An Introduction to Charity Investments

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An Introduction to Charity Investments

• By Paul Mitchell, September 2006

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Asset classes

• Cash
• Bonds
• Equities
• Property (Commercial)
• Hedge Funds
• Private Equity
• Commodities
• Structured Products

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Cash

• Capital guaranteed
• Capital available at short notice
• Rate of interest variable

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Cash

• Bank Deposit
• Term Deposits
• Active Cash Management
• Currency Factors
• Credit Ratings
• Duration

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Why hold cash?

• Safe haven
• To meet fixed obligations

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What is a bond?

• An I.O.U.
• Specified amounts
• to be paid on specified days
• Coupons regular interest payments
• Principal final repayment
• Maturity anywhere between 1 and 50 years

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Who issues bonds and why?

• Issued by
• governments, government sponsored agencies (EIB,
  World Bank etc.)
• corporates/companies
• Issued in order to
• finance a shortfall between revenue and
  expenditure (budget deficit)
• finance an acquisition or capital expenditure
  project

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Why hold bonds?

• Bonds provide
• high levels of certainty
• defined income stream
• lower risk, BUT
• lower prospective return
• risk depends on borrowers ability to pay
• the price of bonds is variable
• inflation erodes purchasing power
• Used for
• meeting near term payments/liabilities
• matching some longer term liabilities
• reducing risk

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Equities

• The risk bearing part of a companys capital
• Shareholders
• Own the company
• Have the right to elect dismiss Directors
• Share in the profits via dividends
• Vote on company policy
• Types
• Ordinary
• Convertible
• Deferred
• Preference

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Who issues equities?
World equity markets
1960 0.5 trillion
2005 21 trillion
Source FTSE
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Who issues equities?
Sectors using industry classification From 1900
Source UBS Global AM
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Why hold equities?

• Long term returns historically highest, reflect
  growth in profits
• But ... short term reflects expectations
• Uncertain long-term returns
• Volatility
• Diversification is critical
• Sensitivity to interest rates, inflation,
  economic and political events
• Used for
• long term capital growth

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But equities are highly volatile
UK Equity Returns versus RPI
Source UBS Global Asset Management, Pension Fund
Indicators
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Property

• Commercial
• Direct
• Pooled Funds
• Yield is important

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What are property assets?

• Offices, industrial sites and shops
• A yield rent from the occupier
• Capital growth
• But
• difficult and expensive to buy and sell
• diversification important and individual units
  large

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Why hold property?

• High Yield relative to other assets
• Low correlation with equities or bonds
• A good diversifier

Correlation2
Yields1

• 1 Source Datastream
• 2 Source Property Market Analysis

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Hedge Funds

• Target Absolute Return
• Different Strategies Include
• Relative Value
• Event Driven
• Long-Short Equity Hedged
• CTA/Managed Futures
• Macro Trading

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What are hedge funds?

• A catch all for non-traditional investment
  funds
• Typically they
• hedge something to some degree
• often gear
• charge incentive fees
• Wide spectrum in terms of
• investment style
• volatility and risk
• liquidity

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Hedge Fund Styles and Approach
Different styles within the asset class hedge
funds
Relative value

• Seeks to profit from the mispricing of related
  financial instruments (Fixed income arbitrage,
  convertible arbitrage)

Event driven

• Strategies which exploit special events in the
  financial markets (merger, distressed securities,
  special situations)

Long / short equity

• Directional trend following in equity markets and
  sectors

CTA / Managed futures

• Strategies that invest in financial and commodity
  futures markets and currency markets with a high
  leverage usually applied

CTA / Managed futures

• Opportunistic strategies using leverage and
  derivatives to enhance positions

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Hedge fund performance relative to other markets

• Glancing at the last 15 years, it is clear to see
  that hedge funds tend to perform when equity
  markets perform, and preserve capital when they
  fall

HFRI Fund of Funds Index returns benchmarked
against Equity and Bond indices January 1990 to
July 2005
Annual growth rate 1/1/90 31/07/05
350
9.9 pa
300
250
7.6 pa
200
Return
6.5 pa
150
100
50
0
-50
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan -90
HFRI Fund of Funds Index
JP Morgan Global Bond Index
MSCI World Equity Index
Source Hedge Fund Research Inc., Datastream
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Hedge fund performance relative to equities

• It can be seen that the excess performance does
  not come from outperforming in good years, but
  from protecting capital in poor years

Annual returns of MSCI World and HFRI Fund of
Funds IndicesJanuary 1990 to December
2005 Average quarterly total return ()
Source Hedge Fund Research Inc., DatastreamPast
performance is not a guide to future performance
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Private Equity

• Target Absolute Returns
• Long term investment in non quoted (private)
  companies
• Venture Capital
• Focused on building businesses
• Buyout Funds
• Buy majority control of mature businesses

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Why invest in private equity?

• Private equity offers investment opportunities
  denied to those who invest exclusively in Public
  Markets
• Private equity funds have outperformed other
  asset classes over the longer term
• Private equity investments seek Absolute Returns
  as opposed to tracking an index
• Private equity managers have a greater degree of
  control and influence over investments
• Private equity managers have more information
  prior to making an investment in a portfolio
  company
• Private equity can increase portfolio returns,
  diversification and can reduce portfolio
  volatility

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Why the interest in private equity?
Actual returns and consensus expectations
Med 15
Med 11
Med 4
Med 11
Source Goldman Sachs International and Russell
Investment Group Report on Alternative Investing
by Tax-Exempt Organisations, 2003 Note Data are
for European private equity
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Commodities

• Basic Raw Materials Foodstuffs
• Trading
• Spot market for immediate delivery
• Commodities Exchange for later delivery
• Generally obtain exposure via equity markets,
  pooled funds, or structured products

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Structured Products

• Protection
• For investors with a low risk tolerance looking
  for full or partial capital protection
• Risk of loss limited to the non guaranteed
  capital element
• Return potential higher than with comparable
  money market investment
• Recent Example
• Basket of top 20 UK equities by yield
• Capital protection of 100
• Participation of 94.75 of market upside
• Guaranteed yield of 4.02 with participation in
  growth
• 3 Year time period

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Risk a quote

He who is not courageous enough to take risks
will accomplish nothing Muhammad Ali

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Performance

• Benchmarks
• Industry standard - WM
• Composite
• Cash plus inflation
• Beware
• Compare Like with Like
• Capital Return
• Total return
• Relevance

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Understanding performance
What objective have you set?
How is your manager doing?
How did they achieve it?
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How is performance calculated?
?

• Percentage change in market value
• too simplistic
• ignores contributions/withdrawals to fund
• Money-weighted return
• change in market value, adjusted for cashflow
• assumes cashflows happen at mid point of period
• Time-weighted return
• change in value, adjusted for cashflow
• allows accurate day weighting of cashflows

?
?
Industry Standard
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Review

• Trustees Responsibility
• Quarterly Reports
• Annual review
• Separate Committee?

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Contact Details

• Paul Mitchell
• Associate Director
• UBS AG
• 1 Curzon Street
• London W1J 5UB
• Telephone [phone]
• E-mail paul-d.mitchell_at_ubs.com