March 2010

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Contents

Introduction

01 Charities and Defined Benefit Pension Schemes: Managing the Unmanageable?

05 Charity investments and tax – a users guide

07 Pensions Trust Growth Plan

09 In the Spotlight: What our clients are doing with their pension schemes

11 Pension Protection Fund Levy – act now to save money

13 Managing in a Downturn: Are charities feeling more optimistic?

17 A look behind the headlines on alternative investments

19 Controls over investments – top tips

20 PwC in the Community: Charity of the year – Smile Train

Back page Dates for your diary

Introduction In this issue we have a strong focus on Finally, we summarise the third iteration of pensions, investments with articles on Managing in a Downturn. We continue to alternative investments and some of the tax have good response rates to this survey considerations when making investments as which is jointly conducted with Charities well as the next iteration of Managing in Finance Directors Group (CFDG) and the a Downturn. Institute of Fundraising.

It seems timely with so much in the mainstream With the economy now in a perceived upturn press about the effects of defined benefit (my fingers and toes are crossed as I write pension schemes, to give you a summary of a this), things don’t seem to have been quite seminar we held in October with CFDG. There as bad as fundraising and finance directors are a significant number of charities that still had expected a year ago, but there’s still real have these schemes in operation. Whilst such concern about the impact on the sector in schemes can be a great benefit to attract staff the next 12 months. For those with significant when salary isn’t as high as the commercial- government/statutory funding, the anxiety world equivalents, the potential long term cost levels are not-surprisingly higher as we run is a particular concern in the current economic into the imminent general election. environment. In a separate article we analyse some aspects of the Pensions Trust Growth May I wish you a good spring – time for a few Plans, vehicles used by many charities to green shoots to flourish I hope. provide pension arrangements – they’re not always as straight forward as they may seem Liz Hazell at first sight… National Charities Group Leader

In the Spotlight features City & Guilds. Having recently delivered a new pension deal for their employees, Sharon Saxton (Director of HR and Development) explains how a challenging project was helped by really engaging with their employees.

Charities and Defined Benefit Pension Schemes: Managing the Unmanageable?

The economic downturn in the UK has pushed the funding of defined benefit pension schemes to the top of both charity trustees and scheme trustees’ agenda, alongside concerns over how to react to the adverse economic environment.

Over the last few years, the Pensions Regulator has established a set of rules for pension scheme trustees to follow in order to ensure that the funding of the scheme is at an appropriate level. These rules provide, in essence for a regular, three-yearly, review of the size of the scheme deficit, if any, followed by the need to agree with the scheme employer the period over which this deficit is repaid (“the recovery plan”).

01

During 2009, PwC were increasingly asked to assist either charity employers and/or pension scheme trustees to navigate their way through some difficult decisions in trying to balance their respective obligations in this regard. In October 2009, we hosted with the Charities Finance Directors Group (CFDG) a seminar for nearly 100 charities facing challenges arising from the potential liabilities presented by defined benefit schemes.

A sizeable minority (40%) of those charities attending this seminar felt that defined benefit pension schemes were still required to recruit or retain staff. In addition, over 40% of our audience felt that such pension schemes were an unmanageable cost to their charity.

“It is essential for the trustees to form an objective assessment of the employer’s financial position and prospects as well as his willingness to continue to fund the scheme’s benefits (the employer’s covenant). This will inform decisions on both the technical provisions and any recovery plan needed.”

[Taken from the Pensions Regulator’s Code of Practice 3]

It is important to understand that the deficit on a scheme is assessed in part as a result of the strength of the employer covenant, which in turn affects the level of caution required in the so-called “technical provisions” (the assumptions behind the calculation of the liability to the scheme).

The employer covenant

The downturn is having a severe impact on the employer covenant of many pension schemes. At the same time asset values have decreased significantly increasing scheme funding deficits.

This means that charities can expect trustees to be more concerned about the strength of the employer covenant and to be considering the options they have to protect the scheme’s position as a significant unsecured creditor.

A key part of managing the contributions required by the scheme is to understand and communicate the strength of the employer covenant.

An employer covenant review is an objective and independent assessment of the overall financial strength of participating employers of a pension scheme.

Employer covenant

Pension scheme

Investment Funding strategy levels

The assessment of the strength of a charity’s covenant will differ in material respects from those of a “commercial” or “for profit” employer. Whilst some aspects will remain constant, such as the quality of management, other traditional measures, such as profitability and balance sheet strength, must give way to measures of flexibility and reserves.

Ensuring that an appropriate assessment is made will affect significantly the strength of the employer covenant, which will in turn make a material difference in many cases to the size of the scheme deficit. It is essential, therefore, that charity employers take appropriate legal and accounting advice where a significant deficit is likely to result.

Why is the employer covenant so important? As well as helping the charity and trustees to understand the current level of security offered to the pension scheme, having an understanding of the employer covenant also enables:

• The trustees, with the charity, to set the technical provisions which drive the liability valuation;

• The trustees and the charity to agree on a recovery period

• The trustees, with the charity to consider the appropriate equity strategy and pick appropriate equity classes so as to achieve a natural hedge to the risk associated with the employers industry; and

• The trustees and the charity to understand if an event is atype A (events that could have a financially detrimental effect on ability of a pension scheme to meet it’s liabilities) and the resulting impact on funding.

