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Putting assets in service of mission

In Short

Traditionally, philanthropists give money away and investors make money. The former want to create change and the latter want to pocket it. You’d think that the two goals would be incompatible, but a new hybrid of philanthropy and private equity investing blurs the lines, allowing foundations to do well by doing good. 

Imagine that your foundation is dedicated to eradicating childhood asthma. One day, you hear a report that the sulfur dioxide emissions from an aging coal-fired power plant are causing a high incidence of childhood asthma in neighboring towns. 

A week later you are reviewing your foundation’s investment portfolio and realize you own a good chunk of shares in the very same energy company that owns the power plant. In fact, the dollar amount of the company’s stock in your investment portfolio is almost equal to the dollar amount you are putting into your childhood asthma eradication efforts. 

Moral Dilemma: What to Do?

It’s a common conundrum for private foundations: Many that are established to solve society’s most pernicious problems have investments as their lifeblood. Their assets need to be invested in profitable businesses in order to sustain operations and grow. So what happens when a foundation’s mission is directly contradicted by its own investments? What if the very ills a foundation fights are exacerbated or even caused by the behavior of business entities found in its own portfolio? 

It can sometimes seem as though the foundation’s assets and its grantmaking programs are in direct opposition to each other or at the very least, failing to work together to accomplish a charitable mission. And since many foundations invest 95% of their assets while distributing about 5% for charitable purposes, it’s even conceivable that the damage done by the investments exceeds the good accomplished by the distributions! 

Over the last decade, more foundations have been attempting to address this issue and get all of their horses pulling in the same direction. These foundations want their investments to enhance their philanthropic efforts or at least not run counter to them. If their 5% for their minimum charitable distribution requirements are regarded as the “do good” portion of their foundations, the goal for the other 95% might at least be conceived as “do no harm.” Hence, their adoption of “impact investing,” a widely popular investment strategy that aims to generate a positive social or environmental impact in addition to providing a financial return. 

As private foundations ideally aim for 100% of their endowment assets and grant funds to serve the greater good, we examine four distinct approaches they can take for impact investing, ranging from fiscally conservative to financially risky:

• Community Investing

• Socially Responsible Investing

• Program-Related Investing

• Social Venture Capital Investing

A “Safe” Introduction: Community Investing

One of the easiest ways to dip a toe into impact investing waters is by simply moving your money from a traditional bank to a community development financial institution (CDFI) such as a community bank or community credit union. These financial institutions are common throughout the United States, and you have probably heard of them without realizing that they have a social mission tied to their financial products.

The real difference between traditional banks and community banks is what they do with the money on deposit. Rather than lend it out to large corporations outside the local vicinity, community banks invest it locally through loans for affordable housing projects, home mortgages in low-income areas, and new businesses. 

Community investing can be a relatively low-risk cash management strategy, an easy way for a foundation or philanthropic individual to put more financial assets in the service of a charitable

mission. To look for a CDFI in your community, go to www.cdfifund.gov for a listing of CDFIs by city and state.

Socially Responsible Investing

The concept of socially responsible investing (SRI) has been around for more than 30 years. It began with a simple idea: don’t hold the stock of companies that actively work against your values. So environmental grantmakers might screen “big oil” out of their portfolios and health grantmakers might avoid “big tobacco.” Such tools to filter investments have been dubbed “negative screens” because they focus on what investors don’t want in their portfolios, like companies with interests in gambling or pornography. 

Critics note that while employing negative screens to eliminate “sin stocks” may help an investor sleep better, they don’t necessarily accomplish much else. The companies that are screened out are usually very large and very profitable, so if investors screen out a whole host of potentially profitable sectors, they may be limiting their ability to earn returns on par with the market as a whole. 

In recent years, however, investors and their advisors have taken a new approach to SRI, one that involves “positive screens” that actively seek companies demonstrating the kind of corporate social responsibility that philanthropic investors would like to encourage. The primary positive screens are around environmental, social, and governance (ESG) practices, collectively known as “ESG screening.” So rather than focus on what you don’t want companies to do, ESG screening selects companies based on the positive things they are doing.

Beyond being good philanthropy, ESG screening is increasingly accepted as just good business. ESG investing has become more mainstream over the past decade, fueled by rising investor interest and recognition that social and environmental impacts are creating material financial risks for companies and investors. In other words, polluting the environment to make a quick buck today is what investors might call a “short-term play.” That is, it’s not going to be an effective strategy over the long haul as companies with poor ESG practices are increasingly penalized through loss of business, lawsuits, bad publicity, and costly clean-up. 

