Untying the hands of private trusts

Charities are pushing for the same control over investment as pension funds, writes Paul Gosling

Charitable and private trusts are to be allowed to earn more income as a result of measures currently being introduced by the Government.

Trusts will be able to invest a larger proportion of their funds in equities, although they will still be subject to a restriction that is opposed by charities and investment managers.

Under the 1961 Trustee Investments Act, trusts have been required to split their funds equally in two, one portion to be invested in equities, the other in gilts. A statutory instrument was approved by Parliament on 3 April which will enable charitable trusts to invest 75 per cent of their funds in equities. The Treasury last month launched a consultation paper containing proposals to introduce similar changes for private trusts.

Since 1961, gilts have dramatically underperformed against equities, both in income and capital value. Calculations by Phillips & Drew Fund Management indicate that £1m invested in equities in the early Sixties would now be worth £15.8m. The same amount invested in gilts would have a capital value today of just £630,000. After adjustment for inflation, the annual real capital return of equities was 1 per cent, compared to an annual deficit of 8.5 per cent on gilts.

These factors have persuaded pension funds to turn their backs on gilts. Where in 1962, the average pension fund was split between 47 per cent equities and 51 per cent gilts, today the figure is 85 per cent in shares, 6 per cent in gilts. The annual cost to charitable trusts of not being able to manage their funds similarly, says Phillip & Drew, is between £60m and £450m.

Even under the new regulations, trusts will only be permitted to invest 75 per cent of funds in equities. This is justified in part on the grounds that gilts are safer than equities, but this premise is questioned by fund managers and charities, who point to the collapse of some gilt-edged stocks.

"Dividing funds doesn't actually protect funds in the way it is supposed to," says Nigel Siederer, director of the Association of Charitable Foundations. "It is administratively cumbersome, historically hasn't kept pace with inflation, and even at 75 per cent won't be able to do that. The word `safe' is misused. We would regard it as fundamentally unsafe not to protect funds against inflation, which a restriction to gilts does."

The ACF, along with other charities, investment managers and the Labour Party, wants existing regulations to be replaced by a responsibility on trustees to exercise prudence, backed by advice provided by advisers regulated under the Financial Services Act. It points to controls introduced in New Zealand which could serve as a model. Fund managers are also irritated by the restrictions on the type of equities that can be purchased. Sarah Hamilton, charities marketing manager at Flemings, says: "The Act is out of date. You can invest in the European area, but you can't invest directly in the US or Japan, though you can invest in authorised unit trusts that invest in those countries. The balance could go to 90 per cent/10 per cent, which would coincide with what most charities want to do."

Mr Siederer criticises the limitation to buying into companies with a five-year dividend history, which has meant that trusts have missed out on the privatisations. "Why not go to companies listed on the Footsie instead?" he suggests.

The current rules, says Mr Siederer, require detailed background checking on companies, which can be difficult and costly to comply with. As a result, the rules are often ignored. "It costs more if carried out properly, and they have not been carried out properly," he says. "The rules have been honoured more in the breach than in the observance."

Trustees should be given more power, Mr Siederer says. "Is the Government trusting trustees? It doesn't seem to want to, and that doesn't fit ideologically with this Government's approach."

Ironically, although the changes were announced as part of the Prime Minister's "bonfire of regulations" initiative, they do not remove controls, merely reduce the losses they cause. The call now is for the regulations to be fewer and less restrictive.

Investment managers, such as John Harrison, director of Phillips & Drew Fund Management, are demanding more flexibility. "The rules governing investment choice are arbitrary and inconsistent," he argues.

"Many of the country's leading companies, such as NFC, Vodafone and Abbey National, fail the five-year dividend test, yet the requirement for trustee status has provided precious little defence against many of the largest corporate failures - shares in Maxwell Communications, Polly Peck and British & Commonwealth were acceptable investments immediately before their collapse. Investing in narrower range securities is not, in itself, a protection either. Convertible loan stocks with narrower range status were issued by Polly Peck and British & Commonwealth.

"The Trustee Investment Act is a largely ineffective protection regime which has been overtaken both by investment practice and by other forms of protection under the Financial Services Act. There is no evidence that trusts would be at greater risk if the Trustee Investment Act did not exist, and considerable evidence that it imposes a significant investment and administrative cost on charities and other trusts. Increasing the wider range to 75 per cent is a welcome first step. However, the case for removing the Trustee Investment Act altogether remains intact."

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