Not-for-profit investors are revisiting their strategic asset allocations, prompted by rising yields, which have increased the return prospects from bonds and squeezed equity risk premia.

Additionally, investors are also reviewing their responsible investment policies and portfolio implementation. This follows the clarity provided by the Charity Commissions investment guidance update (CC14) which provided guidance that not-for-profit investors are free to pursue an investment approach that best aligns with their interests and purpose.

Aon’s Matt Hurshman, Associate Partner and not-for-profit investment specialist, outlines key current investment themes, and actions, not-for-profit investors should consider as they review their strategic asset allocations, investment policies and governance frameworks.

Responding to Higher Yields in Public Markets

The 10-year UK gilt yield has increased by almost 3% to just under 4% since the beginning of 2022. As a result, fixed income is more attractive for helping to deliver long-term returns than at any point in the decade prior to 2022. Furthermore, a shift from equities to fixed income can help reduce volatility and lower fees – with potentially minimal impact on expected returns.

Due to tight spreads in investment-grade credit, some fixed income asset classes are more attractively priced than others. It’s important that investors assess their current and future allocations carefully.

Higher yields are also cause for a reassessment of shorter-term holdings in bank deposits. We have seen some cases where bank deposits are earning significantly less than the Bank of England Base Rate of 5.0%, as at 15 August 2024, and there are liquid cash-like investments available which offer higher returns.

Opportunities in Private Markets

Private markets offer higher risk-adjusted return potential – and, the reduced equity risk premium now available means that many not-for-profit investors are seeking to introduce, or increase, investments in private markets.

However, not all opportunities in private markets are equal and consideration should be given to a wide range of different assets in this class. For example:

Private Credit

The change in interest rates, and the impact of the 2023 banking crisis, has improved the relative attractiveness of many types of private credit assets including direct lending, asset-based finance, and bank capital relief.

Renewable Infrastructure

For those seeking to tackle climate change through their portfolio allocations, some energy transition strategies, such as renewable infrastructure, also offer an attractive risk/return proposition and an opportunity to align investments with a key responsible investment theme.

Private market entry and exit points cannot be timed with precision – and for this reason they do not necessarily lend themselves to tactical short, or medium, term portfolio positions. However, there are many forms of private market assets that are attractive for the long term and today is a reasonable entry point.

Resetting Responsible Investment Policy

Historically, not-for-profit investors have focused on excluding investments in certain sectors – either to manage the potential for reputational risk, or because those investments didn’t align with the organisation’s interests or purpose.

The clarity provided by the Charity Commission, in its updated investment guidance (note CC14), and the Financial Conduct Authority’s (FCA) new anti-greenwashing rule, which came into effect on 31 May 2024, will help not-for-profit investors assess the real impact of their investments. Taken together, organisations are increasingly considering ways to extend their mission to, and through, their longer-term investments.

The focus is typically on climate, clean energy and fossil fuel divestment. There has been increased due diligence activity on strategies related to energy transition in asset classes such as infrastructure. The dislocations and inefficiencies that may come from decarbonising the economy present investors with a significant opportunity to potentially outperform the market.

Next Steps

Pressure on income for not-for-profit organisations is expected to continue – and, government support is likely to reduce in the coming years. As a result, the role for investments will become increasingly important.

Now is a good time for not-for-profit investors to actively explore several areas with their advisers to maximise the opportunities for returns in the short, medium and longer-term, including:

  1. The balance of public equity and fixed income portfolio allocations
  2. Opportunities in private markets and where best to invest
  3. Responsible investment policies and implementation

While the investment opportunities are broad-ranging and increasingly complex, Aon’s investment teams are well-positioned to ensure you are better informed and better advised to adjust and change your investment approach.

If you would like to discuss any of the themes raised here, please contact Matt Hurshman or email [email protected].

Information contained herein is for informational purposes only and should not be considered investment advice.