Done well, investing in ESG-screened funds can be a natural part of a private foundation’s investment strategy that carries no more risk than traditional investing in the stock market.

Banker To Your Grantees:  Program-Related Investing

When we think of a private foundation supporting a charitable cause, most of us think in terms of grants — money given away with no expectation of it ever coming back. But foundations can also make loans and provide loan guarantees in support of their mission. Such loans are defined by the IRS as program-related investments (PRIs) and are an increasingly common tool among private foundations.

PRIs come out of the foundation’s grantmaking purse and as such, they qualify towards the foundation’s 5% minimum distribution requirement. However, while grant dollars go out the door never to return, PRI dollars are generally recovered in part or in whole, and may even earn some return for the foundation in the form of interest or appreciation. Importantly, the primary objective of a PRI must be to significantly further the foundation’s charitable mission and securing a financial return must not be a significant driver for making such an investment. Because PRIs fulfill a charitable purpose, they are exempt from the jeopardizing investment and prudent investor rules applicable to traditional investments.

Foundations use PRIs creatively in myriad ways. Most first experiment with them in the form of a loan to an organization they already know well, oftentimes a prior grantee. For example, they may offer their community church a very low-interest loan to finance the construction of a new facility. Or they may provide a no-interest line of credit to their favorite art museum to help smooth out the bumpy financial times between blockbuster shows. They even may cosign a loan to allow a housing agency to access funding from a commercial bank, which, absent a default, doesn’t require them to put a dime out the door. 

Graduating to the Big Leagues: Mission-Related Investments

Traditionally, philanthropists give money away and investors make money. The former want to create change and the latter want to pocket it. You’d think that the two goals would be incompatible, but a new hybrid of philanthropy and private equity investing blurs the lines, allowing foundations to do well by doing good. 

Similar to private equity investing, foundation donors make investments in private companies or venture capital funds — the difference being that these investments go beyond mere financial returns to provide social and economic benefits. Foundations that engage in mission-related investing (MRI) use their endowment funds to invest in profit-seeking solutions aligned with their mission. These often are social, environmental, and economic challenges that cannot be easily met through grants alone.

The determination as to whether these “social venture” investments are PRIs or MRIs depends on whether they exist primarily to return a financial profit or to accomplish a social good. Let’s consider two examples for a foundation fighting childhood asthma: 

In our first example, the foundation becomes aware of a promising drug that’s in development.

It’s only effective against a rare variant of childhood asthma, so it doesn’t have much commercial potential and is therefore unlikely to make it into production. The foundation could provide a seed money loan for the drug’s development and this “poor investment for a good cause” would qualify as a PRI and count toward its 5% minimum distribution requirement.

In our second example, the foundation becomes aware of a terrific new company that’s developing an inexpensive, electric car capable of going 500 miles before recharging. This is a very exciting investment opportunity for a whole host of reasons. From a financial standpoint, an extended-range, inexpensive, electric car has tremendous market appeal; from a mission standpoint, it’s also attractive because car emissions contribute to childhood asthma. Clearly, investing in this start-up would be compatible with the foundation’s fiscal goals and mission objectives. However, because the venture foremost is considered a good investment from a financial standpoint, it qualifies as an MRI and not a PRI. 

MRIs may be made in a variety of ways. The three main approaches are:  (1) buying stock in a well-established company that’s aligned with your mission; (2) investing in a social investment fund; and (3) angel investing in start-up companies that have a social mission.

Keep in mind that MRIs, unlike PRIs, are subject to jeopardizing investment rules and that a private foundation can be subject to excise taxes for making imprudent investments. For this reason, involvement in MRIs should be based on a well-considered investment policy that includes a thoughtful asset allocation strategy among different classes of risk.

For foundations that look closely at their current investment portfolio and find a lack of alignment with their grantmaking objectives, there are many options to put both pools of assets to work for positive social outcomes. From relatively low-risk cash management options with community development financial institutions to high-risk angel investing in social enterprises, every philanthropist can become an impact investor. The key to success is to take an incremental approach, starting with a small portion of assets at first and expanding as you gain experience and confidence.

Jeffrey D. Haskell, J.D., LL.M. is chief legal officer for Foundation Source, which provides comprehensive support services for private foundations. The firm works in partnership with financial and legal advisors as well as directly with individuals and families. 

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