02

Managing the pension creditor

Backed by the Pensions Regulator, and in response to the downturn, we are seeing pension scheme trustees take a more proactive approach to safeguard their position. The scheme is now a powerful stakeholder which charities should engage with in a professional manner. As the final part of the scheme funding negotiation, agreeing the recovery plan is often the point at which negotiations break down, as all parties try to bring their differing views to a conclusion. This is borne out by our survey of attendees to the seminar, with a third of participants finding this a point of friction.

Clearly, the period of the recovery plan is a very difficult balance to strike. In a commercial organisation, the position is easier to understand: either the employer can afford to pay or it cannot. With a charity, however, the position is less clear: what proportion of annual funds can a charity sensibly allocate to fund its scheme deficit? There is no benchmark here, it is for each Board of charity trustees to establish a sustainable position and seek to convince scheme trustees that any additional payments would have a negative effect on the charity’s ability to fundraise or support its beneficiaries and therefore its long term future.

Again, it is important to take advice in these circumstances where there is a concern on the part of charity trustees in particular that the charity’s medium term viability could be called into question.

For more information contact: Ian Oakley-Smith 020 7212 6023 ian.oakley-smith@uk.pwc.com

James Berkley 020 7804 0135 james.berkley@uk.pwc.com

Managing conflicts

Many pension scheme trustee boards still include senior management of the charity. Traditionally this was often seen as a positive as they could translate the financial performance for the wider scheme trustees and bring their company insights. However, with pension scheme trustees required to protect the interests of their members in negotiations against the employer, remaining independent is critical. Senior management who try to juggle these competing responsibilities may find it not only very difficult for them personally, but it can also hinder negotiations.

We asked how charities have been managing these conflicts. 21% had already taken the step of appointing an independent trustee to bring knowledge and independence to their trustee board, with a further 13% that had appointed new advisors to help manage conflicts.

Conclusion

With the current economic circumstances likely to impact charity income streams for some time to come, the challenge for charity trustees to balance their obligations to donors and beneficiaries with those to their pension scheme will continue to require ongoing effort. In our experience, this effort can be helped significantly if charity trustees take the initiative, both in relation to the assessment of the employer covenant and also as to the rationale behind any proposed recovery plan period. By taking the lead in this way, the charity will be setting the agenda and it will be for the pension scheme trustees to respond.

Top five tips for Charity Trustees

1 Take the initiative and engage early with your pension scheme trustees

2 Understand the strength of your charity’s covenant

3 Understand and be prepared to challenge the assumptions behind the calculation of the pension scheme deficit

4 Challenge constructively the rationale behind the proposed recovery plan period and be clear about and be able to support how much your charity can afford to contribute each year to any deficit

5 Take advice: this will bring experience of other situations to bear and provide independent support

03

04

Charity investments and tax – a users guide

Do Charities need to think about tax?

Charities are extremely fortunate compared to other taxpayers in having broad tax exemptions available to them for investment income and gains. A charity Finance Director’s first thought in making an investment is usually whether it is of a type allowed in the charity’s constitution and by the Charity Commission, and secondly whether it will make them money and support their charitable aims. However, tax should always be a third consideration because there are several tax pitfalls, and an unexpected tax charge can hit the net return from a good investment or make an economic loss more painful.

How not to make a “Non-Charitable Investment”

The first question charity trustees and executives should ask themselves is whether their proposed investment strategy falls within the guidelines set out by the Charity Commission. These in turn are linked to a list of qualifying charitable investments which HM Revenue and Customs will automatically accept as OK for tax purposes.

• Bank and building society deposits

• Listed shares

• Government bonds

• Secured loans

• Common investment funds and depositfunds

• Land (but not loans secured on land)

• Authorised unit trusts

• Other investments and loans made forcharitable purposes (subject to claim to HMRC)

This list will cover 95% of a typical prudent charity’s investment portfolio, and avoids the need to make detailed disclosure of investment income on your charity tax return. The list for trust charities is in Section 558 of the Income Tax Act 2007, whilst that for companies is in Schedule 20, Income and Corporation Tax Act 1988. They are currently worded slightly differently.

The reason that it matters whether investments appear on the list is that those that don’t are potentially “non charitable investments”. You might think that the tax consequences of making one of these is that the income and gains from it would be taxable, but in fact the way the legislation works is to say that, if the investment cost £10,000, that amount of the charity’s income has been applied for non charitable purposes and so will be exposed to tax. That is potentially very expensive; generating a £2,800 tax charge for a charity in the year the investment is made.

05

Why might you want to invest outside the list?

As you will have read in other articles in this issue of Charity News, conventional investments in listed equities and bank deposits have shown higher risk and lower returns over the past couple of years, and after a 17 year property boom the property development market has collapsed and rental values are falling. There is even a fear that government and corporate bonds could be hit by inflation in the future.

Larger and more sophisticated charities are therefore looking at “alternative investments” such as private equity partnerships, hedge funds and more exotic areas such as commodities. Their aim is to balance their portfolio risk and to enhance returns. Although these asset types are not on HMRC’s specific approved list they may still be charitable investments under the last category in the box above if the trustees can demonstrate that they are taking appropriate professional advice in adopting this strategy, it forms part of a balanced approach to investment and is not for the avoidance of tax. There is a clearance process for approaching HMRC on particular investments, but in practice it is not often used.

