Social investment by charities

Investments are a major source of funding for many charities and, obviously, there are specific legal duties and decision-making processes which relate to financial investment. Generally, the intention of conventional investment is to achieve the best financial return within the level of risk considered to be acceptable for the charity, which is referred to be the Charity Commission as ‘financial investment’.

The financial investment duty can be summed up as one of “prudence”; applying a cautious approach, with due care and skill and balancing risks with financial returns.

However, charities are increasingly interested in how they use funds to generate a financial return AND directly further their charitable aims. This is commonly referred to as ‘programme related investment’ or ‘social investment’. The Charities (Protection and Social Investment) Act 2016 has introduced a statutory power for charities to make this kind of social investment. The intention of social investment is to focus on investments that either directly support or more broadly align with a charity’s mission and purpose. Investments of this sort also generate some financial return, but this may be modest and secondary to the charitable purpose served.

Because the charity rationale is generally foremost in this form of investment, the legal duties which apply here are closer to those associated with charitable expenditure than financial investment. In short, the duty to take reasonable care and apply reasonable skill.

Another approach is so-called ‘mixed motive investment’: investing charity funds in projects which are justified with reference to more equally important charitable and financial returns. Mixed motive investments require both justifications. For this reason, charity trustees will have to show they have complied with their duties in making financial investments (to act prudently and so on, as summarised above) as well as those associated with expenditure.

Flexibility of social investment

Advantages of social investment forms include flexibility. Often, they facilitate longer-term, more flexible investment strategies which might not be possible in conventional investments. These can have helpful financial implications, for example, because short-term financial considerations may be off-set by immediate charitable benefits, which, in turn, facilitate longer-term financial gains, from creating an established, sustainable business, for example.

Social investment may also facilitate a wider range of funding methods and increase the associated support the charity may be able to provide if investments are recouped and/or yield a return. fundamentally, more creativity is possible because trustees are not bound solely by the legal framework for financial investment, and the more permissive social investment considerations apply.

Considerations when making social investment

The Charity Commission guidance “Charities and Investment Matters: a guide for trustees (CC14)” gives an outline as to the considerations for trustees. The key here is that trustees must act in the best interests of the charity and ensure that the investment contributes to the charity’s stated aims, compared with other ways of advancing the aims in terms of effectiveness and risk. There are various risks outlined in the CC14 guidance that trustees should take into consideration when making decisions on responsible investment, including taking investment advice where they do not feel comfortable.

Current approach to social investment

There are indications that public expectations of charities’ investment activities are changing. There is interest not just in what charitable and financial returns charities achieve from these activities, but how they act along the way. “Responsible” investment – whether pursuing social or financial returns – is increasingly important. Charities are now starting to think more about how to reconcile achieving good returns with responsible investments – and conduct more generally – which align with the charity’s mission and purposes. This is generally positive – particularly if this leads to new, effective uses of charity assets – but of course it also opens up new ways in which charities may be exposed to criticism.

Against this backdrop, in the early part of last year, the Charity Commission conducted a listening exercise, asking for feedback from Charites in relation to investment approaches, potential barriers to more widespread responsible investments and what more could be done to support trustees to invest in a way that reflects the charity’s purpose. This exercise became increasingly significant with the knock-on effects of the pandemic in 2020. While some charities were focussed on simply staying afloat (or avoiding controversy), for others it felt increasingly important to consider the questions of how and why they are making investments and deciding what is new approaches might serve the best interest of the charity in these volatile and uncertain times.

This exercise also found that there are apparent barriers, both technical and practical, to trustees making decisions that focus on responsible investment, as we see below.

Survey results - potential barriers to responsible investment

For some the legal framework itself and its interpretation is a barrier, with wide differences in interpretation of the legal framework meaning trustees lack certainty. This is compounded by confusion over trustee duties caused by detail in the CC14 guidance on the topic of responsible investment, which fails to give assurances that the Charity Commission supports this approach to investment.

The feedback also highlighted that trustees feel their overriding duty to their charity is to maximise financial returns over all other considerations when making investments, which hinders them from considering a more responsible investment approach that focusses on their mission or purpose.

Trustees also indicated a degree of anxiety about making mistakes in those investment decisions that could be costly to their charity in sacrificing financial returns. This could be caused by insufficient knowledge or understanding of the jargon and limited access to practical support for trustees considering responsible investment, as well as a perception of a lack of meaningful discussion at board level of responsible investment.

Changing landscape

What was clear from the Charity Commission listening exercise is a lack of trustee confidence in being able to make decisions on social and responsible investments for their charity. It is clearly increasingly important for charity trustees to feel empowered to take a fresh look at their financial investments and make informed decisions in line with the general shift in public feeling about investment. This has prompted the Commission to reconsider their position, with plans to publish draft guidance in Spring 2021 for public consultation and a refreshed interpretation of the law in this area, with the final updated Charity Commission guidance on responsible investment expected in Summer 2021.

It is unclear as yet what this refreshed draft guidance will look like, but it is hoped that the new guidance will give trustees clearer guidance on investment options, the legal framework and clarity as to the Charity Commission’s stance on this matter. Practical considerations for trustees in trying to balance maximising financial return with introducing responsible investments would also be helpful to give trustees more confidence navigating decisions on responsible investment.

The law and practice referred to in this article or webinar has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.

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