OPERATIONAL GUIDANCE

ENDOWED CHARITIES: A TOTAL RETURN APPROACH TO INVESTMENT

NEGATIVE TOTAL RETURN

OG 83 C4-30 May 2001

Purpose: To explain the place of negative total return in the total return approach to investment.

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1. Negative total return

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1. Negative total return

The existence of a negative investment return in a particular financial year does not mean that nothing can be allocated to the trust for application (income) in that year. All that matters is that the unapplied total return should be positive. The following is a very simple example of how the total return approach might work in practice. It shows how funds may be allocated to the trust for application (income) even in a period when the investment return is negative.

(a)

donor gives £100,000 on trust for investment (capital)

£100,000

(b)

In year 1 - total return - (dividends and interest and capital gains) is £40,000

£140,000

(c)

In year 1 - £5,000 allocated to trust for application (income), and spent

£135,000

(d)

In year 2 - negative investment return ( ie a reduction in capital values exceeds the amount of dividends and interest received) of £20,000

£115,000

(e)

In year 2 - £5,200 allocated to trust for application (income), and spent

£109,800

The example assumes that the amount allocated to the trust for application (income) should increase by 4% annually in order to maintain the real value of the grants which the charity makes. The expectation is that the value of the resources held on trust for investment (capital) should increase annually by a corresponding amount. In the example this would mean that the resources would have to reach a value of £108,160 at the end of the second year. In the example, this has been more than achieved even though in the year 2 the charity had a negative investment return.

However, if there is no "unapplied total return" there will be nothing to apply for the purposes of the charity (except where a charity has a power to spend part of its investment fund (see OG 83 B4). In the case of a new charity which is operating a total return approach to investment, if there is a fall in the value of investments in the first year, and that fall exceeds the "income" that the investments have produced, there would be nothing to apply. However, this is an essential feature of the total return approach to investment.

By contrast, if the trustees had followed the standard rules in the circumstances outlined in the paragraph above, there would probably still be the "income" to apply for the purposes of the charity. That said, if the trustees selected shares in companies which paid no dividends, even though the shares themselves rose in value, there would be nothing to apply for the purposes of the charity under the standard rules.

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