However this type of investment does require a very skilled investment approach – there are examples of charities which have done very well through the current financial crisis using alternatives to hedge their portfolio, but also some well publicised cases of individual funds becoming valueless. Typically these funds are hard to exit in the middle of a crisis (for instance private equity partnerships often include a 5-7 year lock in) and even those that were meant to be open ended struggled to give investors liquidity during late 2008 and 2009.

Many funds are domiciled in overseas territories, such as the US, Cayman or Luxembourg. A proper appraisal should be carried out before investing to see whether tax is being paid in the investment territory or withheld on payments by the fund to investors. This can be combined with legal due diligence to understand whether the terms and management fees are acceptable. A particular pitfall with overseas investment funds is that gains made by the fund overseas and reinvested may be taxable in the charity – since this is a notional gain it doesn’t qualify for the charitable tax relief.

For more information contact: Amanda Berridge 020 7213 2994 amanda.berridge@uk.pwc.com

Where EU withholding taxes have been paid on dividends it may be possible to lodge a retrospective repayment claim because your EU Freedom of Movement of Capital has been infringed – after the success of Fleming VAT claims last year many charities are realising just how nice it is to get a cheque back from the taxman, and we are currently co-ordinating these claims around Europe for larger charity investors.

Don’t forget the other investments

Often when we speak to charities they understand that their investment approach should be prudent when it comes to investing their endowment portfolio, but mentally exclude from their “investments” assets such as shares and loans in subsidiaries and parts of their property portfolio. HMRC don’t take this approach – they expect you to be just as rigorous in assessing say an unsecured loan to a trading subsidiary which is running out of cash, and there is a risk that this will be a non charitable investment because it doesn’t make sense in terms of security or income. Capitalising and funding subsidiaries is a recurring issue for charities which will be covered in more detail in a later edition – in this article I would just like to point out that getting it wrong can have tax consequences for the charity.

Finally many charities have owned land for many generations, often acquired originally for a groat or two, and then find that their operational needs change or the area is zoned for residential development and an opportunity arises to sell. Capital gains realised on land sales are exempt in the charity itself (though finding out who actually owns the land can be difficult and sometimes leads to a surprise – it could still be in some ancient trust or related entity). However trading profits and “slice of the action” deals generated from property development can lead to taxable income, so the art is deciding whether you are going to cross this line early and making plans accordingly.

So charitable investments are not as straightforward as they may seem for tax purposes – and if the amounts are significant you would be well advised to take some advice on where you stand.

06

Pensions Trust Growth Plan

Many charities provide pension benefits through the Pensions Trust Growth Plan. The design of the Plan gives rise to a number of issues which could have expensive consequences if they are not fully understood. This article describes the background to the Plan and sets out the points which participating charities need to be aware of.

Background

There are four Growth Plan Series.

• Series 1 relates to contributions paid before April 1997;

• Series 2 relates to contributions paid between April 1997 and September 2001;

• Series 3 relates to contributions paid after September 2001; and

• Series 4 was introduced as an alternative to Series 3 for contributions paid after September 2008.

On first sight, the Growth Plan looks like a defined contribution arrangement, but Series 1, 2 and 3 have some features which mean that they are more like defined benefit arrangements.

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Series 1 and Series 2 contributions were allocated to individual members and converted to defined amounts of pension payable from Normal Retirement Date. This means that these sections can be in deficit (or indeed surplus), and additional contributions could be required in future to eliminate any deficit. They are also caught by some of the defined benefit legislation. In particular, there is a potential debt on an employer if it ceases to have any active members of the Plan. It also means that these sections need to be treated as a defined benefit scheme for accounting purposes.

Series 3 contributions are invested in personal accounts which are then used to buy a pension at retirement either within the Growth Plan or on the open market. There is a guarantee that the value of the members’ accounts can not reduce.

Series 4 is a more traditional defined contribution arrangement. As with Series 3, the contributions are invested in personal accounts, but there is no capital guarantee, so the funds could fall in value.

How should the Growth Plan be treated in the charity’s accounts?

The Growth Plan is a multi-employer scheme and the Pensions Trust say that it is not normally possible to identify the share of the assets belonging to each participating employer on a consistent and reasonable basis. Therefore, paragraph 9 of FRS17 allows the employer to account for the scheme on a contributions paid basis.

This means that the charge to the income statement is simply the contributions paid by the charity, and there is no balance sheet asset or liability.

In this case, FRS17 requires that this treatment is disclosed, together with any available information about the existence of a surplus or deficit and the implications of that surplus or deficit for the employer. Many charities use the draft disclosure available from the Pensions Trust, although it is quite long!

Even if the Growth Plan has only been used to provide benefits from Additional Voluntary Contributions, strictly speaking the full disclosure should be used. However, as with all things in the accounts, your auditor may be happy to omit it if it is immaterial.

Debt on the employer legislation

Perhaps the most worrying aspect of being in the Growth Plan is the potential for a debt to be served on the charity. Section 75 of the Pensions Act 1995, as amended, means that there is a potential debt on employers which participate in a multi-employer pension scheme such as the Growth Plan. The debt would apply if the employer ceases to have any active members in the scheme whilst other employers continue to have active members.

