Could your cash reserves be doing more?

The last two years have been difficult for many of us for a variety of reasons. However, as we move beyond the worst of the pandemic, we are starting to see some of the potentially longer-lasting effects taking hold. Whilst increased home working and more online shopping are no doubt positives for many people, the opening up of world economies has seen the prices of many things increasing at a speed not seen for decades.

This is, of course, inflation. In the early phase of the pandemic, inflation remained subdued, but as economies started to reopen, it began to pick up. At first, most commentators were expecting inflation to be transitory, with many of the drivers seen as short term and created by supply chain disruption and a sharp pick up in demand. However, energy prices have risen substantially and supply chain issues have not eased as quickly as had been hoped. As a result, inflation is now expected to be more persistent than originally thought. Headline inflation in the UK rose above 6% in the 12 months to February 2022 and, according to the Office for Budget Responsibility, is expected to reach a 40-year high of 8.7% in the fourth quarter. Rather than being a short-term blip, rising prices might now be a feature of economies for several years to come.

For some charities, there may be an expectation from employees that their wages will increase to compensate for inflation. Known as wage inflation, a shortage of workers in some areas is making this even more acute. For trustees, this presents yet another factor to consider and plan for. But what options are available?

Cash reserves

The bad news is that trustees are unlikely to get a huge amount of help from interest rates. This is the main tool that central banks will use to try and influence inflation. Generally speaking, higher interest rates are used to combat higher inflation. However, higher interest rates can also slow economic growth and with the recovery from the pandemic still fragile, central banks will have to walk a tightrope between tackling inflation and nurturing the still bruised economy. Expectations are for the Bank of England to raise interest rates again this year from 0.75% in March to around 1.75%. This is higher than we have seen for some time, but still well below the expected rate of inflation. Any cash sitting on deposit is likely to lose value in real terms this year and next. This can be a bit of a headache given that trustees have a duty to protect the real value of their reserves.

There is no ‘correct’ level of cash for charities to hold on deposit. Some reserves will need to be kept in cash to cover ongoing costs and planned expenditure, with perhaps a little more cash held back to cover any unforeseen costs. However, if there is any part of the overall reserve that is not needed for a specific purpose in the near term, it is certainly worth considering whether the funds could be made to work a bit harder to offset the effects of inflation.

Can the reserves work harder?

Considering a move that would see cash reserves reduced in favour of other investments is not a step that should be taken lightly. Placing capital at risk in the short term can lead to better returns in the long term, but the assets can also be subject to fluctuations in value along the way, which may not be suitable for all charities. However, for those who can take a longer-term view with a proportion of their reserves, it is worth considering whether this could be invested with the aim of generating a return better than cash.

Investing does not mean that all of the assets are going to be exposed to the vagaries of stock market volatility. Whilst some involvement in stock markets might be appropriate as part of the overall structure of the portfolio, there are other asset classes that can offer protection against inflation, such as inflation-linked bonds, infrastructure, commodities and renewable energy. Company shares can selectively be appropriate also but, importantly, we would want all the companies to have ‘pricing power’, or the ability to put their prices up at least in line with inflation. If their prices can rise with inflation, then ultimately their profits should follow. A thoughtfully constructed combination of these assets can provide well-diversified exposure to a number of underlying investments, which help to provide some protection against inflation.

Careful review of risk

Before proceeding with an investment, there should be a thorough review of the overall level of risk that the trustees would be prepared to accept in the management of the assets. As every good investment manager will tell you, the value of your investments can go down as well as up, and it is important to understand what impact this may have on the overall financial position of the charity.

Having been absent for many years, inflation is now back with a vengeance, and it looks like it will be with us for some time to come. The sooner trustees consider its implications and what they might be able to do to offset its effects, the better positioned they will be to deal with it. Investment may not be for all charities, but in an environment where it is more important than ever to make the most of reserves, it is certainly worth considering. Even if the decision is made not to invest, trustees will have been through the due diligence process and will know that it is not right for them at the current time.

David Hourston

Divisional Director – Scotland Charity Team

The value of investments, and any income from them, can fall and you may get back less than you invested. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Opinions expressed in this publication are not necessarily the views held throughout Brewin Dolphin Ltd. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.

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