The Regulator for Charities in England and Wales
(Version February 2003)
1. This guidance sets out to explain the powers and duties of charity trustees when investing charitable funds.
2. In this guidance:
The Charities Act means the Charities Act 1993.
The Trustee Act means the Trustee Act 2000.
FSMA means the Financial Services and Markets Act 2000.
The general power of investment means the power of investment which is given to trustees by section 3 of the Trustee Act, taken together with the power to invest in land which is given to trustees by section 8 of that Act.
Governing document means any document setting out the charity’s purposes and, usually, how it is to be administered. It may be a trust deed, constitution, memorandum and articles of Association, will, conveyance, Royal Charter, Charity Commission or Court Scheme, or any other document which describes the trusts of the charity.
The expression "trust instrument" is used in the Trustee Act and in this guidance to describe certain types of governing document. "Trust instrument" includes a trust deed, will, declaration of trust, constitution, or Royal Charter. But the trusts of some charities are set out in Acts of Parliament or subordinate legislation. Neither an Act of Parliament nor subordinate legislation is a "trust instrument".
Trustees means charity trustees. Charity trustees are the individuals or corporate bodies who, under the charity’s governing document, are responsible for the general control and management of the administration of the charity. In the charity’s governing document they may be called trustees, managing trustees, committee members, governors, council members or directors, or they may be referred to by some other title.
A nominee is someone who holds the legal title to the property of a charity (or some part of that property) on behalf of the charity or its trustees. The nominee is the person whose name will be entered on the share register of any company whose shares are owned by the charity. In the case of registered land, the nominee is the person whose name is entered in the proprietorship register. Nominees have no power to make management decisions and must act on the lawful instructions of the trustees.
A custodian is someone who, on behalf of the trustees as a whole, looks after assets of the charity, typically the documents or other evidence of the title to its property - for example share and land certificates. The expression "custodian" is, however, sometimes used to describe a person who is both a nominee and a custodian, and who may also provide a charity with other administrative services which are related to those provided by a nominee or custodian.
A custodian trustee has the functions of both a nominee and a custodian. The powers and duties of a custodian trustee, and the relationship between the charity trustees and the custodian trustee, are set out in the Public Trustee Act 1906.
Investment manager means an individual or a corporate body appointed by a charity or its trustees to advise and make investment decisions on behalf of the charity. The investment manager will make those decisions within the framework of an investment policy which the trustees have formulated.
Collective investment scheme (as defined by s.235 of FSMA) means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income. The arrangements must have either or both of the following characteristics:
Unit trusts and common investment funds are examples of collective investment schemes. In each case money contributed to the scheme by investors is pooled, and the operator of the scheme typically invests the money in a range of investments, in accordance with the published policy of the scheme.
All the money and investments in a unit trust or common investment fund belong jointly to the contributors. The size of each share is determined by the number of "units" each contributor owns. The number of units which each contributor owns is determined by the proportion which the value of his contribution bears to the total value of the assets in the scheme at the time when the contribution is made. Investment returns are allocated to unit-holders in the same proportions. The risk of particular investments falling in value is spread across all the holders of units in the fund, as they each are joint owners of all the investments in the scheme.
Pooling schemes are arrangements to facilitate investment management by a charity trustee, or body of charity trustees, with a number of different charities to administer. They are technically a type of common investment fund, and so are collective investment schemes, but are not regarded as such for the purposes of this guidance.
Derivatives are financial instruments, such as options and futures, whose value is dependent on, or originates from, price movements in other assets specified in the derivatives instrument. These other assets could take the form of currencies, equities, equity indices, fixed-income indices, interest rates, bonds and/or any combination of these.
Land includes any building(s) on the land.
Must or need to are used to refer to actions that trustees, or their agents or employees, are required to take, by law, or under the charity’s governing document.
Where we use terms such as the trustees should or we suggest, recommend or advise we are referring to actions which the trustees, their agents or employees could take and which we consider to be good practice, but which are not legal requirements.
3. Clearly the general power of "investment", or any other power of "investment" which is available to the trustees of a charity, can only be used to authorise the generation of resources by means of an activity which is legally regarded as "investment".
4. The term "investment" is not defined by the Trustee Act. The boundaries of what constitutes an "investment", as interpreted by the Courts, are not static. The key Court decisions in this developing process pre-date the Trustee Act, but they still influence judgements about how the term "investment" should be interpreted when used in that Act.
5. The definition of "investment" given in FSMA determines the scope of regulation under that Act. It is not the same as the concept of "investment" for the purposes of trust law, and cannot therefore be relied upon as a definition for the purposes of deciding what is an "investment" for the purposes of trust law.
6. "Investment" is simply one of a number of methods of generating resources. There are other methods of generating resources which are not "investment", such as the sale of goods and services (trading), gambling, and seeking donations through fund-raising activities.
7. What matters when defining an "investment" asset is the purpose for which the asset is acquired. An asset acquired for the purpose of exercising a trade, or gambling, is not an investment, even though the objective is to generate a financial return. On the other hand, an asset such as a share in a company may be acquired for the purpose of "investment", even though the expectation of financial return lies more in the prospect of being able to sell the share for a higher price than was paid for it than in the dividends to which ownership of the share gives entitlement. The aim of the following paragraphs is to explain the Commission’s view of the distinction between investment, on the one hand, and other forms of income generation, such as trading, which may seem to have some similarities to investment. The distinction is important because, in the case of charities:
8. In order that an asset can be regarded as an "investment", funds must at some stage have been provided by an investor to an "investee". This expression is used in this guidance to describe someone who agrees to provide some form of benefit in return for the use of funds provided by the "investor". Whilst ownership of an investment asset may change many times, whoever owns such an asset at any particular time can be regarded as an "investor". The benefit to the investor can take a number of different forms. For example, it can take the form of:
9. What investees do with the funds which they have received does not affect whether the provision of those funds is "investment". The purchase of a share in a company is still an "investment", even though the company is, say, part of the gambling industry. Similarly units in collective investment schemes are "investments", even though (as for example may be the case with hedge funds) the managers generate resources for distribution to unit-holders through activities which are not in themselves "investment", and which may involve a considerable amount of risk.
10. For the purposes of this guidance, if there is no "investee" in the sense indicated above, there is no "investment".
11.The following are typical examples of investment assets:
12. There is no "investee" where trustees simply purchase an asset in the speculative hope that they will eventually be able to obtain a higher price from a purchaser than they have paid for the asset, or where the trustees are, in substance, merely gambling with the charity’s funds. For example, the following would not be regarded as investment assets:
13. Programme-related or social investment ("PRI") is not "investment" at all, in the sense in which the word "investment" is used in this guidance. PRI is a method of carrying out the objects of a charity, even though the way in which this is done may resemble "investment" by the charity. This view is shared by the Inland Revenue, who similarly do not regard PRI as investment at all for tax purposes. A PRI is treated for tax purposes in a similar way to a grant - qualifying expenditure as long as it is in furtherance of the charity’s objects. We have issued separate guidance on Charities and social investment. This is available on the "Supporting Charities" section of our website under "Useful Guidelines". The duties associated with investment by charities (set out in section E below) do not apply to PRI.
14. The trustees of some charities purchase small holdings of shares in particular companies with a view specifically to acquiring the rights of members, eg to participate in general meetings and thereby to influence the way in which the company conducts its business. If this sort of advocacy is within the objects of the charity, then this is a form of PRI.
15. Although derivatives are not intrinsically "investments", the use of derivatives may be authorised by the general power of investment, when that use is "ancillary" to the investment process.
