Newton reports diminishing appetite for alternatives, despite green infrastructure and impact opportunities.
Almost nine in ten UK charities feel that ESG factors are important in the management of their portfolios, but shifts in asset allocations caused by external pressures have resulted in a degree of dislocation.
That’s the finding of Newton Investment Management’s 2022 Charity Investment Survey, which notes that charities continue to acknowledge and embrace ESG investment factors, primarily at the prompting of trustees.
De-risking in response to global events is narrowing allocations, however, with a decrease in investment to alternative markets despite there being growing interest in areas such as green energy infrastructure.
Risk appetite fall
The use of alternative investments in charity portfolios has continued to fall, with Newton’s latest findings marking the seventh consecutive year in which there has been a decline. Only 31% of charities using alternatives in 2022.
The proportion of charities that would consider the use of alternative investments in the future has also declined. Only 35% of charities that do not currently use alternatives would consider including them in their portfolios in the future – a 5% fall compared to 2021.
This finding goes against similar but global research by investment consultant Mercer. It found in its Global Not-for-Profit Investment Survey that charitable investors view private markets as the biggest opportunity for higher returns over the coming years, alongside the ability to embed ESG factors, with diversification away from traditional asset classes being high on the agenda for trustees.
Notably, the alternative space includes investments that span the ESG spectrum, from impact investments to green infrastructure, indicating a preference for ESG-earmarked capital to be invested along more traditional lines.
At present, almost half of charities see it as important to focus on energy security rather than prioritising net zero, Mercer said, and those investing in energy along sustainable lines reported being more willing to take a hit to their returns.
While private markets represent a fraction of the broader alternatives and ESG space, the findings of the two surveys paint a picture of the pressures being exerted on the charitable sector and how that is influencing investment decisions.
Paul Fleming, Head of UK Endowments and Foundations for Mercer, said, “Not-for-profits have come a long way towards embracing and investing in private markets, accelerated in recent years by turbulent uncertain markets. They are being forced to look beyond traditional asset classes for risk-adjusted returns.”
He said investors are doing so on the back of fewer barriers to such investment vehicles, while a rise in third-party services, such as ESG data and analytics support, is aiding trustees in venturing into non-traditional asset classes.
The size of the charity or foundation plays a pivotal role in this, both surveys found. Newton reported that the use of alternatives is more common among charities with assets under management of over £20 million than with smaller charities.
Charitable organisations with AUM of over £501 million are now the most likely to use such types of investment, with alternatives used by 67% of these largest charities.
Mercer’s survey found that organisations with portfolios of £1 billion or more are more likely to be invested in private markets (86%) compared with those with less than £250 million (40%).
The decline in allocations to alternatives is set to continue among those charities that are currently engaged with alternative investments, with anecdotal evidence suggesting an increasing focus in ESG considerations as a contributing factor.
All main sub-sections of alternative investments have seen reduced consideration this year, Newton found, with commodities seeing a particularly substantial decline, down from 43% in last year’s report to just 5% in 2022.
Pressure on trustees to engage with sustainable topics on this subject has risen this year – up to 37% from a low of 29% in 2021.
Engagement to the fore
Newton reported that engagement is once again the most popular way of considering ESG factors – chosen by 59% of charities, compared to only 27% that prefer divestment.
Trustees are also opting to utilise screening, with a modest increase in all types of commonly barred investments, besides armaments. The largest increase has been seen in gambling where exclusion rates have risen from 54% to 65% of all charities with an ethical exclusion policy.
Charities are looking to “future proof” their investment portfolios in light of broader societal changes, Newton noted, observing also that shifts in the expectations of charitable organisations themselves were feeding through into investment policy.
But longer-term upward trends in the consideration of ESG factors and sustainable investment appear to have stalled, as external pressures on charities begin to mount.
The proportion of charities that think it is their responsibility to think about climate change and to invest responsibly has declined slightly compared to last year, though still remains high at 78%. For context, 2019’s survey had 68% of charities viewing climate change as a responsibility.
Newton suggested that increased energy costs and geopolitical events are driving the emergence of pragmatism over charities’ investment aspirations.
While this may indicate a short-term reaction to global circumstances, rather than a reversion of the overall trend, the sapping of momentum from the space may indicate the start of a wider shift in priorities.
In part, this is evidenced by charities moving from a focus on ethical restrictions and low-carbon portfolios to a focus on investing in companies with broader sustainable business practices and goals, Newton suggested.
This means longer-term, slower-paced sustainable shifts are now viewed more favourably than an exclusionary approach to investing.
“Charities remain more positive over the medium and long term, and certain trends remain unchanged, with responsible investing and ethical considerations continuing to be important topics for charities as they come under increasing pressure from stakeholders,” said Rorie Evans, Head of Charity Clients at Newton Investment Management.