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Q3: OCT 2015 A BULLETIN FOR CHARITIES ECONOMIC OUTLOOK BRIEFING INTEREST RATE RISE: WHEN WILL IT HAPPEN? briefing) but also have an impact on the wider economy, which in turn will have knock on effects for the sector. One of the biggest areas of uncertainty in the UK economy has been when the rise in interest rates will take place. UK interest rates have been held at historic lows for six years and most forecasters assumed that strong growth in 2014 and early 2015 would lead to interest rate rises later in the year. However weakness in key export markets, particularly the European Union and low oil prices which have kept a lid on inflation have meant that interest rates have been kept lower for far longer than had been originally predicated. Lower interest rates will have an impact on charities investments (as outlined in later sections of the Predicated path for UK Interest Rates Lower interest rates should help household incomes, particularly consumers, with those charities that trade with the public enjoying the benefits of better enjoying the benefit of more conducive spending environment for longer. Charities that have borrowed to invest in developing their organisations will also benefit. Low interest rates also signal confidence that inflation will remain lower for longer, helping pounds stretch further November 2015 (BoE) November 2015 (NIESR) August 2015 (BoE) during a time when charity resources have been significantly squeezed. However charities with sizeable deposits will continue to struggle with low returns. Low interest rates will also contribute to a weaker pound relative to other international currencies potentially having significant impacts on the work of charities that deliver services overseas. There continues to be uncertainty around when the rate rise will come, with the latest Bank of England Inflation Report pushing back the predicted first interest rate rise to Q3 2016 from Q1 2016. Whenever it comes, charities will need to be ready to adapt. November 2014 (BoE) 2.5 HEADLINES 2 UNEMPLOYMENT DOWN TO 5.4% 1.5 1 GDP GROWS BY 0.5% IN Q1 0.5 0 Q4 Q1 Q2 2015 Q3 Q4 2016 Q1 Q2 Q3 Q4 2017 Q1 Q2 Q3 2018 Q4 Source: Bank of England, NIESR SPONSORED BY: Charity Finance Group www.cfg.org.uk [email protected] 0845 345 3192 Design: Steers McGillan Eves WHAT IMPACT COULD INTEREST RATES HAVE ON INVESTMENTS? HOW WILL NEW FUNDRAISING REGULATION HIT CHARITY FINANCES? TRENDS & TRAJECTORIES GDP GROWTH Q3 2015 VITAL SIGNS UNEMPLOYMENT: 5.4% Unemployment is continuing to fall gently. However, some of these falls are tapering off. For the 3 months ending August 2015 the highest rate of unemployment in the UK was in the North East (8.6%) and lowest in the South West (4%). CPI INFLATION: 0.5% AGING £92.9 POPULATION compared to 0.7% in Q2. This slower than expected growth has been caused by sharp contractions in production industries and construction. The domestic services sector, which expanded by 0.7% in Q3, continues to be the main contributor to growth. Source: ONS -0.1% BILLION In the year to September 2015, down from 0% in the year to August 2015. This is predominately driven by discounting by retailers and falling motor fuel prices. WHAT DOES THIS ALL MEAN FOR CHARITIES? In October the ONS estimated that the number of people aged 90 and over has reached 470,405, up from 330,572 in 2002. 71% of people over 90 are women. The deficit on the UK’s current account balance widened in 2014. This was the largest annual deficit since records began in 1948. INTEREST RATES: 0.5% Interest rates have remained constant and the Asset Purchasing Programme has remained at £375bn. 470,405 PEOPLE AGED 90 AND OVER Source: ONS The continued fall in unemployment is welcome news for charities – lower levels of unemployment should support economic growth and translate into improvements in household disposable income. The regional differences in employment figures are of note. In relatively deprived areas – where we typically see higher levels of unemployment such as the North East – there are fewer voluntary organisations in proportion to the population. In terms of demand, charities providing services in the North East are likely to experience greater pressures on their services. Although economists predict that the Bank of England will tighten policy early next year, some forecast this move slightly later in 2016 as inflation remains low and uncertainty over when the US Federal Reserve will hike up interest rates continues. Charities will benefit from sustained low costs of utilities and goods as inflation dipped below 0% for the second time in September this year. However, low inflation is indicative of the fragility of the UK and global markets, making it harder for charities to secure good returns on investment. Latest figures show the current account deficit widened to 5.1% of nominal GDP in 2014. This is symptomatic of the fall in exports and reliance on domestic consumption. High current account deficits make economies more fragile, and gives governments less room for manoeuvre in terms of economic stress. In a bid to achieve a budget surplus by 2020, the government has outlined £37bn worth of spending cuts over this Parliament. There is concern that the slower than expected growth in GDP could give the Chancellor rise to announce further cuts to ensure they reach this goal. This will not only further dent spending on charities but may also equate to higher demand on services as government departments and local government look to cut non-essential services. The ageing population poses