Do standard risk labels still work for charities? Luke Apps from atomos asks whether investment industry's terminology around risk still works for charities - and questions whether it ever worked in the first place.
For many charity leaders, a “5 out of 7" tells you almost nothing about whether your charity can pay next year's grants. As charities prepare for a more demanding risk environment, it's time to ask whether the labels the investment industry hands out – Cautious, Balanced, Adventurous – were ever really designed with charities in mind.
The comfort of a number
Somewhere in most charity investment files sits a risk rating. Usually that’s a number on a scale. Perhaps it's a word… “Balanced" being a favourite, providing the reassurance that someone, somewhere, has carefully considered every possible variable and distilled it into a single word.
These labels exist for good reasons. They create a common language between investment managers and clients, support suitability processes and give trustees something clear to record. The issue is not that risk ratings are wrong. It is that they can be asked to do too much.
Most standard risk ratings were built with individual investors in mind. They are very good at describing expected volatility, or in plain English, how much a portfolio’s value is likely to bounce around over time. For someone saving for retirement, that can be a useful proxy for risk. For a charity, it is only part of the story — and sometimes not the most important part.
Volatility is not mission risk
Ask a trustee board what "risk" means and you are unlikely to hear "annualised standard deviation." You are far more likely to hear concerns about running out of money before a programme is delivered, reducing grants to beneficiaries who depend on them, or failing the people the charity exists to serve.
That is mission risk! The risk that the investment strategy prevents the charity from doing what it was set up to do. The uncomfortable truth is that a portfolio can score low on a volatility scale and still be loaded with mission risk.
Consider a charity holding everything in cash and short-dated bonds. The result may be minimal volatility, a low risk rating and a better night’s sleep. But if that charity intends to make grants in perpetuity, inflation may be quietly eroding its spending power year after year. The portfolio labelled “lowest risk” may, over the long term, carry the highest risk of failing the mission. The rating will not necessarily capture that.
Time horizon ≠ volatility tolerance
The industry often assumes that a long-time horizon automatically means a greater tolerance for volatility. For individual investors without near-term commitments, that can be a reasonable conclusion.
Charities are often different because many operate on two clocks at once. There's the long clock, supporting the mission for decades or in perpetuity. Then there is the short clock, committed grants, operating costs and cash needs that must be met in the next one to three years.
A charity can have a genuinely long time horizon and still need certainty over next year’s spending. A single risk rating cannot describe both needs. Forcing it to do so can mean taking too little risk with long-term capital, or too much risk with money already spoken for.
Reframing: from one rating to a purpose-led structure
This is where the conversation gets more productive. Instead of asking "what risk rating are we?", better questions are:
- What must this charity spend, and when, regardless of markets?
- What portion of our assets exists to serve the mission over decades?
- How much loss could we absorb in each pot before the mission is impaired?
Answer those questions honestly and a single risk rating can start to look a little overworked. For many charities, the issue is not one pot of money with one purpose, but several pools of capital with different jobs to do.
In some cases, a single risk profile is entirely appropriate. In others, it may be more sensible to use a blended approach, with more than one risk profile within the same relationship. This is not complexity for its own sake. It is simply matching each part of the portfolio to the job it is there to perform:
- A liability-matching allocation — a lower-risk portfolio deliberately sized against the charity's committed spending, typically a shorter time horizon where the objective is certainty, not return.
- A long-term growth allocation — invested with the ambition its time horizon deserves, tasked with beating inflation and growing real spending power to sustain grant-making over decades or in perpetuity.
To give you an example, take a charity with £5m of investable assets and £300k of annual committed spending. Ring-fencing three years of outgoings in the liability-matching pot leaves £4.1m free to be invested properly for the long term, rather than rather than the entire £5m invested in a portfolio that feels to some extent a compromise due to the conflicting objectives.
The governance benefit can be just as important as the investment benefit. Volatility in the growth allocation stops being a direct threat to next year’s grant-making and becomes what it should be, the price of pursuing long-term returns, paid with capital that has time to recover. Trustees can meet during a market downturn with greater confidence that planned spending is protected, because that risk has already been considered in the structure.
Better decisions, better minutes
If you are a trustee in the process of having these conversations with your investment manager, I would suggest the following four step process is a very useful starting point to reconsider how you think about risk.
- Starting with the spending, not the score. Map committed and likely outgoings over one, three and ten years before discussing asset allocation.
- Matching structure to objectives. Consider distinct risk profiles for short-term liabilities and long-term grant-making rather than a single compromise rating.
- Stress-testing the mission, not just the portfolio. Model what a 2008-style drawdown means for grants and programmes, not just for the valuation.
- Revisiting the framework regularly. When circumstances change (a major legacy, a new programme, a reserves policy review) re-examine the structure, not merely the rating.
Risk ratings aren't going away, and they shouldn't. But for charities, they are the beginning of the risk conversation, not the end of it. The real question was never "are we a 4 or a 5?" It's "will this strategy let us deliver our mission — next year, and in thirty years' time?"
Disclaimer: The information and opinion contained in this article should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy and are presented for information only. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice.
Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and is not guaranteed. Investors may not get back the original amount invested.