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ACCA Research Report No. 97

Kreander, Beattie, and McPhail, 2006

Executive summary

The voluntary third sector (of which the charity sector is the largest element) is growing in significance as governments and communities look beyond the two-sector model of state and market. The growth has been impressive, for example the number of general charities grew by 55,000 between 1991 and 2001 (NCVO 2004). It is estimated that UK charities, in 2001/2, had £70 billion in assets, of which £41 billion were invested (NCVO 2004), with further growth in both influence and size predicted (SustainAbility 2003).

Unfortunately however, this growth, together with well-publicised scandals, has led to increasing concerns about the accountability of charities. Of particular concern is the observation that the monitoring incentives of key stakeholder groups (ie beneficiaries and donors) are much weaker than in the case of for-profit organisations, where investors have direct economic incentives to assure themselves of good stewardship and management.

Accountability

Charities and NGOs have multiple and complex accountabilities. Firstly, they have a ‘downward’ accountability to their beneficiaries and secondly they have an ‘upward’ accountability to their trustees and donors. While charities and NGOs have fiduciary responsibilities, primarily in relation to their trustees, charity reporting is not based on the rights of beneficiaries or donors in the same way that corporate reporting is based on the property rights of shareholders.

The relationship between charities and donors is changing quite dramatically. For instance, an increasing proportion of charity funding is now coming directly from governments. Laying aside the danger that charities might be co-opted by government agendas, this official funding might result in a reorientation in charity accountability. Given the level of government funding that is associated with the New Policy Agenda, there is a concern that accountability will be reoriented upwards away from beneficiaries and towards government targets. There is also a concern that this shift in funding may deter charities from speaking out on certain political issues. Whatever the effect on the work of charities, as they become used for economic and political ends, there is a corresponding increase in the requirement for public accountability.

Investment policies

In terms of investments, charities are much smaller than pension funds. Charities also differ in terms of how ethical investment is put into practice.¹ The most common way for charities to align their aims and investments is through ethical screens. For example, many cancer charities avoid tobacco stocks. Many religious charities also avoid alcohol and weapon companies. By contrast pension funds rarely avoid sectors but instead adopt an ‘engagement’ approach by which they enter into dialogue with companies about ethical issues.

The way in which charity funds are invested is an important aspect of the accountability of charities towards their members and donors. The Charity Commission stated in 1987 that ‘the trustees should not invest in companies pursuing activities which are directly contrary to the purpose of the trust or the charity’ (Sparkes 1995). In the context of charity investment, there is a risk that shareholdings, in corporations that the public would view as being in conflict with the objective of a charity, could alienate donors. Without an explicit ethical investment policy, there is a risk of tension between the expectations of donors, investment managers and charity staff.

A 2001 NOP UK survey indicated that 40% of the 2000 respondents preferred to donate to a charity with an ethical investment policy and 30% thought that charities ought to invest ethically. In 2003, the Charity Commission (2003) recommended that charities disclose any policy on ethical investment, saying that ‘it would be good practice to include such information in the charity’s annual report’.

Reporting

In recent years, UK regulators have sought to improve the quality of charity reporting, through successive revisions of the charity Statement of Recommended Practice (SORP). Indeed, the revised SORP 2005 requires charities to include in their investment policies notice of whether ‘social, environmental or ethical considerations are taken into account’ (Meakin 2005). Specifically trustees should explain in the financial review section of the annual report: ‘Where material investments are held, the investment policy and objectives, including the extent (if any) to which social, environmental or ethical considerations are taken into account’ (Charity Commission 2005).

The research

Despite charities’ economic and political significance, there is a general lack of research on charity accountability and investment practices; to help counteract this, ACCA commissioned a highly respected team of researchers from the University of Glasgow to study the ethical investment policies of large UK charities. The study involved an investigation of the nature of large UK charities’ ethical investment, including how policies relate to charities’ broader perceptions of accountability, how charities operationalise ethical investment and what charities report on ethical investment.

The aims of the research were:

• to provide evidence on the existence and nature of ethical investment policies of large UK charities
• to examine how UK charities monitor their ethical investment policies
• to examine what information on investments generally and ethical investment in particular charities disclose externally
• to explore the nature of charities’ conceptualisations of accountability relationships.

The research methodology was in three parts:

• A postal questionnaire among 197 large charities (44% response rate: 86 usable responses received)
• interviews with 11 charities and one fund manager specialising in charity clients and responsible investment (in most cases the interviewee was the finance director of the charity)
• content analysis of 122 charity annual reports (62% response from the charities in the survey sample).