The debt on the employer is effectively the employer’s share of the Growth Plan’s total buy out deficit (ie the shortfall in the assets compared to the cost of buying out the liabilities with an insurance company). As such, it includes an amount in respect of ‘orphan liabilities’ (the liabilities for deferred and pensioner members of previous employers who have already withdrawn from the scheme). These liabilities are apportioned among the employers in proportion to the liabilities which can be attributed to the current employers in the Plan. The Growth Plan trustees have decided that when they undertake this debt calculation the shortfall will only be apportioned with respect to the Series 1 and Series 2 liabilities.

Is there any way of avoiding the debt on employer?

Series 3 now offers very little investment return, as the capital guarantee means that the investments are effectively held in cash. The low returns on cash mean that the Growth Plan is no longer suitable for many members, particularly the younger ones. So some charities are thinking of offering a different pension arrangement - but withdrawing from the Growth Plan will trigger the debt. Is there any way of avoiding it?

The easiest way to avoid the debt is not to trigger it in the first place. This would happen if the charity continued to have active members in the Growth Plan. One alternative to consider is to switch to the Growth Plan Series 4 rather than withdrawing from the Plan altogether.

The Growth Plan Series 4 invests in a managed fund (comprising 65% in equities and 35% in bonds) until 5 years before retirement date and then switches investments so that at retirement the fund is invested 75% in bonds and 25% in cash. The key difference from the Growth Plan Series 3 is that there is no capital guarantee and so the funds can fall in value. However, in the long term, it would be expected that the Growth Plan Series 4 would provide better returns than the Series 3. The Series 4 may not be suitable for all charities and advice should be sought before making a decision.

The Pensions Trust offers charities the opportunity to switch from the Series 3 to the Series 4 on a regular basis.

There are other alternatives to paying the debt (Apportionment and Withdrawal arrangements), but they are only possible in certain limited circumstances, usually on a restructuring. Legal and actuarial advice would be needed if you wanted to consider one of these options.

Conclusion

Participating in the Growth Plan has certain consequences which follow from the design of the benefits. It is important for employers to understand these consequences, particularly if you are looking to make any changes to pension benefits for your employees.

For more information contact: Nick Towers 012 1265 5913 nick.towers@uk.pwc.com

08

In the Spotlight: What our clients are doing with their pension schemes

City & Guilds are the leading vocational awarding body in the UK, and the only one solely dedicated to vocational learning, offering over 500 qualifications in 28 industry areas. They have a workforce of around 1,000 people operating in several different offices across the UK.

City & Guilds recently underwent a significant change to their pension scheme and Sharon Saxton, Director of Human Resources and Development, shares her experience onhow to manage the transition.

I joined City & Guilds at the end of 2007 and one of my first challenges was to oversee a review of our pension arrangements. At the time we operated two different pension schemes for the bulk of our employees, an open final salary scheme for employees aged over 40, and a money purchase scheme for employees under this age.

In common with many final salary schemes, the scheme was suffering from a deficit as a result of both stock market volatility and increasing life expectancy assumptions. The take-up of the money purchase scheme was low and around 40% of our employees were not in a pension arrangement at all.

As our business has grown, the requirements of our employees have evolved and we wanted our pension provision to reflect that. Our main objectives from the review were to:

• Move away from a ‘two tier’ workforce with different pension schemes

• Continue to provide a scheme with a defined benefit promise

• Share the risk of pension provision more evenly between employees and City & Guilds

• Provide a pension that is competitive for recruitment and retention purpose

• Increase participation in the scheme

• Engage employees in the review and use their input to shape the final scheme design

For us, engaging our employees and obtaining their thoughts before finalising the new design was an important part of the exercise. Like any business we also had constraints in terms of cost and future risk/volatility to work within.

City & Guilds opened its final salary pension scheme in 1966 and it was open to all employees until 2001 when membership was restricted to employees aged over 40. Between 2001 and 2007 employees under this age were offered membership of a money purchase section of the 1966 scheme. In 2007 in response to changes to age discrimination legislation, the money purchase section was transferred into a new scheme.

Making it happen

City & Guilds worked closely with their pension consultants to come up with a proposed new design, which was subsequently taken to employees

through a consultation process. In a project that would last over 12 months and with many stakeholders to manage, including the recognised trade union, employees and pension trustees, careful planning at the outset helped City & Guilds map out a path to completion. The solution proposed was a Hybrid scheme – combining a CARE (Career Average Revalued Earnings) benefit with an optional money purchase top up element. This gave everyone the security of a defined benefit promise with the opportunity to boost their pension at retirement by contributing to a money purchase fund.

To communicate the new proposed design, ‘What if’ statements were sent to each individual, illustrating their estimated retirement pension before and after the proposed changes, and every affected employee was invited to a presentation with the opportunity to provide feedback. A website was set up with a pension planner to let employees see how they could change their estimated pension by paying more or less into their money purchase fund. A pension employee forum was also set up to represent employees and at the same time City & Guilds consulted with the recognised trade union to take on their views over the changes.

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The consultation feedback from both employees and the union led City & Guilds to amend the detail of the design in several areas, keeping the overall Hybrid structure but altering certain benefit and contribution levels to better match employees’ requirements. To show employees the impact of the amended scheme design updated ‘What if’ statements were sent to everyone showing an indication of their pension at retirement based on the actual design that was now planned to be adopted.