16. For the use of derivatives to be "ancillary" to the investment process the following conditions must be satisfied:
If the related investment transaction is one which is proposed for the future, but the proposal is then changed or abandoned, the derivative transaction may, as a consequence, cease to be "ancillary". In such a case the charity should normally "close out" or withdraw from the derivative transaction as soon as it is economically sensible to do so. What this means is explained in paragraph 17. In other instances it may be necessary to enter into a new derivative transaction, or to terminate or restructure an existing one, if the nature of the related intended investment transaction itself changes. A derivative transaction may be ancillary to more than one investment transaction, and more than one derivative transaction may be ancillary to a single investment transaction. Different derivative transactions may be ancillary to a single investment transaction even though they are entered into at different times.
17. The following are given as examples of situations in which the use of derivatives is ancillary to the investment process.
What if there is a change of plan after 3 months, and the charity decides that it no longer will need to raise cash at the end of the 6 month period? The charity should normally then consider selling the put options as soon as it is economically sensible to do so, as the derivative transaction will no longer have any related intended investment transaction.
18. Anti avoidance tax measures apply to the use of derivatives by charities - see Section L below.
19. The majority of derivative use by charities will be treated as investment by the Inland Revenue. However, some transactions in derivatives may be regarded as trading and any profits may not be exempt from tax. It is also possible that the profits arising from some other derivative contracts entered into by non-corporate charities will not be exempt from tax. The comments made in section E below about the need to take professional advice extend to the consideration of these tax issues where trustees are proposing to enter into any derivative contracts.
20. The power of investment set out in section 3 of the Trustee Act allows trustees to invest trust funds in any kind of investment, excluding land, in which they could invest if they were the absolute owner of those funds. This is the automatic power that trustees will have (subject to what is said in paragraph 22) where there is no provision in the charity's governing document which restricts or excludes the power. This power of investment is available to a corporate trustee as well as to an individual trustee or to a body of individual trustees. Constitutional or statutory limitations on the investment powers of a particular corporate trustee relating to the management of its corporate property do not apply to the management of property it holds on trust. This point is particularly relevant to NHS Trusts, which do have statutory limitations on the way in which they invest their corporate property.
21. Although land is excluded from the power of investment in section 3 of the Trustee Act, trustees are, in section 8, given a power to acquire as an investment freehold or leasehold land in the United Kingdom. This is available on the same basis as the power in section 3. The expression "general power of investment" is used in this guidance to refer to the powers conferred by sections 3 and 8. The Trustee Act does not authorise the purchase of land outside the United Kingdom as an investment – some other power will be required to authorise that. Nor does it authorise the purchase of anything other than a legal estate in land (as defined in the Law of Property Act 1925), or equivalents in Scotland and Northern Ireland.
22. The general power of investment is potentially available to the trustees of any charity, the assets of which are held on a trust. This includes charitable unincorporated associations, charitable trusts, charities governed by Scheme, charities governed by Royal Charter and unincorporated charities governed by Act of Parliament and other legislation. The general power of investment is available to the trustees of pooling schemes, but is not available in the case of the following types of charity property:
23. Where the general power of investment is potentially available, it is only restricted or excluded where the governing document contains a provision which has this effect. It follows that if the governing document contains no express provision relating to investment, the general power is available.
24. The governing document of a charity will sometimes provide that the trustees' powers of investment are as prescribed by law for the time being. The trustees of such a charity will have the general power of investment.
25. A provision in the governing document of a charity will only be a "restriction or exclusion" (see below) if it is intended to prevent the trustees from making a particular form of investment which would be within the scope of the general power, or if it is intended to apply a procedural restriction to the making of an investment (for example, a requirement of consent from the person who set the charity up).
26. Substantive provisions which are "restrictions or exclusions" – ie provisions which actually prohibit particular forms of investment - are likely to be rare outside the area of ethical investment, which is discussed in section F below. In all cases, the restrictions or exclusions will have the effect of limiting or excluding the general power of investment, however they are actually expressed in the governing document of the charity.
27. For example, an express power in a governing document made on or after 3 August 1961 (the date when the Trustee Investments Act 1961 came into force) which says that the trustees cannot invest in companies where more than 25% of the turnover in the last financial year was derived from the sale of alcohol or tobacco related products would be a "restriction". It would limit the scope of the general power of investment by excluding consideration of the shares of those companies.
28. A particular investment provision may be partly a "restriction or exclusion" and partly not. An express power to invest "in shares quoted on the London Stock Exchange, but not in shares of X plc" would now be taken simply to restrict the availability of the general power of investment by excluding consideration of the shares of X plc. It would not prevent investment in shares not quoted on the London Stock Exchange – that aspect of the provision is part of an enabling power rather than a prohibition.
29. A positive direction in a governing document only to invest in a particular way (eg only in the shares of X or Y plc) is a "restriction or exclusion" of investment in any other way. Such a direction may be effective (unless it is contained in a trust instrument which took effect before 3 August 1961). However, the Courts would not, in our view, give effect to restrictions or exclusions which were so extensive that they prevented trustees from discharging the duties referred to in paragraph 51.
30. Procedural restrictions – for example a provision requiring the consent of the charity founder to the making or retention of an investment – are effective, unless they are contained in a trust instrument which was made before 3 August 1961.
31. The following provisions are not, or are deemed not to be, "restrictions or exclusions", and the general power of investment is available.
A provision which is simply part of the definition of a power of investment intended to be wider than the statutory power in force at the time when the provision was made.
32. These provisions are very common in practice. They may be contained in Schemes made by us or the Court, or they may be included in a trust deed or other governing document by the person or people who set up the charity.
33. Until the Trustee Act took effect, trustees were restricted to the investment powers contained in the Trustee Investments Act 1961, and in other legislation, such as the power in the Charities Act to invest in common investment funds, unless the governing document(s) gave the trustees wider powers of investment. The powers contained in the 1961 Act had, for many years, been regarded by many as too restrictive for modern circumstances. Under the 1961 Act, trustees were compelled to divide the investment funds between narrower and wider range investments, if they wanted to make any investment at all which was not within the narrower range. Typically, narrower range investments were interest-bearing securities and wider range investments were dividend-bearing securities. Strict rules applied to the division of funds between the ranges. Strict rules also applied to the identification of the investments which might be acquired in each of the two ranges.
34. As a result, many people setting up charities extended the powers of investment available to the trustees by specific provisions in the charity’s governing document. In addition, some charities acquired wider powers of investment by Schemes made by the Court or by us. These wider powers often included some specific qualifications – the powers were not always as wide as the general power of investment. For example, some powers were based on the Trustee Investments Act idea of a split between a "safer" and a "more risky" range of investments, but the proportions were often different, and the actual investments capable of being selected within each range were usually more extensive. But the qualifications were simply part of the definition of the wider power being given. They are not "restrictions or exclusions" for the purposes of the Trustee Act.
A provision in a power of investment which merely sets out to explain its effect
35. This point is particularly significant when looking at whether a power of "investment" can authorise the use of derivatives. Some wide powers of investment which we have given by Scheme are in terms similar to the general power of investment, except they specifically state that the powers given do not authorise the use of derivatives.
36. At the time these Schemes were made, the view was taken that that the use of derivatives could not be a part of the process of "investment" at all. Such use needed to be explicitly authorised. These provisions reflect this view, and were essentially declaratory. But declaratory statements are not a "restriction or exclusion" for the purposes of the general power of investment. As indicated above, we consider that the general power of investment does authorise the use of derivatives in the circumstances specified in paragraph 16.
Any investment provision contained in a trust instrument which was made before 3 August 1961
37. These provisions are deemed not to be "restrictions or exclusions". However, if the governing document of a charity is not a "trust instrument" ie it is an Act of Parliament or delegated legislation, there is no such deeming provision. If a provision in the relevant legislation is a "restriction or exclusion", it will operate to restrict the general power of investment. This is so whether the legislation came into force before or after 3 August 1961.
