitats for wildlife.

Right now we cannot foretell the final terms of Brexit, the actual movement of labour across borders, or the longer term societal consequences of the UK’s political separation from Europe. However, we can and should explore the likely economic, investment and governance implications for the charity sector.

Currency volatility: impact on charitable services and funding of overseas operations
In finance, the most immediate response to Brexit was played out in the currency markets; the two days after the Referendum result were the most dramatic for sterling since the UK’s exit from the European Exchange Rate Mechanism back in 1992.

The pound’s resultant weakness impacts the entire “value chain” of the UK economy. Near term benefits for exporters must be balanced against the higher import costs of many materials. The greater out of pocket cost of holidaying abroad for UK consumers stands in contrast to the improved value of property prices for many overseas buyers.

Rising costs and UK inflation - especially higher food and fuel costs – has unwelcome implications for domestic household budgets. Some welfare charities and foodbanks are already witnessing a greater need for their services.  Promises by UK political parties ahead of June’s election for greater funding for schools or hospitals seem unlikely to materialise, given the state of public finances. The UK is highly indebted by all developed market standards, and already runs large budget and current account deficits.

Of course, charities operating internationally or funding services abroad understand currency volatility. Many frequently use forward contracts to hedge out this risk in an effort to budget effectively. However, higher currency volatility generally increases the opportunity cost of using forward contacts whenever sterling strengthens. 

Another potential approach is to allocate financial assets, whether endowments or even reserves, in a way to match those payment liabilities. For some it makes sense to purchase secure overseas bonds of the funding currency that are set to mature shortly as payment falls due.

Stock market reactions, volatility and investor activism
The post-Brexit stock market reaction surprised many. After an immediate sell-off, the FTSE All Share rose dramatically, as investors digested the currency translation benefits to UK company earnings1. Together with a partial recovery in commodity prices, which disproportionally benefits the UK listed market, a weaker sterling helped the FTSE 100 achieve a record high in March2. This has been matched by corresponding records for US indices the S&P500 and Dow Jones Industrial Average this year3.

Charity investors might therefore wonder what all the fuss is about. Major equity markets have performed well since June 2016, so those invested globally have experienced strong portfolio returns, assuming they had not hedged overseas assets back to sterling.

But questions are being asked around the endurance of the current global economic cycle, and the ability of US President Donald Trump to deliver on promised regulatory and tax reforms that have so far wooed global equity investors.  In short, charities should have a view on the prospects for both investment markets and currency volatility, and expect good tactical awareness from their investment managers. The point here is that the current high market volatility looks set to continue and this requires attention by charity investment functions. 

A sector under assault
Sadly, many charities nowadays spend less time than ever addressing investment matters. This is probably because the sector is facing its own institutional crisis, following a spate of publicised failings trumpeted by a more hostile UK media.  A 2016 UK survey into public trust and confidence in charities makes for grim reading, with 33% of respondents citing decreased levels of trust, and worse findings still for larger and international operators .  This has obvious and direct consequences for public fundraising, and also poses wider structural questions for the sector collectively.

Charities are having to respond to greater operational demands in the face of more demanding regulators; changes are being made in fundraising standards, political lobbying, the treatment of personal data and accounting practices, in addition to new tax reporting obligations around major donors. 

But less time spent on investment matters can also mean more risk. The public is becoming increasingly critical of investment activity that does not conform to their view of social responsibility – witness students lobbying universities for a wholesale divestment from fossil fuels, or the recent furore surrounding the Church of England having invested in payday lender Wonga.com.  For charities, reputational risk comes in a variety of forms.

While hesitating to make direct comparisons, much of this sounds familiar to the banking sector. So, as they face an uncertain future, those responsible for the governance of charities may do well to spend more time with their financial advisers, both to benefit both from their investment advice and also to learn from their own organisational experience.

1While the FTSE All Share lost 4% on the day of the referendum’s results on 24 June, it subsequently rose 6% by 1 July 2017
2Closing at 7,424.96 on 17 March 2017, and hitting a new intraday high of 7,533.0 on 16 May 2017
3The S&P500 closed at a record high of 2,399.27 on 5 May 2017; the Dow hit a record high above 20,000 on 1 March 2017
4Public trust and confidence in charities’ research conducted by Populus on behalf of the Charity Commission, 2016

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