Managing Drawdowns Without Breaking Strategy

These challenges are amplified when drawdowns are not approached strategically. Rather than viewing drawdowns as merely a decision about when to sell an asset, charities should consider them a critical component of liquidity management. The success of managing these drawdowns hinges on careful pre-planning: understanding when cash will be needed, where it will come from, and how to ensure the long-term portfolio remains intact. Evidence supports the benefits of having clear drawdown policies, liquidity buffers, scenario planning, and strong governance to guide asset sales decisions.


Why Drawdowns Matter

Drawdowns are the ultimate stress test for any charity's investment strategy. They require the charity to convert paper gains into real cash at a specific time, which is when the actual market conditions and portfolio performance matter most. The risk becomes pronounced when markets are falling, as a required withdrawal can lead to a permanent loss if assets are sold at depressed prices. This is why planned drawdowns should be based on a charity's cash needs and risk tolerance, rather than which assets are easiest to liquidate.


Planned vs. Forced Selling

Planned Drawdowns occur on a predetermined timetable, with expected cash needs mapped in advance. These withdrawals are deliberately designed to meet both short-term cash requirements and long-term portfolio health. For example, a charity may know it has a major capital project in 12 months or a recurring need for funds in the next quarter and can plan to sell liquid assets accordingly.

Forced Drawdowns, on the other hand, arise when an unexpected funding shortfall or market downturn leaves a charity with no choice but to sell whatever is liquid, even if it’s not the best asset from a portfolio construction perspective. If a charity is not careful, these “emergency” sales can disrupt the diversification of the portfolio, concentrating risk in a few assets, and potentially locking in losses. A robust policy reduces the likelihood that charities will sell assets simply because they are easy to access, which can undermine the long-term value of the portfolio.


Sequencing and Timing Risk

Sequencing risk refers to the negative impact of withdrawing funds during periods of market downturns. If a charity draws down capital when markets are down, it may be forced to sell more units of its portfolio to meet the same withdrawal amount. This hurts future compounding, as assets are sold at a loss and can't participate in future growth when the market recovers. Sequencing risk is especially important when large one-off withdrawals are anticipated, as these should be accounted for separately from regular operational spending. Without proper planning, these withdrawals can exacerbate losses, affecting the long-term sustainability of the portfolio.


Liquidity and Asset Mix

The asset allocation should match the charity’s expected cash needs, not just its long-term return target. That usually means holding a liquidity buffer in cash or near-cash assets so routine needs and near-term capital calls can be met without disturbing the growth portfolio. The buffer size depends on the charity’s spending profile, the predictability of grants or project payments, and how quickly other assets can be sold at fair value.


Governance and Decision Rules

Charities should adopt a clear drawdown policy that sets out who decides, what triggers a sale, how much can be taken, and which assets are first in line. Good governance means the board or investment committee reviews the policy regularly, uses independent advice where needed, and documents the rationale for any capital sale. This helps protect trustees from reactive decisions made under pressure and keeps the charity aligned with its long-term mission.


Scenario Planning

Scenario analysis is another powerful tool that charities can use to prepare for potential funding shortfalls. Charities should evaluate various stress-test scenarios that could trigger a drawdown, such as:

• Market downturns
• Delayed or reduced grants
• Unexpected project cost overruns
• Combinations of lower returns and higher cash needs
  

By considering different scenarios and testing whether the charity can meet its obligations using liquid reserves, planned asset rebalancing, or staged sales, charities can ensure that they are not caught off guard. Scenario planning helps to create a roadmap for action in the event of an unforeseen cash shortfall, minimising the likelihood of forced selling in unfavourable conditions.


Practical Planning Steps

1. Build a 12-to-36-month cash-flow forecast – Understand when and how much cash will be needed, mapping out specific time frames.
2. Separate essential spending from discretionary spending – Distinguish between unavoidable commitments and more flexible expenditures to allow for more nimble planning.
3. Set a minimum liquidity buffer – Establish a cash or near-cash reserve to meet foreseeable needs.
4. Pre-assign which assets will be sold – Clearly define the order in which assets will be sold, if necessary, based on liquidity, risk, and return profiles.
5. Test adverse scenarios – Run different financial and market scenarios to ensure that the charity can weather various funding challenges without sacrificing portfolio health.
6. Review the policy regularly – Regularly reassess the drawdown policy, especially after major market moves or changes in the charity's financial position.
   

A Simple Example:
Imagine a charity expecting a major capital call in six months. If the charity has not prepared in advance, it might have to sell a volatile equity holding at a time when markets are weak. Instead of waiting until the last minute, the charity should either hold enough liquid assets already, or start to phase sales of riskier assets early, ensuring that the portfolio is not disrupted at the worst possible time.


The Core Principle: Protect Long-Term Outcomes

The goal is to protect the long-term financial health of the charity through careful planning. This means matching liquidity needs with liabilities, selling assets by design rather than desperation, and making drawdown decisions through a documented governance process. By adopting this approach, charities can ensure they meet their immediate needs without compromising their future objectives.