Having established the design of the new scheme, City & Guilds worked closely with the trustees of both pension

schemes and other stakeholders to ensure a smooth implementation of the new arrangements.

Results delivered

The commitment to a comprehensive communication programme to educate employees, and a genuine consultation exercise, meant that employees were able to influence the final scheme design and better understand the benefits of the new scheme. By setting up an internal pensions employee forum we established a group which could take informal feedback from employees and answer concerns, a concept which worked well for us.

The changes were generally well received. Pension take up has increased and over half of the pension members have opted to pay into their money purchase top up funds to boost their pension. The new design went live as planned on 1 April 2009.

Going forward, City & Guilds has managed to reduce its pension costs to a more manageable level while continuing to offer a good quality pension arrangement. Most employees also now have a much better understanding of their expected level of pension at retirement and how to increase this, if desired.

10

Pension Protection Fund Levy – act now to save money

11

All defined benefit pension schemes have to pay a levy to the Pension Protection Fund (PPF), the UK pension scheme lifeboat. In this article Nick Towers warns about potential increases and suggests some ways of reducing the levy.

Background

The PPF was established in 2005 to provide compensation to members of defined benefit schemes if their employer fails and there are insufficient assets in the scheme to meet the liabilities. To fund it, compulsory levies are charged on all eligible schemes.

The levy is made up of two parts:

• The scheme-based levy, which depends on the scheme’s liabilities; and

• The risk-based levy, which also takes account of the risk of a scheme’s employer failing.

The PPF has recently announced that the total levy they aim to collect for 2010/11 has increased to £720m. The PPF is also proposing to introduce a cap for organisations in distress, which will leave a greater proportion of the total levy to be borne by other organisations.

How the risk-based levy is calculated

To assess the risk of failure, the PPF uses a credit scoring agency, Dun & Bradstreet, who provide a ‘failure score’ for each scheme’s employer. This failure score is based on various pieces of information including:

• Financial information, including the organisation’s latest accounts;

• Details about the age and size of the organisation;

• Details about the directors or their equivalent;

• Details about trade payments; and

• Public negative data such as county court judgements, and mortgages or charges.

In previous years, charities were encouraged to send their accounts directly to D&B. In a change this year, employers filing accounts with the Charity Commission will now have them automatically picked up by D&B up until 30 March 2010. However, if you are in any doubt that D&B may not pick up your accounts from the Charity Commission website, we recommend you still send them directly to D&B.

How the risk-based levy can be reduced

There is only a limited scope to reduce the scheme-based levy, but the risk-based levy can often be significantly reduced.

• For 2010/11, the risk-based levy could be reduced by putting in place a PPF-compliant guarantee from a related organisation, or by providing other security.

• For 2011/2012, the risk-based levy can also be reduced by improving the D&B score for the scheme’s participating employers.

Conclusion

Management of charities should act promptly in the next two weeks to reduce their liability.

For more information contact: Nick Towers 012 1265 5913 nick.towers@uk.pwc.com

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Financial Times23 October 2009

“Where have all thegreen shoots gone?”

“UK businesses fear double-dip recession.” Financial Times

15 February 2010

“Public sector plan cuts

20,000 jobs.”Financial Times

7 October 2009

MIAD survey resultsFebruary 2010

“If we need to use reserves to maintain services we will do so in the short term whilst we change our strategy and develop new sources of income.”

13

Managing in a Downturn: Are charities feeling more optimistic?

MIAD survey resultsFebruary 2010

“The market place is becomingmore crowded and dominatedby the larger players. We aretaking time to understand whatour place is in the future(5 years from now) and how we

get there. What is unique andpowerful about us and how weput in place strategies to defendthis position.”

“Recession has not so farimpacted our income - weare growing well. but weexpect government financesto be markedly tighter innext 12 months.”MIAD survey resultsFebruary 2010

“We are also using

our reserves to invest

in our infrastructure

in order to ensure we

have effective, cost

efficient systems to

drive the organisation

forward.” MIAD survey resultsFebruary 2010

“Government budgets,

particularly the NHS, are

expected to be under severe

pressure.” MIAD survey results,

February 2010

In December last year, we launched the third of our surveys focusing on the impact of the current economic climate on charities. In collaboration with Charity Finance Directors Group (“CFDG”) and Institute of Fundraising (“IoF”), the surveys provide an insight into the expectations of finance directors and fundraisers. The questions have looked at the various sources of income and expenditure, together with the actions being taken by charities as a result. In an addition for the latest survey, we also looked at the focus of charities’ fundraising investments and how fundraising strategies had changed as a result of the current economic climate. Our report has recently been issued and copies can be obtained from our website at http://www.pwc.co.uk/ eng/issues/managinginadownturn.html or by emailing Ian Oakley-Smith on ian. oakley-smith@uk.pwc.com.

Below we give a summary of the survey results.

Anxiety over Income – what income streams are worrying charities?

Whilst the upturn in the economy may have just begun, anxiety within the charity sector remains

Whilst the upturn in the economy may have just begun, many charities remain anxious that income will fall in the next 12 months. Between the first and second surveys, overall anxiety increased significantly in all income streams; however charities appear to be less anxious now.

