Adopting total return for permanent endowments: What it means for charities

This, however, often led to missed investment opportunities and left the charity susceptible to fluctuating dividends or interest rates. The adoption of the total return approach has gained traction in recent years, offering charities the potential to achieve both stronger investment returns as well as greater flexibility and control. In this article, we explore what adopting total return for permanent endowments means for charities and the benefits it can bring.

Understanding total return

Total return is an investment strategy that focuses on optimising the overall return on an investment portfolio, rather than merely generating income. It allows charities to utilise both income (interest, dividends, and other distributions) and capital appreciation (realised and unrealised gains) from investments to support their activities. By utilising the total return approach, charities can aim for more significant long-term investment returns and hence better meet their financial obligations and charitable objectives.

Benefits of adopting total return

1. Enhanced financial sustainability: Total return allows charities to adopt an investment approach unconstrained by the need to generate income and so can lead to a wider universe of potential investments. This provides the potential to generate a stronger overall investment return, ensuring they have a more sustainable source of funding for their activities over the long term.
2. Increased impact: Through the provision of potentially stronger investment returns, charities can allocate more funds to support their charitable programs, initiatives, and projects, leading to a greater positive impact on their beneficiaries and communities.
3. Improved flexibility: Total return enables charities to adapt to changing market conditions and economic environments, optimising the withdrawals they take from their investment portfolios without being solely reliant on interest rates or dividends.
4. Future-oroofing: With the potential for higher returns, charities can better withstand economic downturns, inflation, and other financial challenges that may arise in the future.

Transitioning from income-only to total return

In the past, Charities with permanent endowments required specific approval from the Charity Commission to adopt a total return approach. This, however, changed with the Charities Act 2011, and now all that is required is for the Trustees to take advice, properly consider the matter and pass a Resolution.

The transition to total return does still involve a shift in investment mindset, moving to a position where Trustees should be indifferent as to the split of return between income and capital appreciation. Where an investment approach has previously been constrained by the need to generate income this can lead to a move to include a wider mix of assets such as Gold or a greater allocation to low/nil-dividend shares.

Key considerations for adopting total return: 

1. Investment Policy: To adopt the total return approach, charities must revise their investment policy to align with their new financial objectives. The policy should clearly define the target return, risk tolerance, and asset allocation strategy to maximize both income and capital growth.
2. Spending Policy: Total return requires a dynamic spending policy that allows for periodic adjustments based on market conditions and the endowment's performance. A balanced spending policy can ensure that charities can sustainably fund their charitable activities without compromising the long-term growth of the endowment.
3. Risk Management: The transition to total return may involve Trustees reconsidering the most appropriate level of risk compared to the income-only approach. Charities should implement robust risk management practices, including diversification, periodic stress testing, and ongoing monitoring of the investment portfolio.

Adopting the total return approach for permanent endowments represents a strategic shift for charities, allowing them to optimise their investment returns and better support their charitable activities. By embracing a balanced approach that combines income and capital appreciation, charities can achieve greater financial sustainability and increased impact on their beneficiaries. However, this transition requires careful planning, a revised investment policy, and effective risk management to ensure the long-term success of the total return strategy. With a well-executed approach, charities can position themselves for enduring success in fulfilling their mission and creating lasting positive change in society.