38. One of the effects of the Trustee Act is that charity trustees having the general power of investment will be able generally to make "shared-control" investments (that is, investments in which the charity is joint owner with one or more other charities or individuals or non-charitable bodies). Previously, most trustees had the power to invest in at least some forms of collective investment scheme. But trust law generally required trustees to confine the investments of any particular trust to those which were under their sole control, as trustees of that trust, unless they had explicit authority to do otherwise. This meant, for example, that trustees administering two or more trusts had to keep the investment portfolio of each of those trusts separate, unless they had explicit authority to do otherwise. Trustees had no general power to amalgamate the investment portfolios of the separate funds which they administered, and treat each fund as having a percentage interest in the portfolio as a whole.
39. The basis for the rule prohibiting shared control investments was that trustees were expected to exercise an individual discretion in relation to the investment of the funds belonging to that trust. The exercise of such individual discretion was, of course, incompatible with the consideration of the needs of a joint owner: one effect of this was that trustees were prevented from putting funds from different trusts into a common investment pool, without an explicit authority such as a pooling scheme.
40. It is, however, now generally recognised that the consolidation of investments belonging to different trusts under the management of the same trustee or body of trustees is, in many cases, of greater advantage to the beneficiaries than preserving the ability of the trustees to pursue a separate investment policy in relation to the funds of each individual trust under management. As trustees now have the investment power of a beneficial owner, they can clearly do this. They can also now make investments jointly with other bodies of charity trustees, or with individuals or non-charities.
41. There are, of course, still advantages to be obtained, in some circumstances, from the making of shared control investments through the medium of a collective investment scheme. The investments in the scheme will be professionally managed on behalf of the participants, who are not directly responsible for making or reviewing those investments. The proprietary and contractual rights of the participants, including the machinery for liquidating their investment, will be clearly defined by the scheme. Tax considerations may also be relevant: for example common investment funds are themselves treated as charities for tax purposes.
42. The general power of investment is in addition to any express (or other statutory) powers which the trustees have. But, because of the breadth of the general power, express powers are unlikely to have much significance now, except in relation to investment in land outside the United Kingdom, and except in those cases where the general power cannot be available, or has been restricted or excluded.
43. As indicated above, the general power of investment cannot be available in the case of the property of common investment funds and common deposit funds. However, we will include express powers of investment in all Schemes we prepare which establish common investment funds and common deposit funds.
44. The general power of investment cannot be available in the case of the corporate property of charitable companies, but express powers of investment are normally included in the memoranda of association of charitable companies. They are usually expressed in terms similar to those of the general power of investment.
45. A provision in a memorandum of association to the effect that the powers of investment are those prescribed by law would, as a matter of construction, give the general power of investment to the directors of the company. But a provision which specifically gave the directors the powers of investment in the Trustee Investments Act 1961 would need to be altered before the directors could use the general power of investment. The alteration would require to be made by special resolution: we are prepared routinely to give the consent which is required under section 64(2) of the 1993 Act.
46. Trustees can only invest within the scope of the powers of investment available to them, and are likely to be liable for losses which arise if they do not.
47. The other duties associated with the investment of property which is held on trust are now largely set out in the Trustee Act, in those cases where the Act applies. There are specific duties associated with the use of any power of investment of trust property (except in the case of the property of common investment funds and common deposit funds). The duties are not associated only with the use of the general power of investment. These duties cannot be excluded or restricted by provisions in the governing document of a charity.
48. None of the duties in the Trustee Act applies directly to the investment of the corporate property of charitable companies. But it seems likely that the Courts would decide that comparable common law duties do apply to the directors of charitable companies.
49. There is a general duty of care (in section 1 of the Trustee Act) attaching both to the use of any power of investment (this does apply to the use by the operators of common investment funds and common deposit funds of their powers of investment) and to the discharge of the specific duties. But the duty of care can, within certain limits, be lowered by the person or people who set a charity up. This would be done by including explicit provision to this effect in the governing document of the charity.
50. The duty of care is the duty to exercise such care and skill as is reasonable in the circumstances having particular regard to:
52. The "exception" is that a trustee need not obtain such advice if he or she reasonably concludes that, in all the circumstances, it is unnecessary or inappropriate to do so. For example, where a trustee is himself or herself sufficiently expert in matters of investment, it would be otiose for him or her to obtain advice from someone else. And, in practical terms, the investment discretions of the trustees may be so limited by the small size of the funds available for investment, that looking for investment advice would be pointless, or not cost effective.
53. For example, the trustees of local charities investing a moderate income reserve may have no realistic investment choice other than to deposit their funds at a high street bank or building society. But where there is a choice, it is not possible to offer specific guidance on the size of the funds available for investment below which investment advice need not be taken. There are too many variables. For example, trustees with some investment knowledge are likely to set a higher threshold than trustees with little or none. Some bodies of trustees may have readier access to investment advice than others; this consideration may affect the question whether or not they should take investment advice.
54. The statutory duty to consider "suitability" exists separately at the level of asset allocation and at the level of stock selection. The duty will, therefore, include:
55. In the case of charities with permanent endowment, the duty to consider suitability also involves recognising the implications of the duty to be even-handed between the interests of present and future beneficiaries of the charity. Permanent endowment in the present context means funds which are held on trust for investment, the income alone being applicable for the purposes of the charity.
56. Where a charity has an ethical or socially responsible investment policy (see section F below), the duty to consider suitability involves recognising the need for consistency with that policy.
57. The object of "diversification" of investments is, of course, to reduce the risk of the loss that might result from concentration on a particular investment, or type of investment, which then falls in value. The extent to which diversification is practicable will depend on the amount of resources which are available for investment, and, in some cases, on the nature of the investment assets which are currently held.
58. "Proper advice" is the advice of a person who is reasonably believed by the trustee to be qualified to give it by his ability in and practical experience of financial and other matters relating to the investment which it is proposed to make or retain. The adviser may or may not be another trustee. If one or more of the trustees of the charity can satisfy the other trustees of their financial ability and experience, then they may provide the advice. Any trustee who proposes to do so, however, needs to bear in mind that he will be assuming a specific responsibility for the quality of the advice which he offers to the other trustees. That trustee may, like any other adviser, incur a liability to the trust, if loss results from negligently given advice
59. The trustees who receive advice from a fellow trustee also have a responsibility here. They need to consider objectively whether or not it is, in fact, in the charity’s interests to take advice from a fellow trustee rather than from an individual or firm who is not connected with the charity. They may feel that an adviser who is not connected with the charity may more easily be held to account for the adverse consequences of negligently given advice.
60. What is a suitable qualification for the adviser will depend on the extent and nature of the assets available for investment. The giving of investment advice may be (but is not always) a regulated activity under FSMA, and a person who requires authority under that Act to provide investment advice, but does not have it, may be committing an offence. But the Trustee Act does not require that the adviser should be qualified to provide advice under the provisions of FSMA. "Proper advice" may in certain circumstances be given by people who are not regulated under this Act, for example, people who are providing the advice otherwise than by way of business, or who are advising on investment in land.
61. FSMA draws a distinction between regulated advisers who can provide advice on the whole universe of investment products, and those who can provide advice only in relation to the products of a particular company or group. The Trustee Act does not make any such distinction. But it is considered that a "tied" adviser is unlikely to be qualified as required by that Act, unless he gives advice in conjunction with someone who is able to consider the merits of a broader range of investments.