Whilst on the whole, anxiety levels appear lower, anxiety over funding for government/statutory income is at its highest level across the three surveys. This is not unexpected, in the light of the recent volume of press coverage of likely public sector spending cuts

MIAD survey resultsFebruary 2010

“The market place is becoming more crowded and dominated by the larger players. We are taking time to understand what our place is in the future (5 years from now) and how we

get there. What is unique and powerful about us and how we put in place strategies to defend this position.”

“Recession has not so far impacted our income - we are growing well. but we expect government finances to be markedly tighter in next 12 months.”MIAD survey resultsFebruary 2010

“We are also using

our reserves to invest

in our infrastructure

in order to ensure we

have effective, cost

efficient systems to

drive the organisation

forward.” MIAD survey resultsFebruary 2010

“Government budgets,

particularly the NHS, are

expected to be under severe

pressure.” MIAD survey results,

February 2010

expected in the next government spending review, or earlier, after the pending general election. To compound the uncertainty, the sector is unsure when the timing of the cuts is likely and some of the comments in the survey suggested that they do not expect a drop in income until 2011. This is of course a difficult area to predict, but inevitably those charities with a dependence on statutory funding will want to understand and plan for possible reductions in those income sources over the next few years.

Investment in fundraising -where should we invest and how do we measure success?

With the economy now in a perceived upturn, charities should be reflecting on their future income

We asked questions in the survey around charities’ intentions in relation to investments in fundraising activity. Many charities had previously reported that they were cutting back on fixed fundraising costs, but at the same time seeking to invest in certain fundraising initiatives.

One challenging question facing both the fundraising and Finance Directors is the length of time and amount of resource that should be utilised in a fundraising stream, if it does not initially yield income.

Our report contains a series of tips and guidance (see p16) which have been prepared by the Institute of Fundraising from workshops and specific surveys to their members to help charities ensure that their fundraising activity is as effective as possible throughout the recession. The surveys have reinforced the broad diversity of fundraising organisations, their fundraising mechanisms, their donor bases and their relative size. It is this diversity that has resulted in different experiences and reactions to the recession.

Financial Times23 October 2009

“Where have all thegreen shoots gone?”

“UK businessesfear double-diprecession.” Financial Times

15 February 2010

“Public sector plan cuts

20,000 jobs.” Financial Times

7 October 2009

MIAD survey resultsFebruary 2010

“If we need to usereserves to maintainservices we will doso in the short termwhilst we changeour strategy anddevelop new sourcesof income.”

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Wages and Salaries – is there scope for belt tightening in line with corporate trends?

Some 68% of charities in the survey expected an increase in their wage bill in the next 12 months

The latest survey suggests that expectations of wage increases over the next 12 months may mean that charities are not being as realistic on pay as their private sector counterpart. Charities may be under pressure to reduce public sector wages in the next few years, which may in turn impact charities’ response to pay negotiations.

Reserves Planning – do we know what we are using our reserves for?

It is positive that charities are considering the level of their reserves and using them to maintain their service delivery in the short term; however, there are concerns that a lack of detailed scenario planning may result in sustainability issues in the medium to long term

Many charities responding to the latest survey confirmed that they are continuing to use reserves in order

to maintain service delivery, which of course is very positive; however, there are concerns that with a lack of detailed scenario planning these reserves will be become the short term answer, which in turn may bring pressing sustainability issues.

The overriding conclusion from this research is that all charities need to understand how long their reserves can be used to continue to maintain services and all charities, but in particular, small charities need to think carefully about what contingency plans they have in place in the event that the reserves are run down. Such plans, which may include collaboration, merger, or scaling back services, will all take time to implement and decisions taken now will mitigate the challenges if actions need to be taken later.

Successful scenario planning requires: • Competent and equipped staff;

• Quality information;

• Trustee engagement;

• Open, honest debate amongst those charged with governance; and

• Independent challenge.

Case Study

We recently advised a charity which has for some time been reliant upon a significant income stream. The charity received notice that this income stream was going to be terminated during 2010. The charity relied on this income to cover a large part of its core costs and is now very concerned as to its ability to survive as a stand alone charity. We are exploring the options facing this charity, which include collaboration with other charities, merger and possibly even cessation of some of its activities with other activities being taken over by another charity.

Conclusion

The three surveys have asked detailed questions of the sector and will provide an historic record of experience and expectation within the sector for future analysis. In the short term, they also provide charities with a benchmark of expectation against which to compare their own. The latest report, with some analysis and comparisons, has highlighted the above headline factors.

The next year will be a challenging time for charities with many of the impacts of the recession still to be felt, as we do not expect the charity sector, by and large, to be fully impacted by the downturn until 2011. Many charities may still therefore face challenges in the months to come, although for those charities which are robust and well managed, there will of course be significant opportunities arising in part from the financial challenges faced by others.

As ever, our message is that there remains a need for strong and strategic management to ensure that the expected reduction in income in some areas over the next 12 months, is mitigated as much as possible, and that charities are in a position to make the most of the opportunities that may arise.