two challenges to charities. First, it threatens to compound the sector’s pension deficit (currently valued at £1.6bn). Second, the number of people needing support will increase, and the nature of the services required will change, thereby placing increasing strain on charity finances. SECTOR INSIGHT: A FUNDRAISING DOWNTURN ANDREW O’BRIEN, HEAD OF POLICY & PUBLIC AFFAIRS AT CHARITY FINANCE GROUP ASKS WHETHER AND HOW THE CHARITY SECTOR SHOULD PREPARE FOR A FUNDRAISING DOWNTURN. A RAY OF LIGHT So far one of the few rays of light for the finances of the charity sector has been the continued generosity of the public and holding up of fundraising income. example, the Civil Society survey into charity shops showed a worrying drop in profitability. According to the survey, the profits of charity shops increased by 1.4% overall in 2015. This is compared to its peak in 2012 – 14.3%. Around 43% of charities saw profit growth decline in 2015. Although only one part of the fundraising strategy for the charity sector; the move towards trading with the public had been one of the biggest shifts since the recession and the fall in profitability is an early warning sign that growth in this sector is not guaranteed. However, the summer of discontent on charity fundraising is likely to have the biggest long term impact on charity finances. The RNLI has reported that it expects its opt-in policy for communications to see it lose around £7m a year or 4% of its income – costing £36m by 2020. Even before the Etherington Review was concluded, a number of charities had said that restrictions on frequency of communications With public funding for charities under considerable pressure due to the government’s could cost their organisations millions of pounds a year. Other charities are also in deficit reduction strategy, charities have had to rely more on fundraising and donations from the process of calculating the cost of new the public. Looking ahead, with the government rules on fundraising income. likely to announce further spending cuts at the If there was a 4-5% fall in donations and upcoming Autumn Statement, this isn’t likely fundraising income across the charity sector to change anytime soon. this would cost between £440-500m. If this turned into a long term loss of revenue, it However the charity sector has suffered could cost charities billions by 2020. At a a significant level of negative press attention time when the charity sector is already facing on fundraising over the summer which a £4.6bn funding gap due to a combination some believe has damaged public trust of inflation and continued falls in government and confidence in charities. There has also revenue. It will add to the financial difficulties been a review into the fundraising regulatory facing charities. landscape by Chief Executive of NCVO, Sir Stuart Etherington. This review has IS FURTHER REGULATION LIKELY? recommended toughing up the regulations The Etherington Review had already proposed around fundraising. a number of changes that may reduce the income of charities; the most controversial is A PERFECT STORM? the Fundraising Preference Service (FPS) Even before the press attention on charity which would prevent charities from contacting fundraising there were indications that some those that put themselves on the list – even if revenue streams were under pressure. For According to a review into the financial sustainability of the charity sector carried out by NCVO and supported by CFG – fundraising income has held steady at around £4bn a year since 2007/08. Donations have also remained steady at around £7bn a year, around where they were at their peak in 2010/11. they are registered supporters. There is also the potential cost of the new Fundraising Regulator which will be an additional bill for fundraising charities. There are continued concerns around reporting and monitoring of fundraising requests at a governmental level. Additional reporting requirements could build in new hidden costs into the fundraising process. However the government has not said that it has finished dealing with this issue and charities will have to cope with continued regulatory uncertainty that will affect future planning. WHAT CAN CHARITIES DO? The fall in government income means that charities cannot turn to the state for support leading to even greater competition between charities for dwindling resources. There may also be movements towards less regulated areas such as trading with the public, consultancy and corporate partnerships. However all these forms of income are not particularly large and could not on their own make up for a depression in fundraising income and donations. Another growth area since the recession has been charging for services, which has already been responsible for 98% of the sector’s income growth since 2008/09. However this is not something charities can transition to overnight and may have negative impacts on service users. For most charities, the plan will be a combination of further belt tightening and squeezing suppliers to maximise resources. But after five years of tough financial conditions a lot of the low hanging fruit has already been picked. A downturn in fundraising is the last thing that charities need. Andrew O’Brien Head of Policy & Public Affairs, CFG SECTOR INSIGHT: HIGHER RATES AND COMMERCIAL PROPERTY JEFFREY MATSU, SENIOR ECONOMIST, ROYAL INSTITUTION FOR CHARTERED SURVEYORS, WRITES ABOUT THE POTENTIAL IMPACT OF HIGHER INTEREST RATES ON COMMERCIAL PROPERTY INVESTMENTS – A GROWING MARKET FOR CHARITIES. Economic recovery in the UK has broadened