62. There are essentially two aspects to the consideration of risk: counterparty risk and investment risk.
63. Counterparty risk is the risk that one of the firms with which the charity does investment business – bank, stockbroker, investment manager - will default on its contractual obligations. The risk of loss is perhaps low in a climate where financial services are closely regulated, and where compensation schemes are in place, but this does not, by any means, cover the whole investment universe. Trustees may be more or less concerned with this issue, depending on the nature and extent of the investments which they make. But they should not lose sight of the possibility of counterparty default, and of the need to assess and manage the risk in the context of their particular investment strategy.
64. Investment risk is the risk which is inherent in any investment. At one level, the risk may be seen as lying in the failure or under-performance of a particular investment, but this risk can, obviously, be mitigated by having a suitably diversified portfolio.
65. The effect of the duties described in paragraph 51 is that investment portfolios which are constructed by trustees should be of a non-speculative nature. The Courts have on many occasions made it clear that speculative forms of investment are not "suitable" for trustees. But what is "speculation" is a matter which needs to be considered in the context of the investment portfolio of the charity as a whole. An investment may, in isolation, seem highly speculative. But in the context of the portfolio as a whole the same investment may be seen as a proper part of the process of limiting the overall risk.
66. The duty to avoid speculation does not mean that security of return is the only consideration which matters in the construction of a charity investment portfolio. It is a question of striking a rational balance between security of return and level of return, in the context of the operational needs of a particular charity.
67. The Trustee Act requires the objective consideration of the suitability and diversification points mentioned above. There are a number of areas where difficulties can arise here:
Retaining investments which have been donated to a charity, rather than purchased by it
68. Recent tax legislation has provided incentives to donors to charity of land and certain other types of investment (eg quoted shares), provided that the gifts are accepted by the charity. But the Trustee Act duty to consider whether investments belonging to a charity should be retained or varied – having regard to the suitability and diversification points referred to in paragraph 51 - extends to investments which have been given to a charity as well as to investments which have been purchased by the charity trustees. The Act simply refers here to the "investments of a trust".
69. Provisions which purport to modify the duty to review, or the duty to consider the suitability and diversification issues mentioned in paragraph 51, are sometimes found in the governing documents of charities which have received gifts of shares. Such provisions have no legal effect.
70. Nor does the fact that the donor has some control over the decision of the trustees whether to vary or retain the investment affect the nature of the trustees’ duties. Donors must exercise any powers available to them in this connection in the interests of the charity. They cannot, for example, withhold consent to a proposed change of investment because they see it as being in their own personal interests to do so.
71. But the question whether it is in the interests of a charity to vary investments which have been donated to it may involve a wider range of considerations than the question whether it is in the interests of a charity to vary investments which the trustees have purchased. Would donors be discouraged by a disposal of the investments which they have given from making further gifts to the charity? Are the investments which have been given of a nature which makes changing them practicable? Will the true value of the investments given be realised on a disposal, or will this only be achievable by holding on to the investments for a period?
Making or retaining investments in companies which are wholly or substantially owned by the charity
72. The making of investments in companies which are owned wholly or substantially by the charity is within the scope of the general power of investment. But the suitability and diversification considerations apply as much to this form of investment as to any other. So does the duty to take "proper advice".
73. Experience suggests that some trustees lose sight of this, and become committed to the support of the connected company, regardless of whether, considered objectively, it is in the interests of the charity to make or retain an investment in that company. Investing in a company which is not economically viable, and has no real prospect of becoming so, involves a failure on the part of the trustees to discharge their duties with regard to investment. This applies more strongly where the only object in making the investment is to prevent the company from going into insolvent liquidation. We offer detailed guidance on investment in connected companies in our booklet Charities and Trading (CC35), which can be obtained from us in hard copy or viewed in the Publications section of our website. It should also be noted that the Inland Revenue looks critically at investments in, and loans to, trading companies, where the investments/loans are made by a charity in a trading company connected with the charity. In particular, investments that are made to prop up an ailing connected trading company may not be considered to be made for the financial benefit of the charity: this may have the consequences referred to in section L below.
Making or purchasing investments in companies in which the charity trustees, or people connected with them, have distinct private interests
74. A decision on the part of trustees to make or purchase investments in a company in which they, or people connected with them, have significant personal interests, may give the charity the right to choose between keeping the investment or requiring the conflicted trustee (or, in some cases, the investee) to purchase the investment at the price paid by the charity. The conflicted trustee may also be liable to account to the charity for any private profit which that trustee has made as the result of the charity making the investment. Trustees contemplating an investment of this nature should always seek our advice. Again it should be noted that the Inland Revenue looks critically at investments made by a charity in companies connected with the trustees of that charity, or in which those trustees, or their associates, have a significant personal interest. The Revenue will have to consider whether the investments are made for the financial benefit of the charity. Making the investments for some other purpose may have the consequences referred to in Section L below.
75. Some permanently endowed charities have been authorised by us to adopt a total return approach to investment. The effect is to give the trustees greater flexibility in the allocation of investment returns between the trust for investment and the trust for application for the purposes of the charity. The trustees are not subject to a rigid code for determining which investment returns are "income" and which are "capital", as would otherwise be the case. They are subject instead to a general duty to be even-handed between the interests of present and future beneficiaries" in the allocation of investment returns.
76. Trustees who adopt the total return approach will have to recognise their responsibility to protect the interests of both present and future beneficiaries when deciding on the investments which they should make or retain. But they will be able to focus on investments which are expected to give optimal performance in terms of their overall return, rather than on investments which will give the "right" balance of capital and income returns under the normal rules for determining which investment returns are income and which are capital.
77. More details on the total return approach may be found in our guidance OG83, written primarily for our staff. This is available on the "Operational Guidance" section of our website.
78. Following the normal rules for the analysis of investment returns between capital and income will normally present no difficulties to trustees, if the invested fund is itself expendable for the charity’s purposes.
79. The duties referred to above, as regards the selection and retention of investments, apply as much to the selection and retention of investments in collective investment schemes as to any other form of investment. But the duties do not extend to the consideration of the investments which are made by the operators of the scheme.
80. "Ethical investment" is a wide phrase which is used to cover many different approaches to investment strategy. An ethical investment policy may involve looking for companies which demonstrate best practice in areas like environmental protection, employment and human rights, or for companies whose businesses contribute directly to a cleaner environment or healthier society. Or it may involve negative screening, to avoid investments in a particular business or sector. Many ethical investors and ethical investment funds adopt a combination of positive and negative criteria.
81. "Socially responsible investment" (SRI) is often used as a synonym for ethical investment, although it can also be used to describe a particular ethical approach. Ethical investment and SRI both need to be distinguished from social investment – see paragraph 13 above. Social investment is not investment in the ordinary financial sense at all. Ethical investment is investment in the financial sense, and the duties referred to in section E apply to it.
82. The governing document of a charity sometimes imposes ethical restrictions on the scope of the general power of investment. These restrictions cannot, consistently with the body being regarded as a charity, go beyond those which are compatible with the principles which are discussed in this section. Such restrictions must, of course, be observed by trustees.
83. More commonly, it will be the trustees themselves who decide to adopt an ethical investment policy. In doing so, they need to keep in mind the underlying principle that their power of investment has to be used to further the purposes of the trust, and that those purposes will normally be best served by seeking the maximum return consistent with commercial prudence. As the Judge put it in the case of Harries (Bishop of Oxford) v Church Commissioners [1992] 1 WLR 1241 (commonly known as the Bishop of Oxford case), "most charities need money; and the more of it there is available, the more the trustees can seek to accomplish".
84. An ethical investment policy may be entirely consistent with this principle of seeking the best returns. For example, there is an increasingly held view that companies which act in a socially responsible way are more likely to flourish and to deliver the best long term balance between risk and return. Trustees are free to adopt any ethical investment policy which they reasonably believe will provide the best balance of risk and reward for their charity. As with any other investment strategy, they must be careful to discharge the duties referred to in section E. In particular, they must consider the need for diversification and must take advice where appropriate.