Key findings

The research team found that 55% of the questionnaire respondents had a written ethical investment policy. Both the questionnaire and the interviews identified a few additional charities without a written ethical policy but with an informal agreement with fund managers to avoid certain companies (for example tobacco producers).

The most common form of ethical investment was negative screening (51%). Positive screens, such as best in sector environmentally, were employed by 15 charities (17%). Indirect engagement with companies through fund managers was used by 24 charities (28%). Less common approaches included direct engagement with companies, voting of shares and social investment².

The most important reason given for developing an ethical policy was to avoid conflicts with the aim of the charity. The most problematic sectors for charities in this regard were viewed as being tobacco and weapons. Other sectors often avoided were alcohol, gambling and pornography.

Findings suggest that there is clear room for improvement in how charities monitor their ethical investment policies. Many charities relied (solely) on their fund managers for monitoring their ethical investment policy. The questionnaire also revealed that a few charities with a published ethical investment policy did not monitor the implementation of this policy. The interviews highlighted a few additional cases where charities with an ethical policy admitted that the policy was not applied to their hedge fund investments. Only two charities made specific disclosures about the monitoring of their ethical investment policy in their annual report.

A few charities had engaged with companies directly on environmental and ethical issues in order to influence corporate practice. Much more common however was to delegate engagement with companies to the fund managers. The financial institution CCLA, which manages funds for thousands of charities, engages with companies and they vote on corporate governance and ethical issues. Working directly with both companies and investors can be a fruitful avenue for charities to affect change.

The most common way of publishing an ethical investment policy was in the annual report. However, many charities chose not to report the (entire) policy. The content analysis found that 28 charities disclosed their negative ethical screens. The interviews supported the finding that some charities were reluctant to disclose their (entire) ethical investment policy by identifying reasons why some charities preferred not to disclose their complete policy.

There may be further room for improvement in terms of transparency relating to investments. For example, none of the charities who claimed in the postal questionnaire that shares were voted as part of their ethical investment strategy made any disclosures about voting shares in their 2003/4 annual report. The five charities who stated, in the questionnaire, that they engaged directly with companies on ethical issues, did not provide examples of this in their 2003/4 annual reports either. Other weak areas in charity reporting included specific details about ethical screens, investment policy and examples of companies a charity actually invested in.

Both the interviews and the content analysis revealed differences in the perceived accountability relationships of the fundraising charities and non-fundraising charities included in the research. Content analysis indicated that the fundraising charities studied discuss accountability issues more frequently in their reports than the non-fundraising charities. The fundraising charities disclosed more information on their goals and the effectiveness with which they meet those goals than the non-fundraising charities. Their reports also contain more references to their stakeholders and more examples of stakeholder dialogue. More of the fundraisers’ audit reports were addressed to their members, whereas those of non-fundraisers were mostly addressed to trustees, which suggests a more accountable approach to corporate governance by fundraisers.

Recommendations

The researchers draw on their findings to provide seven recommendations for charities and charity regulators relating to ethical investment policies, disclosure and accountability, all of which they elaborate on in their report.

1. Charities should align the aims of the charity and its investments
2. Charities should consult beneficiaries and/or donors about the investment policy
3. Larger charities should engage with companies and vote their shares³
4. Charities should improve the monitoring of the ethical investment policy
5. Charities should improve external disclosure in the annual report relating to investments generally and ethical investment issues in particular.
6. Charities should develop key performance indicators and disclose performance in relation to these indicators.
7. Charities should increase stakeholder dialogue and report on this in their annual reports.

References

Charity Commission (2003), Investment of Charitable Funds, CC14, Charity Commission for England and Wales [online report], accessed 10 May 2004.
Charity Commission (2005), Statement of Recommended Practice [online text], accessed 20 August 2005.
Meakin, R. (2005), Socially responsible investment by charities, in Scanlan, C. (ed.) Socially Responsible Investment: A guide for pension schemes and charities (London: Key Haven).
NCVO (2004), The UK Voluntary Sector Almanac (London: NCVO Publications).
NOP (2001), Ethical Investment [online text], accessed 2 May 2004.
Sparkes, R. (1995), The Ethical Investor. (London: Harper Collins).
SustainAbility (2003), The 21st Century NGO, in the market for change (London).

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