Total Return Investment Accounting Basis, for Permanently Endowed Charities
The Charity Commission’s (CC) total return investment regulations allow trustees of permanently endowed charities to adopt a total return approach to the investment of the Charity’s funds, providing that the resolution is made in accordance with any relevant provisions in the Charity’s governing document, and that the Trustees can demonstrate that they have addressed each of the following points in making their decision to adopt a total return approach:
- Acted within their powers, considering all relevant factors, and disregarding any irrelevant ones.
- Acted in good faith and only in the interests of the Charity.
- Adequately informed themselves.
- Managed conflicts of interest.
- Made decisions that are within the range of decisions that a reasonable trustee body would make.
Authority, for adopting a total return approach to the investment of the Charity’s funds, does not need to be sought from the CC and they do not need to be notified of the passing of a resolution.
What is an endowment fund?
Endowments may be either permanent or expendable:
- Permanent endowment cannot be spent as income. It must be held separately to produce an income for the Charity. Permanent endowment can be held under a trust which might mean that it would not be available for the purposes of total return investment.
- Expendable endowment by contrast can be spent if the trustees wish. This sort of fund is not affected by these regulations or guidance.
To adopt a total return approach to investment the Charity should have assets which are held on a trust that specifies that they must be invested to produce income to be spent on furthering its aims.
Calculating the permanent endowment and unapplied investment return
The CC cannot recommend any basis for making the ‘reasonable estimate’ as to which part of their resources represent the unapplied investment return from the investment of the endowment, but the Trustees will not be expected to carry out an elaborate tracing exercise to determine the values.
How far back in time it is reasonable to go in making the analysis will depend on the Charity’s circumstances and the amounts involved. In most cases, it will not be practical to go back to the founding of the Charity. They do though recommend that the resolution identifies the relevant fund and the date of its valuation, as well as considering whether an existing Charity Commission Order is being discharged and if there are any outstanding recoupment provisions.
The CC’s regulations do though commit them to review the Charity’s resolution every 5 years from the date it came into force, ensuring the regulations achieve what they set out to do, and whether any amendment is necessary. The aims and results of the review will be published on the CC website.
Before passing the resolution, the Trustees must first be able to identify and record:
- The assets they hold which represent the value of the original endowment when made.
- The assets they hold which represent the unapplied investment return arising from the original endowment. Unapplied investment return includes: interest receivable; dividends; all forms of capital gain; and any capital losses. Unapplied total return means that part of the total investment return from the Charity’s investment fund which has not yet been allocated to either the income fund (term used to mean the part of the Charity’s unapplied total return which the Trustees have decided to spend on its aims) or the investment fund.
The unapplied total return can be carried forward if not needed, or allocated to be spent as income, or reinvested in the investment fund in a particular year. If there is a negative unapplied total return, this means that the amount of unapplied total return in that year is less than nil.
Allocating unapplied total return
Each time charity trustees allocate part of the unapplied return to the income fund, they should look at the overall amount of total unapplied return available to them, rather than just the Charity’s investment return in that financial year. The amount that can be added is capped. This is calculated by using the rise in inflation, based on whichever index the Trustees think is appropriate to the sector their charity works, from the date of the last allocation to the Investment Fund or, if no allocation has previously been made, then the date used will be the valuation date of passing the resolution to use total return.
In deciding what part of the unapplied total return is to be used as income, the Trustees should take account of such factors as:
- fluctuations in the value of investment assets from year-to-year and the effect of anticipated inflationary increase in the cost of funding the Charity’s aims.
- Analysis of potential investment risks.
- Changes in the services the Charity provides.
The fact that a charity might receive a negative total return (means the value of the assets at any time held in the Charity’s Investment Fund is less than the ‘relevant value’ of the original endowment that established the Fund) in a financial year does not prevent the Charity from allocating funds to the income fund from the unapplied total return in that year. What is important is that the unapplied total return is positive and that the Trustees can justify the balance of funds remaining as unapplied total return, after any allocations to the income and/or investment funds have been made.
Any funds not allocated, and remaining as unapplied total return, should be invested in the same way as the permanent endowment, because, at that point, they are not freely available for expenditure on the aims of the Charity.
Trustees should not normally need to retain funds for any length of time in the income fund. This is because part of a charity’s unapplied total return may be allocated to the income fund at any time, and so there is no need to build up reserves in the income fund.
Releasing funds from investment funds to income funds, and recoupment
Charities have the power to release some of the funds held in their investment fund so that they can be used as income and spent on the Charity’s aims, providing that: the amount that may be released from the investment fund, to the income fund, is subject to a cap and must not at any time bring the total of the sums released to more than 10% of the value of the investment fund at the date of the first such release which has not yet been repaid; and it is to be repaid. The reason for the upper limit is to provide a degree of suitable protection for the investment fund, representing the gift to the Charity.
If charities wish to release funds held in their investment fund, they must recoup it, meaning the replacement of any part of the investment funds that the Trustees have decided to spend.
Financial Statement disclosures
The Trustees’ Annual Report must contain certain information about how the total return approach to investment has been applied by the Trustees, explaining how the value of the investment fund has been established and the date from which the income and gains have been allocated to the unapplied total return. The Trustees must also explain the considerations and policies that were relevant to their determination of the amounts allocated to the Trust for their application during the financial year. Similarly, an explanation must be provided about decisions made to allocate any part of the permanent endowment to the income fund.
The Statement of Financial Activities (SOFA) must, under SORP principles, record any allocations made from the unapplied total return of the investment fund as a transfer between funds in a charity’s SOFA with the notes to the accounts providing an explanation of the transfer.
Finally, charities should provide a note to their accounts that reconciles the movements on the unapplied total return in the financial year.
The Charity Commission’s (CC) total return investment regulations allow trustees of permanently endowed charities to adopt a total return approach to the investment of the Charity’s funds, investing in a way that has regard to the furtherance of the Charity’s aims both now and in the future, by ensuring that they are receiving adequate income for current needs, and enough capital growth to safeguard future income.
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