Charitable foundations look towards impact investing

Alex Goldmark Dec 28, 2012

Charitable foundations look towards impact investing

Alex Goldmark Dec 28, 2012

Pierre Omidyar wanted to take the fortune he earned from his company, eBay, and become a philanthropist.  So he started a traditional foundation for giving out grants. He called it the Omidyar Family Foundation. Soon after, the entrepreneur decided giving away money wasn’t the best bang for his buck. There were companies creating jobs and developing social innovations he wanted to support. And grants could deplete his foundation’s endowment. So Omidyar switched his philanthropy organization to a hybrid structure, part grantmaker, part investment bank and called it the Omidyar Network. (From OFF to ON … get it?)

Matt Bannick runs ON day to day. “I don’t think there’s inherently anything wrong with the foundation,” he said. “I think what we’re arguing, what we’re doing is expanding beyond the typical grantmaking approach to having positive social impact.”

The Omidyar Network is on the leading edge of a trend in philanthropy: To merge the practices of an investment bank with the goals of a traditional philanthropy.

Private foundations have always been legally allowed to invest their considerable endowments in social causes. It’s just that most of them chose not to, preferring to separate the Wall Street side of the organization that handles bank accounts from the Skid Row side that handles charitable giving.  That’s done in the form of grants, usually around five percent of assets each year because that’s what the IRS requires.  The Wall Street side earned money, the grants side gave it away.

That’s changing.

Foundations increasingly see for-profit investments as a tool to do their social good, sometimes as a better tool than grants.

“We are seeing an uptick of interest among foundations and anticipate that it could become standard practice overtime,” Ashley Mills of the Council of Foundations wrote in an email. The COF recently issued a memo supporting the idea of impact investing, the first endorsement from the leading industry trade group. The most recent survey data from COF found 14 percent of foundations were using some kind of socially motivated investing in 2010. Anecdotally, there seems to be a boom since.

This trend is known by a few names, but mostly as “impact investing.” These investments are similar to conventional investments, but with a social goal as well as a financial one.  That might mean microloans to fight poverty, or an equity stake in a startup company if it has a philanthropic aim like affordable healthcare/training for poor farmers.

Several foundations recently joined the City of New York on the NYC Housing Acquisition Fund to create more affordable housing for the city’s lower and middle class. Banks agreed to lend $160 million to build or rehabilitate affordable housing units.  But only after the City and two foundations promised $40 million to the fund, and with different terms than the banks. The foundations and City agreed to take the first loss if any of the loans don’t pay off. That lowers the risk for banks, so they lend more. As the foundations see it, this leverages the philanthropic investment further doing $200 million in good with $40 million in impact investments.

This kind of view is typical of the new foundation financiers, like Bannick at the Omidyar Network. “If you’re a straight commercial investor, you’d say that’s not enough [return], and you’d walk away. We would say, ‘Oh my goodness look, there’s a firm that’s delivering significant positive social impact and they’re generating a profit.’”

Compared to the alternatives, it’s a great deal if you can achieve social gains with a loan. “When you provide a grant, you are guaranteed you are going to lose 100 percent of your money,” Bannick said.

That view isn’t the only driver of the impact investing trend in foundations. The reason more foundations haven’t taken to impact investing in the past is fear. Making low return or risky investments on social causes could deplete a foundation’s endowment. But, the recent sluggish market has altered those calculations.

Most charitable foundations follow a similar formula.  They take a big pot of money — traditionally bequeathed by a wealthy businessperson — and invest it for profit. The investment profits are what get doled out as charity. The endowment never gets touched. Poof. Perpetuity. Great system… unless you aren’t actually earning a profit.

Foundations are required by the IRS to give out 5 percent of their assets each year. That’s a problem, according to Tom Blaney, a partner at accounting firm at O’Connor Davies. He has hundreds of foundations as clients. Blaney summarized what he’s been hearing from many of them in the past six months.  They say “By giving out 5 percent, which is required by tax law, and we’re only making 1 or 2 percent, in essence we’re depleting our endowment and could spend ourselves out of existence.”

One solution he suggests is impact investing (sometimes also called “program related investments for foundations”). If the investments are connected to a foundation’s stated charitable purpose, the IRS will count them toward that five percent requirement, a deal-sweetener for previously cautious philanthropists.

That makes now a big growth moment for longtime advocates of impact investing in the foundation community.

Luther Ragin heads the Global Impact Investing Network an industry group that encourages impact investing by foundations and banks alike. He says foundations who only invest for profits and perpetuity hurt themselves and their cause. “The fact is that 95 percent of their resources, are invested in conventional ways without regard to the social purpose mission [for which] the foundation was created.”

Ragin likens the world of private philanthropy to “a pool of $600 billion of assets in the U.S., of which only five percent is used directly for social benefit.”

More impact investing means “increasing the proportion of that asset pool that goes to support activities for social and environmental benefit,” he said. “That can make a decisive difference in the world.”

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