85. The next question is how far trustees can allow their investment strategy to be governed by considerations other than the level of investment return. The Bishop of Oxford case recognised three situations where they can properly do so.
86. First, there are cases where investment in a particular type of business would conflict with the aims of the charity. A charity with objects for the protection of the environment and wildlife may decide not to invest in businesses which pollute what the charity is trying to protect. But the point here is a practical conflict with the charity’s aims and activities; not just moral disapproval. Where the judgment is a moral one, the trustees’ room for manoeuvre is more limited, as explained below.
89. Secondly, a charity can avoid investments which might hamper its work, either by making potential beneficiaries unwilling to be helped because of the source of the charity’s money, or by alienating supporters. This requires a balancing exercise. On one side are the difficulties which the charity would encounter, or the likely cost of lost support, if it were to hold the investments. On the other side there may be a risk of financial underperformance if those investments are excluded from its portfolio. The greater the risk of underperformance, the more certain the trustees need to be of the countervailing disadvantages to the charity before they incur that risk.
90. Thirdly, even if an investment does not come into either of the previous two categories, trustees can accommodate the views of those who consider it to be inappropriate on moral grounds, provided that they are satisfied that this would not involve "a risk of significant financial detriment". In many cases, trustees may be able to conclude, after taking advice where appropriate, that a particular ethical policy is likely to perform as well as an unrestricted policy. But trustees are not free to use their investment powers to make moral statements at the expense of their charity.
91. The key here is for charities to make a judgment in the light of their own circumstances, rather than trying to conform to a supposedly homogeneous "public opinion". Here are some pointers for trustees:
92. Since July 2000 some pension fund trustees have been required by law to state in their statement of investment principles "the extent (if any) to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments", and "their policy (if any) in relation to the exercise of rights (including voting rights) attaching to investments".
93. In its Report "Private Action: Public Benefit", the Cabinet Office’s Strategy Unit has recommended that the trustees of larger charities should be required to make similar disclosures in their annual reports. They have also expressed the view that it would be good practice for all charities to make such disclosures even where not required to do so. Whilst there is, at present, no legal requirement on any charity trustees to do this, it would be good practice to include such information in the charity’s annual report.
94. These are within the scope of the general power of investment, although they were not within the powers in the Trustee Investments Act 1961. In certain circumstances, deposits qualify for statutory protection against default by the institution with which the deposit is made: trustees need to bear this in mind when making choices.
95. The deposit should ordinarily be in an interest-bearing account, unless the intention is to find a use or an investment for the money within a very short period, or unless retention in a non-interest bearing account is part of an arrangement with the bank to keep down bank charges. If the income of a charity is placed in a non interest-bearing account for lengthy periods the Inland Revenue may question whether it is being applied for charitable purposes and challenge any claim to tax exemption.
96. Investment in land in the United Kingdom is authorised by section 8 of the Trustee Act, although many trustees will already have had the power to invest in land, either from their governing document(s), or from the Trusts of Land and Appointment of Trustees Act 1996. Investment in land sometimes appears an attractive asset class, but trustees of charities wishing to invest in this way should consider all of the following points before doing so:
97. Investment in land is not the same thing as the commercial development of land. The purchase and development of land with a view to sale is not "investment", as is explained in paragraph 12 above. It is the exercise of a trade.
98. Hedge funds are typically set up as collective investment schemes, managed offshore in what is often a substantially unregulated environment. The purchase of units in such schemes is within the general power of investment, but the resource generating strategies of hedge funds are diverse, and may involve a considerable element of risk. Hedge funds are typically highly leveraged, and this has the potential to exaggerate the gains or losses which can result from investment in them. The liquidity difficulties referred to below as a risk of investment in private equity can also arise in connection with investment in hedge funds.
99. The risks may, to some extent, be balanced or mitigated by investment in a collective investment scheme which itself invests in a number of different hedge funds, thereby gaining access to diverse income-generating strategies. Claims are made that the careful construction of a hedge fund portfolio, whether directly, or through a fund-of-funds approach, can balance or mitigate the risks of a portfolio based on stock exchange and other investments. These claims are based on the view that certain hedge fund returns are disconnected from movements in stock exchange indices. Investment in hedge funds may be "suitable" for a charity, but it is likely that it would only be so as a small part of a well-diversified investment portfolio.
100. Hedge funds are a complex form of investment, where the practical implications of the duty to review (see paragraph 51) may be considerably more onerous than is the case with other forms of investment. Expert advice in connection with the selection and review of hedge funds as an investment is essential, but may be difficult and/or costly to obtain.
101. Anti-avoidance tax measures apply to investment by charities in hedge funds – see section L below. The tax treatment of investment in, and returns from, hedge funds can depend on the precise details of the fund and the interest in it. In particular, the investment and return may not come within the tax exemptions provided for charities. The comments made in section E about the need to take professional advice extend to the consideration of these tax issues where trustees are proposing to invest in hedge funds.
102. Investment in private equity – ie company shares which are not traded on a stock exchange – either directly, or through the use of collective investment schemes, is within the general power of investment.
103. Some concerns over investment in private equity which is connected with the charity, and/or its founder or trustees have already been discussed in the "need for objectivity" paragraphs in section E. However, there are "suitability" and "diversification" considerations which affect investment in private equity generally.
104. Private equity may offer the opportunity for higher rewards than might be obtained from shares which are quoted on a stock exchange, but sometimes at greater risk, and expense. The risk may be balanced or mitigated by gaining access to a number of different private equity investments, but, in practice, it may only be possible to achieve this by investing in a collective investment scheme which specialises in private equity.
105. Direct investment in private equity has the disadvantage that the investees rather than the trustees are likely to have the greater control over the timing of investment return, because of share transfer restrictions, and the lack of a ready market for unquoted shares. This may mean that:
106. Anti-avoidance tax measures apply to investment by charities in private equity – see section L below.
107. Investment in private equity is another form of investment where the practical implications of the duty to review may be considerably more onerous than is the case with other forms of investment. Expert advice but may be difficult and/or costly to obtain.
108. This is the subscription for shares conditionally on the non-subscription of the shares by others. It is within the ambit of the general power of investment, but the number of shares acquired by the charity as underwriter will be dictated by circumstances outside its control. If the charity acquires any shares it is likely to be at a price which exceeds that at which the shares could be purchased in the market.
109. These considerations will be relevant to the question whether the conditional subscription is compatible with the proper discharge of the duties referred to in section E. Those duties will not have been discharged if the purpose is simply speculative, balancing the commission payable by the share issuer against the loss resulting from possibly having to sell the subscribed shares at a discount. Any commission income is taxable under Case I or Case VI of schedule D (section 18 of the Income and Corporation Taxes Act 1988) and there is only limited relief available for charities under these cases.
110. The lending of money for an economic return, whether in the form of interest or otherwise, is within the general power of investment. This is unless the lender is a bank or is otherwise engaged in lending as a business; the process of lending will then be a trade.
111. There is no difference in principle between the lending of money and the lending of stock. In both cases, the "investee" gets the legal ownership of the asset which he has borrowed, and makes use of that asset for his own purposes, subject to the terms of the contract between the lender and the borrower.
112. Stock-lending fees are taxable under Case VI of schedule D (section 18 of the Income and Corporation Taxes Act 1988), and there is only limited relief available for charities under this Case. This point, and the risk of non-repayment, are factors which will be relevant to the question whether the lending of stock is compatible with the proper discharge of the duties referred to in section E.
