UK: Charities, A Briefing For Charitable Organisations, Spring 2010 - The Landscape Of Tomorrow

Last Updated: 5 May 2010
Article by Matthew Maneely

INVESTMENT OUTLOOK

The traumatic conditions of 2008 and early 2009 were followed by a welcome and dramatic rally. As a result, a pause for breath at the start of 2010 was not unexpected. This was seen in January but markets have rebounded again during March. Investors are now asking whether we are heading for greater volatility in a downward direction or whether last year's recovery is the start of a growth phase?

There is no doubt that there are more negatives than positives. Over the long term, equity prices should be driven by fundamentals – economic and corporate trends which ultimately determine shareholder returns. Clearly the coming UK general election and the debate over how to tackle the national deficits does not bode well in this respect for 2010, and probably for longer. Less fundamental, but equally important over the short term are issues such as investor confidence or attitude to risk, and cash flows – both domestically and from overseas investors. Behind all of this however, charity trustees will always need to ask themselves what do they need from their investments? This can of course change over time, but we sense that after the fall out in 2008 and volatility in 2009, some kind of stability would be welcome even if returns are boring.

Will 2010 be boring? Probably not, but hopefully one investment area will provide some stability – income. Many charities suffered sharp falls in investment income in 2008/2009 on top of declines in revenues from other sources. Much of this was due to the collapse in the banking sector, but it is difficult for income from this area to get much worse. Other companies have struggled, but if investment is biased towards better quality companies, then again the worst may now be over and investors are more confident to 'draw the line'. For investors looking for some degree of certainty, this should offer comfort.

While this is based on the reasonable assumption that company balance sheets are stronger, any further dramatic economic collapse may force further declines, albeit this is more likely to be at the end of 2010 or 2011. A significant factor will be currency fluctuation. With around 60% of the FTSE 100 profits coming from overseas sources, this has a potential impact on both profits and importantly, dividend payments. On balance, we expect Sterling to depreciate further against the US$, the most important of the overseas currencies and this should help boost dividends in 2010. However, it is a brave man who bets on currency movements and a prudent approach is probably wise.

The other main investment asset class which investors traditionally favour for income is fixed interest bonds. Although historically popular, both for the security of capital and the income that they provide, government bonds are now less attractive and the security is clearly under scrutiny, as has been recently highlighted by events in Greece. Higher income can be generated outside the government bond sector, but the risk profile will also rise.

Is the investment outlook a challenge? Perhaps not surprisingly the answer is usually always yes, but investors need to assess what their requirements are. If they can accept what could well be another year of volatility in capital values but with the prospect of more settled income streams, then perhaps 2010 has attraction. The alternative of leaving cash on deposit in the bank remains unappealing.

FOR THE PUBLIC BENEFIT?

In July last year, the Charity Commission published its public benefit assessment reports on 12 charities. It failed 4 of the charities, 3 of them on public benefit grounds. This sparked further controversy in the ongoing public benefit debate.

Some of the press coverage continues to imply that the Charities Act 2006 (the Act) made radical changes in charity law, introducing a new legal definition of charity and 'tough' requirements for charities to 'prove' that they 'provide' public benefit. This seems to be based on the commission's public benefit guidance.

The Act required the Charity Commission to issue guidance to promote awareness and understanding of the operation of the public benefit requirement. This is a statutorily defined term referring to the requirement that, to be a charitable purpose, a purpose must be 'for the public benefit'. In other words, a simple restatement of the law.

The only change that the Act made to the law of public benefit is that it is 'not to be presumed' that a particular purpose is 'for the public benefit'. This, arguably, affects charities established for the relief of poverty, or advancement of religion or education, which historically had the benefit of such a presumption, but they were never exempt from the requirement. It does not affect charities established for purposes for which there was no presumption.

The commission's guidance could have made this clear and, having dealt with the legal requirements, gone on to set out best practice guidance for charity trustees on pursuing their charity's purposes, encouraging maximum access to benefits. The guidance could also have increased public trust and confidence in the sector by noting that charities tend to do this anyway – because they want to, not because they have to.

But, disappointingly, the guidance suggests that the Act "required all charities to operate for the public benefit". The guidance advocates that this is part of the 'public benefit requirement', confusing the legal definition of a charity (and hence charitable status) with the way in which trustees pursue their charity's purposes.

Following consultation, the commission acknowledged 'significant challenges' to its approach, but published the guidance anyway. In principle, this need not matter: it is only guidance, and charity trustees are only obliged to have regard to it. However, the commission is now assessing registered charities on the basis of its guidance alone; the law has been neatly sidestepped.

The commission states that its assessment decisions are 'final' and apparently not subject to appeal. The assessments require action by charity trustees but fail to identify the authority for this. In response to a freedom of information request asking the commission to identify the power being exercised, the commission stated that it is "acting in furtherance of our general objectives and functions, indicating actions which it is clear to us must be taken". This, disturbingly, confuses an organisation's functions with its powers and fails to clarify the basis for the commission's actions.