For more information contact: Ian Oakley-Smith 020 7212 6023 ian.oakley-smith@uk.pwc.com

15

Top fundraising tips

Looking after staff Making the most of Monitoring fundraising digital media income Knowledgeable, loyal and

hard-working employees Make the most of the Effective and time-sensitive are the lynchpin when tools that are available. monitoring is more fundraising in difficult times Many such tools are free important than ever. and the base upon which to use, although they will Results need to be effective fundraising can involve some investment in understood and charities flourish in an upturn. staff time if they are to be need to have the confidence

used effectively. They can to act upon them. help organisations reach

Better Donor Care new audiences and build engagement with

Ensure targeted donor Maximising tax-existing supporters. care. Build lasting effective giving relationships in both the Tax-effective giving is good and bad times. Keep asking potentially one of the most

cost-effective means of Don’t panic! – The success increasing voluntary income. of fundraising is, essentially, Diversity in fundraising Seek to promote tax-dependent on the ask so it’s effective giving by

Can help safeguard income is imperative to keep asking. your donors. during the depths of After all, if you don’t ask, the recession as well as you don’t get. securing a healthy recovery Clarifying the ask as the economy readjusts.

Organisations should prioritise their fundraising asks. This may involve concentrating on securing general funds or focusing on restricted projects.

Source: Institute of Fundraising

16

A look behind the headlines on alternative investments

The only experience the average person will have of hedge funds will be the frequent media headlines they generate. These headlines range from applauding the tremendous skill exhibited by those managers, to those contemptuous of the perceived mystery and occasional scandal that surround them.

Despite the risks generally associated with these investments, a significant proportion of institutional investors, including charities now hold hedge funds within their portfolios.

So is it worth charities risking their cash with these investments? And how much of a gamble do they really represent?

To answer these questions we need to look behind the headlines and consider hedge funds in a wider context.

Investors typically use hedge funds to reduce risk

Investors seeking to achieve high returns typically invest in equities. However, £1,000 invested in UK equities ten years ago would now be worth only £1,117 – even after allowing for the 30% return last year, this is a return of less than 2% a year. Since 1999, there have been positive equity returns in six calendar years, and negative returns in four, with returns ranging between +30% (in 2009) and -30% (in 2008).

So, the price paid for the expectation of high returns is volatility. Investors need to consider how much is appropriate for them? And can they do anything to reduce volatility without reducing expected returns?

Institutional investors, such as charities and pension funds, have been increasing their allocations to alternative investments, which include hedge funds, private equity and so on, for some time, in the belief that diversification can help them reduce volatility without reducing returns. Hedge funds have been widely adopted as part of the solution.

Hedge funds come in many shapes and sizes, so the majority of investors have invested in ‘funds of hedge funds’ that combine a number of hedge fund strategies in a single fund. Over the past ten years, £1,000 invested in a typical multi-strategy fund of hedge funds would now be worth around £1,500 (a return of about 4% a year). This looks pretty good compared to equities, so hedge funds must be pretty risky, right?

Well, that depends on how we measure risk. Let’s consider the volatility of returns: between 2000 and 2007 there were no negative years, with returns ranging from around 0% to 12% in a single calendar year. So, returns were less volatile than equities – hence hedge funds looked attractive to institutional investors looking to reduce risk.

17

Hedge funds vs equities in 2008

But obviously it all went horribly wrong in 2008? Well, sort of. Not many investors had an easy time in 2008, and hedge funds were no exception. While some individual hedge funds did manage to profit from financial crisis, on the whole hedge funds lost out like the rest of us. The typical fund of hedge funds lost around 15% to 20% in 2008 (although some did much better or worse than this). Returns in 2009 were positive again, with most funds up between 7 and 12%.

Calendar year returns, 2000-2009

40% Hedge funds

30% UK Equities

20%

10%

0%

-10%

-20%

-30%

-40%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Hang on minute; didn’t equities lose 30% in 2008? And what would the fund have been holding if it hadn’t been in hedge funds? Probably equities; so the hedge fund investments could actually have reduced the loss (although equities did subsequently bounce back dramatically).

So, while some specific losses through hedge funds have become high-profile and raised questions about the appropriateness of hedge funds for, say, charity investment, it’s important to remember that many funds’ equity holdings will also have lost value in 2008/9. But, as most institutional investors had large allocations to equities, perhaps that is a much more difficult message.

What should investors do now?

Investors shouldn’t be criticised for seeking to diversify their risks. Some trustees may now have decided that hedge funds are not for them, but other investors are satisfied with the protection that their hedge fund investments have provided during recent turbulent markets.

Hedge funds are not without risk, and their unregulated nature means that investors should seek professional advice and ensure appropriate due diligence is carried out when selecting investments – the main risk to investors is often operational rather than market-related. However, a carefully selected portfolio of hedge funds can provide true diversification from more traditional investments, reducing the expected volatility of returns.

Investors looking to achieve a more stable investment return should:

• Look behind theheadlines and try to understand the real story;

• Consider their riskappetite and how they define risk;

• Avoid putting all their eggs in one basket;

• Look for assets that seekto generate returns from a variety of sources; and

• Ensure that appropriate due diligence is completed on all investments.

For more information contact: Richard Ferris 020 7804 0553 richard.j.ferris@uk.pwc.com

18

Controls over investments – top tips

Gone are the days when Charities could place investments with a well known fund manager and rely upon trust of their good reputation to provide adequate assurance that they are being managed in a well controlled environment. Charity trustees and executives are not necessarily investment experts though, so what should they be doing to discharge their responsibilities? Here are some tips:

For more information contact: Karen Sharpe 020 7804 7473 karen.sharpe@uk.pwc.com

Wendy Gunthorpe 020 7804 1531 wendy.gunthorpe@uk.pwc.com

Define internal responsibilities

The Audit Committee and Investment Committee are both interested in investments, albeit from different perspectives and both should be involved in selecting fund managers and monitoring their governance and performance.