113. Anti-avoidance tax measures apply to stock lending by charities – see section L below.
114. In our view, the subscription or purchase of life insurance or similar policies, and the payment of premiums on those policies, is within the general power of investment, unless the existence/level of return in substance involves a gamble, say on someone’s life expectancy.
115. However, there may be significant tax disadvantages to this form of investment. The gain made on the realisation of the policies may be taxable, and charity tax relief is not available. Further, the Inland Revenue will treat any premiums paid by the charity as non-charitable expenditure, leading to a restriction of the charity tax relief otherwise available to the charity. On this basis, it seems unlikely that the making of this form of investment would be compatible with the proper discharge of the duties referred to in section E above.
116. The fact that an investment made by trustees is unsuccessful does not mean that they are automatically liable to make good the charity’s loss. Normally trustees would only be personally liable for the loss resulting from an unsuccessful investment if they had failed to discharge the duties referred to in section E when making or retaining the investment. But in certain circumstances there may be a stricter liability:
117. Before obtaining advice on specific investments, we strongly recommend that the trustees decide on an investment policy for their charity, and record it clearly in writing. They should then keep the policy under regular review. Under the Trustee Act this is a legal requirement if the trustees delegate their investment function to an investment manager – see section J below. Trustees have certain duties to report on investment strategy and performance – see section M below.
118. Any investment policy should address the following considerations:
119. Many trustees will consider that the management of the charity’s investments by an investment specialist is likely to result in optimal investment performance. But under trust law trustees need an explicit authority to delegate discretions, including those connected with investment management.
120. Until the Trustee Act came into force on 1 February 2001, such a power had to come from the charity’s governing document, or failing that from the Court or us. Many trustees had acquired the power to delegate investment management by one or other of these methods.
121. Section 11 of the Trustee Act now gives trustees generally certain powers to delegate discretions. These powers are in addition to any powers of delegation which are expressly stated in the charity’s governing document, or are otherwise available to the trustees. The functions that may, under the statutory powers, be delegated by charity trustees are set out in section 11(3). These delegable functions include functions relating to the investment of assets subject to the trust (including, in the case of land acquired as an investment, managing the land and creating or disposing of an interest in the land).
122. Trustees who had already lawfully entered into an investment management agreement before 1 February 2001 under the authority of existing powers do not automatically have to replace or confirm that agreement under the authority of the powers in the Trustee Act. But where an agreement is being replaced in the ordinary course of a charity’s business, the trustees may, in practice, prefer to rely on the powers in the Trustee Act when entering into the new agreement.
123. The statutory power to delegate investment management can be restricted or excluded by the provisions of the charity’s governing document, but it is thought unlikely in practice that many governing documents will contain any such restriction or exclusion. The statutory power of delegation is not available in the case of the corporate property of a charitable company, though the directors will often have adequate powers to delegate investment management. Nor is the statutory power of delegation available to the operators of common investment funds or common deposit funds: explicit powers are contained in the Schemes by which these funds are established.
124. The Trustee Act is flexible as regards the identity of the investment manager whom the trustees may employ. The manager can be one of their own number, unless he is the sole trustee of the charity. But providing investment management services is a regulated activity under FSMA, and this will restrict the number of people who can offer these services by way of business.
125. In our view, the selection of an investment manager is not itself a delegable function under the Trustee Act. The terms of an agreement with an investment manager cannot, for example, give the manager the power to select his own successor.
126. Many charities conduct their investment business through an investment or other committee, under constitutional powers which authorise this. In our view, such a committee can, on behalf of the charity trustees, discharge the functions and duties set out in the Trustee Act in relation to the delegation of investment management.
127. The Trustee Act gives the trustees the power to remunerate the investment manager, unless he is also a trustee. If the trustees want to remunerate an investment manager who is also a trustee, there will need to be explicit authority for this, either in the charity’s governing document or from us. Trustees should, in any case, use their best endeavours to ensure that the benefits which the manager is to get from the agreement are as transparent as possible.
128. Trustees have a wide discretion under section 14 of the Trustee Act as to the terms on which an investment manager is employed. But, they cannot, unless it is "reasonably necessary" for them to do so, enter into an agreement which:
129. It is our view that these restrictions apply whether or not the statutory power of delegation is being relied upon.
130. The duty of care referred to in section E above applies to the process of selecting an investment manager, and of determining the terms on which he is to act. That includes the decision whether it is "reasonably necessary" to include in the agreement one or more of the special terms referred to in paragraph 128.
131. When selecting an investment manager, trustees will normally need to consider the services offered by a number of different institutions, and compare them, in terms of cost, and nature and level of service to be provided. In practice, investment managers often have standard forms of agreement, and a willingness or otherwise to modify these terms, perhaps by means of a "side letter", may be an important consideration for some charities.
132. Insistence on one or more of the special terms referred to in paragraph 128 is one of the factors which trustees should take into account when selecting an investment manager. It would not be "reasonably necessary" to prefer an institution which insists on one or more of these terms to one which does not, unless there is some good reason for the trustees to do so.
133. An agreement with an investment manager must be in writing or be evidenced in writing. This means that the agreement itself need not be a written one, but there needs to be some written evidence of an agreement being made. That might be a letter confirming an agreement by telephone to carry out certain functions on certain terms and conditions, or minutes of a trustee meeting at which the question of the appointment of an investment manager was considered. We recommend the use of a formal written agreement with the investment manager. The decision to enter into the agreement should be fully reported in the minutes of the meeting at which the decision was taken (or in whatever record of their decisions is kept by the trustees).
134. We consider that the need for a written agreement applies whether or not the statutory power of delegation is being relied upon.
135. Regardless of the terms of the agreement, an investment manager is subject to the same specific duties as would apply to trustees if they were carrying out the function of investment themselves – see section E above. This is subject to the qualification that, where the manager is a person from whom the trustees could properly take advice if they were exercising the power of investment themselves, the manager does not have to seek further advice from another person. It will, of course, usually be the case that an investment manager has a high level of expertise and ability in investment matters, and will be a person whom the trustees could have consulted if they had been carrying out the investment function themselves.
136. The statutory duty of care does not apply to the investment manager. The manager’s duty of care is determined by the agreement between the manager and the trustees. As indicated above, a lowering of the duty of care which would normally be applied by the law of contract would be a special term, and the trustees would have to be satisfied that it was "reasonably necessary" to agree to it. Other legal obligations may also restrict the manager’s ability to lower the normal contractual duty of care.
137. Trustees cannot appoint an investment manager unless they have prepared a statement ("a policy statement") which gives guidance to the manager as to how the investment functions should be carried out. When preparing the policy statement the trustees must formulate the guidance in a way that ensures that the manager will carry out his functions in the best interests of the charity. The policy statement must, like the agreement itself, be in writing or evidenced in writing. The agreement must include a provision requiring the manager to comply with the policy statement (and any revision or replacement of it).
138. The preparation of the policy statement is the responsibility of the trustees, and the statutory duty of care in the Trustee Act applies to its preparation. The preparation of the policy statement cannot be delegated to the investment manager, but trustees are entitled to take independent expert advice on the preparation of the policy statement, and may well find it helpful to do so.
139. In any event, the Commission recommends that the trustees should prepare the policy statement in consultation with the proposed investment manager. As indicated above, the manager is obliged to comply with the policy statement, and may, therefore, be in difficulty if he finds impracticable a policy statement which the trustees have prepared without such consultation.
140. It is considered that a policy statement is required whenever discretionary investment management is delegated on or after 1 February 2001, whether the power of delegation relied on is the statutory power, or a power in the charity’s governing document, or an authority from us. However, where the discretionary management agreement was properly entered into before 1 February 2001, then the statutory requirement for a policy statement does not apply unless or until the agreement between the charity or its trustees and the investment manager is replaced with a fresh agreement.