The commission is bound to act within the law, just as any charity trustee. Changing the law is the role of Parliament. There is no legal requirement to comply with the commission's guidance, but this seems to be the test the commission applies. The commission denies it is changing the law, yet refrains from testing its guidance in the courts. Charity trustees are left confused, unsure as to whether they should spend charity funds trying to 'pass' the commission's test, and unclear of what would be 'sufficient' to do so. Perhaps it is now 'for the public benefit' that any further public money to be spent on this is applied in restoring some clarity and stability.

THE BIG FREEZE

The Government plans to freeze spending for the next eight years. What does this mean for charities?

Both central and local Government have always provided substantial financial support to charities, but over the past decade or so, the relationship between charities and the Government has been changing. While the Government remains a major source of grant funding, the majority of funding now comes in the form of contractual income, whereby charities provide services to the Government for payment. At the same time, the proportion of Government income allocated to charities has increased. In part, these changes can be attributed to the Government effectively outsourcing certain activities to charities.

These trends are clear: it is likely that they will have become even more pronounced in the last two to three years, particularly with increasing sums of lottery funding being allocated to the Olympics.

Looking ahead

But what does this mean for the future? The recent announcement that the economy grew by 0.3% in the last quarter is welcome and means that the UK is out of recession.

Unemployment

The worst aspect of any recession is the human cost of unemployment: lives put on hold, childhoods blighted and for some, youth unemployment morphs into long-term unemployment. There is also the financial cost of unemployment: not just jobseekers allowances and housing benefits, but also the wider support which higher levels of unemployment requires to mitigate its effect. And while people are unemployed they are not creating wealth.

So, what now for unemployment? Regrettably, the story is rather pessimistic. In the last two recessions, unemployment lagged GDP and continued to increase even as the economy started to grow.

If unemployment follows the same trend as in prior recessions, the headline rate could easily increase by a further 2% of the work force. That would imply a further 400,000 people becoming unemployed over the next six months, and potentially remaining unemployed for at least two years.

Government spending and public debt

The Treasury estimated that the recession will reduce the national income by 5.2%, which will increase the public sector deficit by some £73bn. In the short term, this hole is being filled by increased Government borrowing, which will push up the overall forecast debt requirement for 2009/10 to an incredible £177.6bn.

The current Government expects to reduce the deficit and the borrowing requirement as follows.

  • Through the effects of economic growth, which is assumed to resume at an annual rate of 2.75%. Such growth will increase the tax take and should, in time, reduce the cost of social benefits.
  • By implementing a fiscal tightening regime which will reduce the gap between Government income and expenditure by £77bn over the next eight years. This fiscal tightening will be implanted by tax rises and freezing expenditure at current levels (i.e. a reduction in total expenditure in real terms).

The impact of fiscal tightening

The fiscal tightening will be felt throughout the economy. Currently, there is a lack of clarity as to exactly how and where reductions in spending will arise. This is partly because some of the tightening is expected to be achieved so far in advance. However, the Government has limited scope to reduce expenditure. Certain expenditure is deemed to be outside of the normal budgetary control scope, for example:

  • unemployment benefits are dependent on the numbers eligible to claim that benefit (which could rise significantly)
  • interest payments will inevitably rise due to the massive increases in borrowing and potentially increases in interest rates
  • other social costs will increase due to demographic changes in society.

The Government has committed to 'protect' certain expenditure – namely, expenditure on health, schools and overseas aid.

The net result? Some expenditure will continue to increase, so that there is proportionately less money for other areas. Freezing the health service budget in real terms can only be achieved by concentrating reductions in other budget areas. It is estimated that these other areas will face a 12.9% cut on average by 2012/13.

However, the cuts in expenditure are planned to be incremental over eight years. Should the Government choose to keep protecting the expenditure on health, schools and overseas aid, these reductions will deepen to a cumulative 23.8% by 2014/15 (with more to come by 2018).

Investments

Many charities have some dependence on income from investment portfolios, either directly or indirectly. After the collapse of Lehman Brothers in the US and the travails of UK banks, investment performance was woeful. However, in recent months, investments have been increasing in value. While this is welcome, gains should be kept in perspective: if the growth continues, the value of investments may soon be back to where they stood at the start of the decade.

How does this affect charities?

Increasing need

As unemployment increases, so does the demand for charitable services. For many, this recession may be the first time that they experience the horror of unemployment and they may not have the knowledge or resilience to cope without substantial support.

In addition, although personal debt has been falling over the last year, many people have debt that is simply unsupportable without earned income.

So those charities at the forefront of providing support to such people will find their services are in increasing demand.

Income

Both central and local Government will have no option but to reduce expenditure wherever possible. The real increases in funding that charities have enjoyed over the last five years may well be reversed in the coming few years.

Therefore, we can expect to see:

  • grants being reduced, in value and duration
  • limited inflationary increases in contractual income
  • possible reductions in funding rates (as has happened in the higher education sector).