sufficiently for monetary policy to initiate a process of normalisation. With close to full employment, real wages accelerating, growth near its potential, and business investment robust, a sensible strategy would indeed be to extend the expansion through a slow but steady tightening. While the precise timing of lift-off is debatable, we expect the Bank of England to increase its policy rate in 25 basis point increments twice yearly starting summer 2016. At this pace, the Monetary Policy Committee is unlikely to reach what it considers to be the terminal rate until sometime in 2019. Broad fundamentals are supportive for real estate in an environment where economic growth is improving and supply remains limited. Strong investor demand throughout the UK continues to exert downward pressure on commercial property yields amid solid rental income growth expectations. According to the most recent RICS Commercial Property Market Survey, demand for leasable space rose in 2Q 2015 for eleven successive quarters whilst available space fell for its ninth consecutive quarter. This mismatch has driven a firm trend in the rental environment and buoyed projections on the direction of rents. Survey data show that over the coming year, the office sector will experience the sharpest growth with expectations firming across both prime and secondary markets. A majority believe that commercial real estate is in the midst of an early upturn in the property cycle. This contrasts with the London market Meanwhile, demand in commercial property where a majority of respondents perceive continues unabated with investment enquiries valuations as above fair value and entering exceeding pre-financial crisis levels. The limited the peak stage of the upswing. pace and magnitude of rate hikes expected in the coming two to three years may slow this Against this background of strong market pace of acceleration, but overall prospects for performance and a stabilisation of economic the sector should remain undimmed. Interest growth at near trend levels, the commercial from overseas buyers continues to rise as well, property market is well positioned to weather particularly in prime office and retail, and this modest increases in interest rates. The key risks to this call would be stronger than trend toward safe haven assets would be anticipated monetary or fiscal tightening, a supported by any further financial market or weaker than expected occupier market, and economic growth uncertainties in external heightened uncertainty such as an exit of the markets such as China. Coupled with the UK from the EU (thereby crimping business limited availability of properties for sale, investment). While the impact of a Brexit is capital values across all property segments are projected to see sizeable appreciation both currently being underestimated, as is the near term and over the next twelve months. possibility that the Bank of England may As household income growth begins to slow already have fallen behind the policy curve, in 2016, however, lower consumer spending we view these outcomes as unlikely based on may affect retail property disproportionately. our current assessment of market dynamics Potentially most sensitive to rate hikes would and economic fundamentals. be the secondary retail market. Regional Charities can access RCIS’s free Charity variations in investor sentiment and capital Property Helpline designed to assist charities value expectations should also factor into asset and voluntary organisations, by providing allocation and the potential rebalancing of a support and guidance on all property matters property portfolio. Across the UK, 90% of our in the UK. survey respondents view current valuations Call 0870 333 1600. as either at or below fair market value. THE LIMITED PACE AND MAGNITUDE OF RATE HIKES EXPECTED IN THE COMING TWO TO THREE YEARS MAY SLOW THE PACE OF ACCELERATION, BUT OVERALL PROSPECTS FOR THE SECTOR SHOULD REMAIN UNDIMMED. SECTOR SNAPSHOT 10 MILLION 8 6 4 The amount of money that Children in Need have raised since 1980 to help disadvantaged children and young people around the UK. 2 11 20 11 /1 2 20 12 /1 3 /1 0 20 10 / 9 09 MILLION TRUSTEES IN Source: Charity Commission Source: BBC £500 50% 943,000 The amount the current budget for the Charity Commission has fallen since 2007/2008. Further cuts are expected in the upcoming Spending Review on 25th November. 20 8 /0 08 20 07 /0 20 /0 7 6 20 06 5 /0 /0 05 04 20 03 20 20 3 /0 /0 2 02 20 00 20 4 0 20 Source: NCVO Almanac 2015 £790 Voluntary sector investment income 2001/02 to 2012/13 (£billions 2012/13 prices) 12 /0 1 Charity investment income has begun to recover but still remains below prerecession levels. In 2012/13, investment income represented 7.2% of the sector’s total £40.5 billion income. Greater levels of investment income tends to benefit larger organisations and those organisations which have an endowment. Voluntary sector investment income 2001/02 to 2012/13 (% of total voluntary sector income, 2012/13 prices) 01 /0 CHARITY INVESTMENT INCOME RISING ENGLAND AND WALES THE TOTAL INCREASED COST OF THE NEW NATIONAL LIVING WAGE TO THE SECTOR BY 2020. This is compared to 450,000 teachers and 274,000 registered doctors £100,000 has been set aside by the Cabinet Office to help increase the fundraising capability of small charities through subsidised training courses. The training will be delivered between February and June 2016 This figure will be higher once NI and workplace pension contributions are added. Source: Charity Commission ASSETS AND LIABILITIES OF CHARITIES 2012/13 Assets are critical for the work of the charity sector. 