141. A charity’s policy statement is intended to give guidance to the manager to whom investment management has been delegated. It clarifies the responsibilities and the extent of the authority of the investment manager appointed by the trustees. A charity’s policy statement provides a written framework for a charity’s investment strategy and should contain the principles that will govern the detail of the investment decisions taken by the investment manager. These decisions must be taken within the parameters set out in the policy statement.
142. The policy statement should be compatible with the duties described in paragraph 51 above and should expand upon the way in which the investment manager is to have regard to the questions of suitability and diversification in the circumstances of the particular charity.
143. Charities each have different investment objectives, and it is likely that the content and the complexity of a charity’s policy statement will reflect these differences. The Trustee Act does not dictate the content of a policy statement. However, section 15(3) of the Act states that trustees must formulate any guidance given in the policy statement with a view to ensuring that the functions of the trustees which will be delegated to their investment manager will be carried out in the charity’s best interests.
144. As a general guide a charity’s investment policy statement might well contain guidance in the following areas:
The charity's aim in investing its funds including the charity’s position on risk
145. As suggested in paragraph 66, the investment process involves taking a rational decision on the balance between security of return and level of return. This decision is obviously influenced by the operational needs of the particular charity and this is something on which the manager will need guidance. A charity’s policy statement should clearly state what a charity is trying to achieve through the investment of its funds. It should set out the charity’s investment objectives. In considering this, trustees may need to take account of the needs of present and future beneficiaries and how the charity will meet these needs. They will need to consider past patterns of expenditure and the anticipated demand for the charity’s support.
Asset allocation strategy
146. Asset allocation is a function which trustees may decide to delegate to their investment manager, except to the extent that the discharge of the function is to be influenced by considerations such as the trustees’ socially responsible or ethical investment policy, the charity’s need for liquidity and to balance the interests of present and future beneficiaries, and the charity’s stance on risk. But some trustees will wish to exert a wider influence over their charity’s asset allocation strategy, leaving the manager to be primarily concerned with stock selection. If so, the policy statement needs to include suitable guidance.
Benchmarks and targets by which the performance of the manager will be judged
147. The precise nature of the benchmarks and targets by which the performance of the manager will be judged by the trustees will depend on the size of the investment assets, on the terms of the investment policy which the trustees have formulated, and on the extent of the powers which have been delegated to the manager. It is for individual bodies of trustees to decide what system of benchmarking is appropriate for their charity, and what targets should be set for the manager by reference to the benchmark. In this connection, trustees may wish to take expert advice from someone who is independent of the manager, to enable them to formulate such a system. But some rational system of performance measurement should be devised, and the manager should be made aware of what it is through the policy statement.
The charity’s stance on ethical investment
148. It is important that the charity’s stance on ethical investment is explained to the investment manager in a way that enables the manager to give proper effect to it in the decisions which the manager makes. If the trustees do not define the criteria with sufficient precision, then there is the danger that the manager will either select investments which are incompatible with the charity’s ethical stance, or will unnecessarily avoid particular types of investment.
The balance between capital growth and income generation
149. A charity’s policy statement should set out the balance between capital growth and income return that is needed by the charity in order for it to meet its objects. This may, of course, be less significant where the charity has adopted the "total return" approach to investment – see paragraphs 75 and 76 above.
The scope of investment powers
150. As explained in paragraph 135, when investment management is delegated, the investment manager is subject to the same specific duties as are the trustees. The policy statement should explain to the manager any restrictions or exclusions on the general power of investment, if that is the power on which the trustees are relying. If the trustees are relying on other powers, the policy statement should contain an indication of the nature of those powers.
151 Trustees have a duty to keep the policy statement under review, and, where they decide that there is any need to revise or replace the policy statement, they must do so. Since the investment manager has to agree to comply with the policy statement as it is expressed from time to time, the manager’s duties will be automatically changed, if the trustees do decide to revise or replace the policy statement, and give the manager proper notice of the change. So it will normally be sensible for trustees to discuss with the investment manager the terms of any revised statement before it is made, in case the investment manager finds some aspect of the revised statement impracticable.
152. As well as the matters referred to in paragraph 144, the policy statement should clearly set out how often the charity’s investment policy will be reviewed.
153. The policy statement is not itself part of the agreement between the trustees and their investment manager. However, the agreement under which the investment manager is to act must include a provision to the effect that the investment manager will comply with the policy statement (or any revision of the policy statement or any replacement made in accordance with section 22 of the Trustee Act). The effect of this requirement is that the investment manager is contractually bound to follow the instructions in the policy statement, unless there is a good reason not to do so.
154. It is, therefore, important for both the trustees and the investment manager to ensure that the terms of the policy statement are workable. Should the investment manager find the policy statement (or any revised or replacement policy statement) unworkable, he would have no alternative but to decline to enter an agreement with the trustees, or to terminate an existing agreement, as the case may be.
155. Under some discretionary fund management agreements, the investment manager is obliged to send a "client profile" to the trustees for approval on a regular basis. A "client profile" will usually summarise the key provisions concerning the objectives and restrictions under which investment management is delegated to the investment manager. Where this has been approved by the trustees (or is approved subject to amendments) and confirmed by letter sent to the investment manager, this could constitute a policy statement which satisfies the requirements of the Trustee Act. If this process happens sufficiently regularly, it could discharge the obligation of the trustees to keep the policy statement under review.
156. Section 22 of the Trustee Act places trustees under a duty to keep under review the arrangements under which management of the charity's investments is delegated. If appropriate, the trustees must consider whether they should intervene (by giving directions to the investment manager, or revising or terminating their agreement with him) and they must intervene if they consider there is a need to do so.
157. Trustees are required under the Trustee Act to review the actions of the investment manager, whether he has been appointed under the powers contained in the Act, or under any other power, eg in the charity's governing document, or provided by us. "Review" does not, of course, necessarily involve the competitive re-tendering for the position of the charity’s investment manager.
158. The statutory requirement to review does not apply where the manager has not been appointed under the powers in the Trustee Act, to the extent that the statutory requirement is inconsistent with the terms of the power under which the manager was appointed. It would, however, ordinarily be good practice in any case to keep the performance of an investment manager under review.
159. The statutory review duty means that Trustees must consider periodically the suitability of the terms under which the investment manager is acting, and how the manager is performing. Does the manager remain a suitable person to carry out the function? Do the terms of the appointment remain appropriate? Trustees are required specifically to consider whether the manager is complying with the policy statement, and the continued suitability of the policy which is expressed in that statement.
160. This review duty should, of course, be carried out independently of the investment manager, and it should be a properly informed review. If trustees feel that they are unable to make a proper assessment without some expert assistance, they can, at the expense of the charity, employ someone who is independent of their investment manager to provide that assistance.
161. The duty to "keep under review" does not oblige trustees to review the arrangements at specific intervals or in a particular way. The way in which this duty should be discharged will depend upon what is reasonable in the circumstances. For example, the duty to review may be triggered by evidence of inadequate performance emerging from a report which the investment manager has sent to the trustees.
162. The review may throw up concerns about the suitability of the terms under which the investment manager is acting, and/or how the manager is performing. The trustees have to consider using any powers of intervention that they have under the written agreement between themselves and the investment manager or under general law. They may, for example, have the right to give instructions to the manager on certain matters. They may be able to negotiate a change to the agreement. Or they may terminate it.
163. Where the trustees consider that there is a need to use the powers of intervention, they are under a positive duty to do so.
164. When carrying out duties under section 22, trustees are subject to the statutory duty of care (subject to any indication to the contrary in a trust instrument).
