Impacting investing: trends, issues and capabilities
22 September 2016
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When it comes to investment, the traditional approach has been for charities to aim for the best possible financial return within an acceptable level of risk. An alternative to this has emerged, however, in the form of social investment. This is a form of investment that enables charities to directly further their aims by achieving a social benefit, as well as a financial return.
While social investment may appear an attractive concept with the potential to encourage innovation, provide charities with a new income stream and promote positive social impact, it has in the past not been welcomed by all with the enthusiasm you might expect. Some trustees have been reluctant to consider the opportunity presented. Their concern has largely been in relation to how suitable it is for charities that are confined to act within the strict boundaries of a legal framework that was designed without social investment in mind. With the introduction of new legislation in the form of the Charities (Protection and Social Investment Act) 2016 (‘the Act’), however, is the mood towards social investment about to change?
What powers did charity trustees have to make social investment before the introduction of the Act?
One of the key issues highlighted by the Law Commission’s report, Social Investment by Charities, was a lack of clarity among trustees about their power to make social investment.
Prior to the introduction of the Act, some charities had an explicit power to make social investment in their governing document that could be relied upon. In the absence of any such power, charity trustees had to rely on their general legal power to invest. Trustees of unincorporated charities have very wide powers under the Trustee Act 2000 and trustees of charitable companies have an equivalent fiduciary duty to invest prudently. The power to invest requires trustees to use funds to generate a positive financial return. Under the old law, when a social investment was not expected to do so, trustees had to use their separate power to spend (in furtherance of the charity’s aims) in conjunction with the power to invest. There was some debate as to whether this was permissible.
Charity trustees have a general duty to exercise their power in the best interests of the charity and its beneficiaries. Trustees of unincorporated charities or trusts are also subject to the provisions of the Trustee Act 2000, which, when making investments, requires them to:
• Exercise such care and skill as is reasonable in the circumstances
• Take proper advice from a suitably qualified person
• Consider the suitability of investments
• Consider the need to diversify investments
• Review the investments regularly.
These duties are not necessarily compatible with social investment (e.g. social investment is unlikely to be part of a diversified portfolio as it will be selected not just with a financial return in mind but also as a means of furthering the charity’s objects).
A new legal power for social investment
The Law Commission’s report on social investment by charities proposed a number of recommendations. These have been picked up by the Government and included in the Act, which received royal assent on 16 March 2016.
In summary, the Act:
• Creates a new statutory power for charity trustees to make social investment
• Defines social investment as ‘a relevant act of a charity’ which is ‘carried out with a view to both directly furthering the charity’s purposes and achieving a financial return for the charity’
• Sets out duties which will apply to charity trustees when making social investment (e.g. they must be satisfied that it is in the charity’s best interests to make such an investment; they must review the social investment and they must consider taking advice when making or reviewing a social investment).
This new statutory power will give trustees a clear legal basis for their actions and hopefully resolve the uncertainty that for some has acted as a barrier.
How can trustees protect themselves when making social investment?
Even with the introduction of a specific power authorising trustees to make social investment, it is important that certain steps are taken to protect the trustees in the event of their decision making being called into question. In determining whether a social investment would be in the best interests of the charity, trustees should consider the balance between the expected benefit and the likely cost, taking into account any potential risks.
It is crucial that trustees keep records of trustee meetings, noting any decisions taken, factors considered and justification for their decision, taking appropriate professional advice when considered necessary. When a social investment has been made, time should be made to assess the return. Being able to demonstrate positive results can help charities to improve their services, attract funding and build public support. There is no standard method of measuring the impact of social investment. Two common approaches are:
• Social return on investment (SROI) places a monetary value on social, environmental and economic benefits minus costs, creating a ratio of total benefits to total investments (e.g. £5 of social value created for every £1 spent). Although this may seem an attractive approach, it may be difficult, or even impossible, for some organisations to attribute a monetary value to their outcomes when the benefits are intangible.
• Social accounting and audit is a more qualitative approach based on social, environmental and economic impact. Reports on performance are drawn up, highlighting any areas where improvements may be made. It allows organisations to measure how well they are achieving their overall objectives and living up to their values.
Many organisations end up developing their own tools and systems. This can be extremely resource-intensive, time-consuming and expensive. Some smaller charities may not have the internal skills and expertise, resources or suitable data available to carry out impact assessment adequately. There is a risk, however, that poor quality social impact measurement can be more harmful to a charity’s reputation than no measurement at all, if the validity of the findings are called into question.
Although initially greeted with uncertainty, the future for social investment is looking brighter. The new law should provide charity trustees with more confidence to make social investment, safe in the knowledge that they have the legal power to do so. Challenges will remain, however, as trustees will still need to consider how best to measure the overall impact of their investment. There is no one-size-fitsall approach to this and it will be up to each charity to decide what works for them.
The hope is that the new legal landscape will enable and embolden charity trustees to move away from the traditional focus on financial return and take advantage of opportunities presented to effect positive social change.
Download this article as a PDF. This article first appeared in the Philanthropy Impact Magazine Issue 13.