By: Arthur Drache
For directors of charities which are fortunate enough to have investable funds, these are stressful times. With interest rates low (though perhaps on the rise) many trustees are concerned about getting a decent return on invested funds and trying to preserve capital. But they also have to give some thought to a stock market which h is looking increasingly volatile.
To complicate life further, the deterioration of the Canadian dollar against so many other currencies, notably the U.S. dollar and the Euro creates a whole additional set of stresses. Advisers are always talking about diversification which in plain English usually means investing outside of Canada. But that approach not only carries the risks association with any other investment but also involves the risk of currency losses…or gains.
Those charities which hold U.S. or Euro denominated stocks bought when the Canadian dollar was higher have potential large gains when assets are converted back into Canadian dollars. But don’t forget that if you buy foreign stocks now and the Canadian dollar strengthens, you have the risk of an eroding return.
We strongly believe that every organization of any size should have an investment committee to advise the board on investment approaches. We also believe that the historical approach of many charity boards to eschew all risk in in fact bade policy and indeed, creates potential liability of directors.
Prudent investing does not mean buying nothing but government bonds!
Some year ago Ontario re-wrote its Trustee Act and set out very clearly what elements Trustees (who are bound to invest prudently) must take into account.
In determining what is prudent trustees must take into account the following criteria:
- General economic conditions
- The possible effect of inflation or deflation
- The expected tax consequence of investment decisions or strategies
- The role that each investment or course of action plays within the overall trust portfolio
- The expected total return from income and the appreciation of capital
- Needs for liquidity, regularity of income and preservation and appreciation of capital
- An asset’s special relationship or special value, if an, to the purposes of the trust or to one or more beneficiaries.
(We would note that Ontario considers all charities to be “trusts” even if they are incorporated, for the purposes of trustee liability and obligations.)
Further, a trustee must” diversify the investment of the trust property to the extent that it is appropriate to,
- the requirements of the trust; and
- general economic and investment market conditions.”
The trustees may obtain investment advice and trustees will not be in breach of trust in relying on such advice if a prudent investor would do so.
Once the key elements are understood then what about foreign investing?
Those charities in a happy position to have funds which can be invested are, of course, constrained generally by the “prudent investor rules”, rules which suggest that the charity should not take undue risks.
What is “prudent” will depend upon a myriad of factors including the financial needs of the organization and its beneficiaries, the need to account for inflation  and diversification. At some stage, it may well be necessary to get professional advice.
Now almost any investment adviser worth his or her salt will recommend that the diversification should include the purchase of foreign equities…and except for the “big” players who can get involved in world-wide markets, this normally means buying American equities. But what a lot of advisers will not emphasize is that this type of investment carries additional risks. Not only is must the investor look to whether the equities will appreciate in value but they must also take into account the fluctuations in foreign exchange.
In our view, the issue of investing abroad should also be viewed in the context of the organization and its goals.
We recently attended a finance e committee meeting of a charity which had this situation. It has a portfolio worth just over a million dollars. Its role is to make quarterly payments to a number of low income individuals, all of whom are in Canada. The payments are adjusted every so often but in essence are quantifiable for at least a year at a time. Capital is not eroded to make payments but as income flow increases, “bonuses” to the beneficiaries are sometimes made.
The portfolio has been diversified and is now about 15% in U.S. equities.
A few years ago, as the members of the finance committee discovered, the strength of the Canadian dollar had reduced the U.S. return significantly and on occasional quarters, that return has actually be negative, though the Canadian portfolio has shown healthy gains. Indeed, in U.S. dollars, the American portfolio has been doing okay. But as the Canadian dollar strengthened, there were concerns.
The question was whether, given the fact that all beneficiaries were paid in Canadian dollars and all costs were incurred in Canadian dollars, whether it made sense to invest in U.S. dollars. The investment adviser took the position that over he long haul, there were good investment reasons to diversify and that the currency risk was` acceptable. The members of the committee were not so sure. They temporized by instructing the investment counsel not to buy more U.S. stock without specific instructions.
What spooked some committee members was` reading that many analysts feel that the Canadian dollar will strengthen further, thus perhaps exacerbating the situation. But of course there are always other voices which suggest there could be a weakening of the loonie. Again it was a judgement call.
As we know now, the loonie did drop precipitously after these discussions.
In the event, not being in the foreign market may have had a significant cost as the Canadian dollar dived. But in practical terms, how serious was that? The organization ended up (as of now) with less capital than it might otherwise have had. But from the point of view of the Board, a whole level of risk was avoided and they made their decision based on what was necessary to meet their obligations to their beneficiaries
Diversification into foreign markets has its attractions if one has confidence in the advice which is being given. But keep in mind that being a non-taxable entity takes away the “security blanket” of being able to write off losses which stem from currency fluctuations. We are certainly not advocating a “buy Canada” investment policy as an unconsidered “given” but rather simply make the point that for charity investors of modest capital, the currency risk may be unacceptable.
 This generally means that the charity must have some significant assets in equities which can increase in value.