More returns, less risk for your charity’s portfolio

When a charity invests its assets, seve­ral conflic­ting crite­ria need to be met. The first step you take as an inves­tor is to work out your target. This takes the form of expec­ted returns or a risk budget. There are five condi­ti­ons you need to bear in mind here: the invest­ment hori­zon, the need for liqui­dity or regu­lar capi­tal, tax and legal aspects, and indi­vi­dual rest­ric­tions e.g. no invest­ments in tobacco or arms.

The task of a profes­sio­nal asset mana­ger is to achieve your target while respec­ting the condi­ti­ons defi­ned by you.

The invest­ment stra­tegy for a charity’s portfolio

Usually, chari­ties’ funds are inves­ted in line with a defen­sive stra­tegy. Gene­rally, bonds are the core of a charity’s port­fo­lio, but the returns on bonds have been tumb­ling lower and lower over the past few years. At present, Swiss bonds even gene­rate nega­tive returns, regard­less of their duration.

Have you met T.I.N.A.?

This deve­lo­p­ment begs the ques­tion as to what invest­ments are available as an alter­na­tive to bonds. It’s time to meet ‘T.I.N.A.’. T.I.N.A. stands for ‘There Is No Alter­na­tive’, and suggests that the low-inte­rest rate envi­ron­ment means there is no alter­na­tive to shares.

Recently, many boards of trus­tees have deci­ded to increase the propor­tion of shares in their port­fo­lio. Until now, this was the right decis­ion to make, with prices on the global stock market almost tripling since the 2007/8 finan­cial crisis.

Recently, the stock markets are boun­cing from one all-time high to the next, but plenty of inves­tors are alre­ady view­ing this deve­lo­p­ment with suspi­cion. While share prices grew by about five percent per annum in the distant past, these figu­res have almost doubled since the finan­cial crisis. Given this deve­lo­p­ment, it is only fair to ask how long this trend can continue.

It’s hard to pick the right point at which to sell shares: there are an array of early indi­ca­tors that can be harbin­gers of a crisis on the stock market, but they are tricky to identify.

A market anomaly: more returns, less risk

It’s easier to prepare your port­fo­lio for a crisis, even when share prices are shoo­ting skywards. How? By making the most of an anomaly on the finan­cial market.

The tradi­tio­nal theory of the finan­cial markets states that higher (syste­ma­tic) risk (measu­red by the vola­ti­lity of the share price) should be balan­ced out by higher returns. In prac­tice, howe­ver, a diffe­rent pheno­me­non has been obser­ved on the share market for deca­des. Over the long term, shares with low vola­ti­lity gene­rate bigger returns than riskier stocks do (see graphic 1). In expert circles, this stra­tegy is known as ‘mini­mum volatility’. 

Howe­ver, it does come with a catch. When the stock markets are on the up, this stra­tegy often lags behind the market cap index. That said, this defi­cit is more than made up when share prices head southwards. Over­all, inves­tors using a mini­mum vola­ti­lity stra­tegy attain higher returns for less risk, over the long term.

To avoid falling too far behind an index when share prices are incre­asing, it is recom­men­ded that the port­fo­lio includes shares that meet speci­fic quality stan­dards. We recom­mend balan­cing out one-third of quality stocks with two-thirds of mini­mum vola­ti­lity shares.

Look for quality

You should bear three crite­ria in mind when selec­ting these quality stocks: rating, quality and vola­ti­lity. Checking the rating helps you avoid buying over-priced shares. Specia­lists gene­rally define a company’s quality by refe­rence to its consis­tent high profi­ta­bi­lity, as well as aspects such as low levels of debt finan­cing and high opera­tio­nal effi­ci­ency. In terms of vola­ti­lity, make sure not to include compa­nies with parti­cu­larly vola­tile share prices in your portfolio.

If you were putting toge­ther a quality port­fo­lio for the global equity market, you would include well-known indi­vi­dual stocks from Louis Vuit­ton (LVMH) and Novo Nordisk. Tech­no­logy compa­nies from the New Economy, such as Apple, Amazon and Alpha­bet (form­erly Google), also meet the above quality stan­dards. The best Swiss compa­nies, from our perspec­tive, are Emmi, Lonza and Sika.

Diver­sify your portfolio

For reasons of diver­si­fi­ca­tion, it makes sense to add Swiss real estate and gold to your port­fo­lio as an alter­na­tive to shares and bonds.

Inves­t­ing in real estate can either be done directly, in the form of an apart­ment or house, or indi­rectly via real estate shares and funds. This latter option is an essen­tial compo­nent of a charity’s port­fo­lio. The prices for indi­rect invest­ments in real estate have jumped shar­ply recently, but there are still attrac­tively rated stocks out there, such as Nova­vest Real Estate AG or SF Urban Proper­ties AG.

An envi­ron­ment marked by low inte­rest rates and an incre­asing expec­ta­tion of infla­tion is a golden oppor­tu­nity for, well, gold. Gold has always been seen as a safe haven that offers protec­tion for your port­fo­lio. From our perspec­tive, the price of gold looks set to rise again in the fore­seeable future. Howe­ver, you should bear the exch­ange rate risk in mind, given that gold is traded in US dollars. In light of the inte­rest rate diffe­rence between US dollars and Swiss francs at the moment, and the high hedging costs asso­cia­ted with this, we would not curr­ently recom­mend (fully) hedging against the exch­ange rate risk.

In sum, it is clear that the success of a charity’s assets lives and dies by the right stra­tegy, imple­men­ted in a profes­sio­nal, disci­pli­ned way – but don’t forget to keep an eye on the risks at all times. Have you chosen the right stra­tegy? And have you correctly asses­sed the risks you’re facing at the moment?

Ask your finan­cial advisor.