Risk considerations for non-profit portfolios

Risk considerations for non-profit portfolios

Risk is a key topic on the mind of every investor, particularly as global share markets have experienced a correction in the first quarter and there are predictions that both inflation and interest rates will rise in 2022.

Managing risk is of particular importance to not-for-profit (NFP) investors, who often need to produce sustainable absolute returns in order to meet their operational and giving requirements and as a result, can be sensitive to downward movements in markets.

NFPs play a range of important roles in our society, enabling us to practice our Faith, give voice to local communities and donate both time and money to philanthropic causes. According to Philanthropy Australia, there are currently over 600,000 NFPs operating in Australia.

At Uniting Financial Services, we are specialists in managing funds on behalf of NFPs and understand the importance of managing potential risks. Here we outline some of the key risks NFPs should be aware of and our approach to managing them.

Key risks

Market risk

One of the better-known risks of investing in assets such as shares, bonds and property is market risk – which is the risk of loss due to factors that affect an entire market or asset class. This may result from factors such as changes in the global geopolitical environment, changes in government policy, or an environment where asset prices appear stretched.

Within our managed fund range, we manage risk through portfolio construction and asset allocation, creating portfolios that are well diversified by manager, asset class, sector and company.

At times, we also make short-term changes to the asset allocation of our portfolios. As an example, in 2021 when equity markets were outperforming, we held an overweight position in equities within our Ethical Conservative Balanced Fund, which contributed to portfolio outperformance above our targets. However, with inflationary pressures mounting this year, which can be costly for companies, we recently wound back this overweight position.

Non-systematic risks

Another risk investors face is non-systematic risk, which is a risk that is unique to a specific industry or company. Some examples include an industry facing unexpected supply chain issues or a company suffering brand damage leading to earnings disruption.

Another type of non-systematic risk is the risk of investing with a particular investment manager. Some examples of risks that can occur here include sustained underperformance, the loss of a key fund manager or even fraud.

To mitigate these risks, UFS uses a multi-manager approach, thoroughly vetting managers on a range of measures and undertaking manager visits every six months. As part of the monitoring process, the suitability of the current investment managers in achieving the portfolio design and strategies is critically examined.

Should a new manager be required, we undertake qualitative and quantitative analysis on a range of factors known as the Six Ps – principles, philosophy, process, people, performance and price.

By investing with a range of best-in-class managers, our underlying portfolios are well-diversified, minimising the potential impact of shocks to one particular industry or company for investors.

Environmental, social and governance (ESG) risks

Today’s consumers are demanding greater transparency over company activities, from greenhouse gas emissions to deforestation and executive compensation.

Long-term corporate success in a rapidly changing world depends on avoiding reputational risks and protecting corporate integrity. Failing to manage these factors carries increased financial and regulatory risk.

At UFS, managing ESG risks has been at the heart of our operations since the 1980s. Our investments are managed according to our Ethical and ESG Investment Policy, which is directly linked to the United Nations Sustainable Development Goals.

This means that our portfolios are not only managing potential risks but are also actively contributing to a more sustainable future by investing in companies that are actively making changes for the better, such as clean energy companies, green buildings, education providers and efficient users of water.

2022 Outlook

2022 will bring more challenges compared to 2021. Investors cannot expect 2021-level returns for equities, amid an environment of normalising earnings growth. Pressure on government bonds will continue, while interest rates will start to rise. Geo-political risk, with rising popularism and atrocities, adds further complexity to the system. Therefore, our risk and return assumptions, while generally still optimistic, needed adjustments to account for rising volatility in this two-speed world.

Against this backdrop, UFS Investment Management will have to recalibrate risk throughout the year, with a focus on the balance sheet and fund resilience to rising interest rates and yields.

We recommend all NFPs have a clear investment strategy that includes risk tolerance and regularly review their strategy to ensure it remains consistent with their organisation’s objectives.

  1. Philanthropy Australia sector overview: http://www.philanthropy.org.au

Edwin Lo, Senior Portfolio Manager, Uniting Financial Services

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