165. Effective and fair assessment of the investment manager’s performance involves the trustees in having first agreed with the investment manager appropriate benchmarks and targets against which performance can be judged, and having recorded those benchmarks and targets in the policy statement. Trustees may want to consider taking independent advice when assessing how the manager has actually performed against the agreed benchmarks and targets.
166. One important area for a review to cover is the level of transaction costs incurred by the charity under its investment management agreement. There may be two elements to these costs. Firstly, the fee charged by the investment manager itself, normally related to the value of the funds being managed. This fee may or may not include the cost of work sub-contracted by the manager eg dealing and research. Where it does not, the sub-contracted costs are payable additionally by the charity. Such additional costs are not always transparent in the way that the manager’s ad valorem fee is. And there may be particular concerns where the manager has been authorised to act in circumstances capable of giving rise to conflicts of interest, and thus has a financial interest in the sub-contracted costs, as well as in the ad valorem fee. The question whether the charity is getting the best value for money from the arrangements with its investment manager is another area where trustees may well want to consider taking independent professional advice.
167. Another important area for a review to cover may be the approach of the investment manager as regards the use of the rights and powers which are available by virtue of the investments which have been made on the charity’s behalf.
168. The government has suggested that a specific statutory duty may be imposed on the trustees of pension funds, and on their investment managers, to use such rights and powers as are available by virtue of the investments which they hold in the best interests of the beneficiaries. There is a suggestion that the duty may be applied to investment managers when acting for other institutional investors, including, possibly, charities. But this statutory duty is seen essentially as a clarification of a common law duty which already applies generally to trustees.
169. Where a charity is concerned to pursue an ethical or socially responsible investment policy, its trustees may well expect the manager to engage with companies in which the charity’s funds are invested so as to ensure that the charity’s policy is not being compromised by the activities of the company. Disinvestment is, of course, one option for the charity which decides that the business of a particular company does not fit in with its particular policy. But disinvestment will not always be in the charity’s best interests: the use of shareholder rights in particular ways can influence the way in which the company does business, and this may be enough to end the conflict with the charity’s policy.
170. But there may also be purely economic considerations for the use of shareholder rights to influence the way in which the business of investee companies is conducted. Of course, any shareholder activism duty has to be formulated in a way which recognises the practical and legal limitations on the ability of small shareholders to exert direct influence over the policies of companies in which they are invested. But the appropriate use of shareholder rights in response to evidence, say, of weak management, over-payment of executives, or unfair dividend policies, may well ultimately have an impact on the level of investment returns, whether or not the particular shareholders can technically affect the outcome of a vote. Again, this approach may be more beneficial to the charity than disinvestment.
171. Trustees should consider asking their investment manager, in the process of reviewing its performance, about the steps which it takes to ensure that the business of investee companies
The liability of trustees for the acts of the investment manager
172. Section 23 of the Trustee Act provides that a trustee is not liable for any act or default of the investment manager unless the trustee has failed to comply with the statutory duty of care in:
173. "Entering into arrangements" includes:
174. Similarly, if the trustee has agreed a term (ie as part of the agreement with the manager) under which the manager is permitted to appoint a substitute, the trustee is not liable for any act or default of the substitute unless the trustee has failed to comply with the statutory duty of care in:
175. Section 24 of the Trustee Act has the effect that the appointment of an investment manager is not invalidated by any failure of the trustees to act within the limits of their powers to make such appointments (for example, the failure to provide a proper policy statement). This provision will mean that dealings of third parties with the manager are not at risk of being invalidated, so long, at least, as the third party is not aware of the irregularity. It has the effect that third parties will not need to satisfy themselves that the trustees have complied with the requirements of the Act in making their appointments.
176. This provision does not, of course, relieve trustees of any of their obligations under the Trustee Act. They will still be liable for any loss incurred by the trust as a result of an appointment made outside the limits of the powers which it gives. Additionally, if the manager is aware of the irregularity, then he risks becoming jointly and severally liable with the trustees for any loss incurred by the charity. Both parties to the appointment therefore have an interest in ensuring that the appointment is properly made.
177. The trustees of smaller charities may wish to consider whether participating in collective investment schemes is a more cost-effective way of achieving a professionally managed and balanced portfolio, than the appointment of an investment manager .
178. The advantage of discretionary investment management is, of course, that the manager can pursue an investment strategy which is tailor-made to the needs of the particular charity. But this advantage comes at a cost, both direct, and in terms of the trustees having to discharge the responsibilities referred to above in their relationship with the investment manager. For the smaller charity, this cost may be higher than the comparable costs of investment in collective schemes. Trustees do, when considering whether to make or retain an investment in a collective investment scheme, have to consider the suitability and diversification issues referred to in section E above. This point is, perhaps, particularly significant in the context of proposals to participate in schemes which concentrate on particular forms of resource generation, such as hedge funds. But trustees who invest in collective investment schemes are not "delegating" functions to the operator of the scheme. Nor do they have any responsibility for selecting or reviewing the investments which are made by the operator of the scheme.
179. Subject to certain qualifications, the Trustee Act enables the trustees of a trust, including a charitable trust, to appoint a person to act as their "nominee" and/or the same or a different person to act as their "custodian" in relation to such of the assets of the trust as they determine. The nominee and custodian can be the same person as the charity’s investment manager, or a company in the same group as the investment manager. The new statutory power is in addition to any power to appoint a nominee/custodian in the governing document of a charity, and does not replace the statutory power to appoint a custodian trustee. Nor does it replace, in the case of charity land, the trustees’ power to request the Commission to transfer the title to the land into the name of the Official Custodian for Charities.
180. Detailed information about the scope of the new statutory power, and the duties associated with it, is given in our guidance Appointing Nominees and Custodians: Guidance under s.19(4) of the Trustee Act 2000 (CC42). This is available in hard copy on the Publications section of our website.
181. The making of certain types of investment can be regarded as "non-charitable expenditure" by the Inland Revenue, and this can lead to a restriction of the charity’s tax reliefs. The making of the investments described in paragraphs 2-8 of schedule 20 to the Income and Corporation Taxes Act 1988 cannot be treated as "non-charitable expenditure". The making of other investments may be treated as non-charitable expenditure unless the trustees can show that the investments are made for the financial benefit of the charity and not for the avoidance of tax, whether by the charity or by any other person.
182. Detailed guidance can be found on the Inland Revenue website (http://www.inlandrevenue.gov.uk/charities/annex_iii.htm) but the investments, the making of which may be treated as non-charitable expenditure, include:
183. Charities contemplating making an investment which may be treated as non-charitable expenditure should bear in mind that they will need to be able to satisfy the Inland Revenue that the investments are made for the financial benefit of the charity and not for the avoidance of tax, if they are not to risk a restriction of their charity tax reliefs.
184. Trustees also need to be careful before selecting a form of investment for which there is either no charity tax relief in respect of the investment returns, or for which no such relief is necessary, because the investment returns are generally non-taxable. Charity trustees are not prohibited from making such investments, but the inability to use the charity’s tax advantages may mean that the investment is intrinsically disadvantageous as compared with one where the returns are relieved from tax in the case of a charity. This may mean that the investment is not a "suitable" one for a charity to make.
185. These concerns are applicable to any form of investment which exposes trustees to a risk of a charge to tax on "notional" income or gains. Notional income or gains clearly cannot be applied by the charity for charitable purposes: as this is one of the conditions for charity exemption, no exemption will be available.
186. The statutory annual report of a charity has to give a description of the policies (if any) which have been adopted by the charity trustees for the selection of investments for the charity.
187. For larger charities (those with a gross income in the relevant financial year of over Ł250,000) the report must also contain a statement regarding the performance during the financial year of the investments belonging to the charity (if any).