The impact of the increase in investment values may be minimal. Many charities chose to maintain their activities even as investment value plummeted, taking the view that the significant value reductions were temporary.

The continuing low interest rates are also adversely affecting charitable income. Even charities which were able to place money on longer-term deposits (at higher rates) are being affected as these contracts expire. Although interest rates will rise in the future, no-one can reliably forecast when this might be.

Finally, individuals continue to be an important source of funds for charities. However, the average individual donation remains low and it is to be hoped that reductions in personal wealth will not significantly impact on the level and frequency of donations.

Competition

As income available to charities reduces, there will be increasing competition between charities to access the available funding. This will not only relate to contractual income, but also to grant income and voluntary income.

Charities will be forced to offer more for less, simply to retain their existing income sources or to access funding previously provided to others. In the short term this may create greater sector efficiency. But in the longer term, this trend will lead to a mismatch between income and costs, particularly as costs will rise (for example, employers national insurance rates will increase from 1 April 2011).

So where to from here?

The charity sector has benefited substantially from recent high Government spending and the outsourcing of activities. However, this does mean that charities are now going to feel the impact of the forthcoming reductions in Government spending. Most charities do not seek to make substantial surpluses and charities which are reliant on any form of Government funding can expect to see real reductions in income.

Such charities will be forced to make hard choices: with Government spending being frozen for the next eight years, it will not be possible for charities to use reserves to ride out the storm.

These charities will need to increase efficiencies, reduce staffing or simply withdraw from providing the relevant services.

Longer-term planning, based on the future realities, is vital if charities are to survive.

WAVENEY CROSSROADS AND THE SOCIAL INVESTMENT BUSINESS

Case study

Waveney Crossroads is a registered charity that provides respite care for carers in the Waveney district of Suffolk. It offers traditional 'in the home' care services and day services from two centres in Lowestoft.

The charity applied to The Social Investment Business who manages the Futurebuilders Fund on behalf of The Office of the Third Sector, with a view to purchasing a new building. Its application was successful and it was given an investment package of £157,500, making it the Futurebuilders Fund's 200th investee.

The investment was split into a £97,500 loan to buy, refurbish and equip the new care centre, and a £60,000 revenue grant to fund the creation of a new 'development manager' post. The loan is repayable over ten years with an interest rate of 6%. Waveney was also given an initial repayment holiday of three months.

Waveney director/treasurer Sheila Hyde explains: "As a small organisation already planning a mortgage to purchase new premises, we weren't ready to take on another loan from the bank. Working with a consultant from The Social Investment Business we were able to develop a realistic business plan. The thorough application process and ongoing support has enabled us to expand our service while thinking about future plans."

The new centre, 'Crossroads Care Centre' opened last year, with the opening ceremony performed by Waveney MP Bob Blizzard (Labour), who said: "Waveney Crossroads is a charity that so many people rely on, and I am sure it will go from strength to strength." Through buying the new building, Waveney has been able to increase its services offered to adults in need of care and introduce a new family support service. This includes a Saturday club for cared adults, as well as hosting group activity for carers.

"The new centre has enabled us to provide a variety of new services all under one roof," said Sheila. "The centre promotes social inclusion and provides a stimulating environment for those being cared for and provides carers with the opportunity to take extended breaks and meet others in a similar situation."

The centre currently supports up to 50 people each week and Waveney is expecting numbers to increase to over 90 in the near future. The organisation also support a further 100 carers, their families and the people that they care for in their homes.

Waveney Crossroads has contracts to deliver its services with Suffolk County Council, Suffolk Family Carers and the Social Services Children's Department. It also takes referrals from the Alzheimer's Society.

The Social Investment Business

The Social Investment Business is the UK's fastest growing social investor. Our aim is to improve substantially the capacity of Third Sector organisations, helping them to play an ever greater role in improving the lives of the people and communities they serve.

We manage a number of different funds, each with a different focus, meaning they can support a broad range of proposals. These can include restructuring or changing ways of working to become more sustainable, building capacity to win public sector contracts, or the delivery of health or social care outcomes.

We also understand that loan finance is a new approach to funding for many organisations and are committed to tailoring our support to suit each organisation's circumstances.

Why should you contact The Social Investment Business?

The Social Investment Business is an engaged investor – we work together with our applicants to ensure an investment is viable and will make a sustained change to their organisation. We want our investments to make a positive impact on the organisations and their capacity to deliver a permanent change for the better.

Our team can help organisations gain the skills and systems needed for sustainable development, and we continue to work with our investees throughout the life of an investment. We are always happy to discuss your ideas. Our business development team will listen to your needs and try to tailor an investment option that suits you.

Working with us is easy "

  • Our business development team will work with you to develop the information needed to make an application. Starting the process requires nothing more than a phone call or an email.
  • We invest in projects that banks will not. All organisations and ideas are considered on their own merits, although the project must benefit people living in England.
  • Business support is integral to our process to help applicants and investees reach a level of sustainability that ensures the investment is a success for your organisation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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