89% of charities hold some form of asset which they use in their work or to generate income. This adds additional concern for charities ahead of the Spending Review where the Chancellor is likely to review business rates and may make further changes to the charity sector’s rate relief. The sector’s assets are worth a net £105 billion, which equates to 1.4% of the UK’s net assets in 2013. Asset values have recovered since the recession but this has not been evenly distributed, with the North of England seeing slower growth compared to the South East and London. Source: NCVO Civil Society Almanac 2015 Source: TSRC Source: Cabinet Office Billions, 2012/13 prices 120 22,000 100 80 60 The number of charities that will go through auto-enrolment from 2015 onwards. 40 20 0 -20 Liabilities Current Assets Fixed Assets Net Assets Source: Institute of Fundraising INVESTMENT OUTLOOK CHINA’S SLOWDOWN AND THE PROSPECT OF RISING INTEREST RATES HAVE HEIGHTENED STOCK MARKET VOLATILITY. NICOLA BARBER, HEAD OF CHARITIES AT JAMES HAMBRO & PARTNERS, DISCUSSES WHAT RATE RISES MEAN FOR CHARITY INVESTMENTS. From an investment perspective, rising interest rates could easily be perceived as a coming storm – something to shelter from. It might be more helpful to think of them merely as a sign of a changing season. Janet Yellen, the Chair of the Federal Reserve, has made clear that the US Central Bank will raise interest rates only when inflation is heading towards 2% and the country is enjoying close to full employment. With inflation close to zero and unemployment at around 5%, this may not happen till next year. The UK is likely to follow suit rather than lead the way. So, though we’ve been expecting interest rate rises for some time, the wait continues. Yellen and Bank of England Governor Mark Carney have made clear that when rises do come, they are likely to be limited and gradual. As economic confidence remains fragile, this should be reassuring, but even incremental changes may unsettle the markets. Beyond the investment arena, rising interest rates present challenges for those charities that borrow, while increasing returns for those with cash deposits. The following reflections may be useful in informing your conversations with your investment managers. Rising interest rates are not usually good for conventional government bonds – you have typically committed to a fixed rate of return and if interest rates rise, other asset classes, such as cash, become relatively more attractive. If this occurs along with rising levels of inflation then the real (after inflation) value of the bond will also fall. From a starting position where bonds are priced at historically high levels, largely as a result of a concerted effort by central banks to stimulate economies by programmes of Quantitative Easing, rising levels of interest rates and inflation may prompt investors to reconsider the merits of this asset class. BEYOND THE INVESTMENT ARENA, RISING INTEREST RATES PRESENT CHALLENGES FOR THOSE CHARITIES THAT BORROW, WHILE INCREASING RETURNS FOR THOSE WITH CASH DEPOSITS. Our preference in the fixed interest area is for high quality strategic corporate bond funds and index linked bonds rather than high yield, sub investment grade or emerging market debt. Interest rates affect currency markets too. As widening interest rate differentials may lead to a stronger dollar, it is no accident that some of our fixed income exposure is in US Treasuries. Equities typically outperform during the early stages of the Fed’s tightening programmes as the economic conditions are perceived as favourable. The key however, will rest on the valuation of equity markets which, in the US, presently look expensive to us. This is part of the reason we have recently added to our European and Japanese equity weightings. But remember, the performance of a market index represents a random walk comprising several hundred companies some of which will be winners and others losers. Historic sector beneficiaries of rising interest rates have included financials – banks can increase their margins when interest rates are higher, improving profitability and the consumer discretionary sector as higher rates are perceived as a sign of economic growth and higher levels of employment, resulting in greater confidence and increased levels of spending. Within our direct equities we are also positioning portfolios to avoid heavily indebted companies, focusing on those that generate plenty of cash (and can increase prices if necessary) to support progressive dividend policies and reinvest to create further shareholder value. Looking further afield, we believe (at the time of writing) that there will be better opportunities to invest in emerging markets and commodities. Amongst alternative assets, we are already seeing a cooling in London prime commercial property which may be exacerbated in a rising interest rate environment, with capital values rolling over as a consequence. But there may still be selective opportunities elsewhere – provincial shopping centres for example. So, rising interest rates can bring positives and new opportunities – they are a sign of ‘summer’ in the market cycle. But summer is followed by autumn and as markets begin to price in expectations it is always sensible to evaluate the investment strategy and focus on the medium term fundamentals and prospects for asset class returns. Nicola Barber Head of Charities at James Hambro & Partners (JH&P). She is also a trustee and chairs the investment committee of the Citizens Advice pension scheme.