Carry out adequate pre-investment due diligence

At this stage, it isn’t enough to just look at performance. Reputation is important – does the investment manager have a history of problems? Is the manager audited by a reputable firm? Have you reviewed their financial statements for evidence of balance sheet strength? Is performance volatile? Is there segregation between safeguarding your assets (custody) and managing your portfolio? If not, how are you comfortable that your assets still exist? Do you understand the products that you are investing in and how they fit with your risk profile? You should also consider management of operational risk. Does the manager produce a controls report (e.g. AAF 01/06 or SAS 70) that covers your investments? Is it signed off by a reporting accountant from a reputable firm? Are there any exceptions that might have an impact on your investments? How does the manager handle investment risk?

Understand the basis of performance statistics

It is important to be sure that the performance statistics tell the whole story and don’t distort reality by cherry picking the best results. Increasingly, investment managers are adopting the Global Investment Performance Standards (GIPS) which provides a track record over a five year period. Look for evidence that performance reported in the marketing material has been independently verified as conforming with the standards.

Understand the basis of performance statistics

It is important to be sure that the performance statistics tell the whole story and don’t distort reality by cherry picking the best results. Increasingly, investment managers are adopting the Global Investment Performance Standards (GIPS) which provides a track record over a five year period. Look for evidence that performance reported in the marketing material has been independently verified as conforming with the standards.

Hold regular monitoring meetings with your investment managers

Don’t limit these meetings to discussions about performance. Also, challenge on issues that are indicators of continued financial strength, such as liquidity, movements in assets under management, capital strength. Consider operational issues – have there been errors relevant to your portfolio? Have the systems operated effectively?

Review annual controls reports

Obtain a copy of the report – if there isn’t one, ask why not. The reporting accountant will have formed an opinion over whether the control objectives are suitable for the asset manager’s sector and whether the control procedures are suitably designed to achieve the control objectives. You should also consider: Does the scope of the report cover the funds that you have invested in? Is the reporting accountant’s opinion qualified? If so, what is the impact on your investments? Are there any reported exceptions arising from the reporting accountant’s testing? What is the impact on you? Does management’s response seem reasonable? 19

PwC in the Community: Charity of the year – Smile Train

Each year, staff within PwC’s Government and Public Sector Assurance department (in which resides our charities team), select a charity to support for the year. The charity voted for by our staff for 2009/10 was Smile Train.

The Smile Train is focused on solving cleft lip and palate’ problems. Clefts are a major problem in developing countries where there are millions of children who are suffering with unrepaired clefts. Most cannot eat or speak properly, aren’t allowed to attend school or hold a job. And face very difficult lives filled with shame and isolation, pain and heartache. The good news is every single child with a cleft can be helped with surgery that costs as little as £150 and takes as little as 45 minutes.

Smile Train’s mission is:

• to provide free cleft surgery for millions of poor children in developing countries; and

• to provide free cleft-related training for doctors and medical professionals.

Until there are no more children who need help and we have completely eradicated the problem of clefts.

We have run a number of events for staff including a number of football and cricket sweep stakes, raffle and table games at a charity ball, a games night and a Christmas quiz.

The total raised so far is over £6,000 which includes £3,000 added through the PwC matched giving scheme, with more events to come.

www.smiletrain.org 20

pwc.co.uk

Dates for your diary

Mergers and Collaborative Working seminar Tuesday 20 April 2010 16:00 - 18:30

We are delighted to invite you to the next in our series of seminars for charities. This seminar will be a discussion of the potential for collaborative working and mergers in the charity sector including presentations from those who are already in the process and those who are starting to reflect on the possible benefits. The seminar will be held on Tuesday 20 April 2010 from 4pm. Drinks and nibbles will be provided afterwards. The seminar is primarily aimed at charity finance directors and charity CEOs, but interested trustees would be welcome.

Accounting, Legal, Tax Technical Update November 2010 TBC

This seminar will be a technical date covering recent accounting, legal and taxation developments.

PricewaterhouseCoopers runs a series of events for our charities every year and other events for 2010/11 will be announced shortly.

All seminars are held at our Embankment Place office (address below), commence at 4pm and are followed by drinks and nibbles. There is no charge for our seminars and CPD hours can be claimed.

PricewaterhouseCoopers LLP, 1 Embankment Place, London, WC2N 6RN

If you would like to attend these events, please contact:

Lorraine Sackey lorraine.e.sackey@uk.pwc.com 020 7804 1301

PwC’s Charity News is going green

Many of you will have received this edition of Charity News in electronic format; thank you for helping us to reduce our impact on the environment. We hope that more of our readers will switch to receiving an electronic copy in the future. We will, however, continue to mail printed copies to those of you who prefer this format.

If you would like to receive Charity News electronically, please send your email address to:

Joshua Davis joshua.e.davis@uk.pwc.com 020 7212 6508

pwc This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2010 PricewaterhouseCoopers LLP. All rights reserved. ‘PricewaterhouseCoopers’ refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

Contacts If you would like to know more or speak to one of our team, please contact: Liz Hazell liz.m.hazell@uk.pwc.com 020 7804 1235

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