A Call for Mission Related Investing

In order to maintain their legal status, foundations are required to distribute 5% of their earnings each year to nonprofit organizations.  This 5% is determined by a 2-5 year rolling average of earnings.  In years like these when earnings are very low foundations have less to distribute, which makes ideas like mission-related investing more appealing.  Mission-related investing is when  a foundation uses part of it’s corpus (the 95%) to invest in social enterprises that are related to the foundation’s mission.  For example, a foundation interested in the environment could invest part of their 95% in wind farms, thereby receiving a social return in addition to a financial return and extending the reach of their mission despite an economic downturn.

Scott Collier, Managing Director of Triton Ventures, has thought a lot about mission-related investing, and I’ve asked him to do a guest blog on the topic.  Scott has been a venture capital investor since 1991. He has experience in all aspects of venture capital fund formation and management and the associated growth, financing and exit strategies for a diverse range of companies.  Scott serves on the board of the Entrepreneurs Foundation of Central Texas and is an active participant in microfinance and social enterprise initiatives, primarily focused on financing for social business. Here is his post:

From the largest foundation to the smallest donor-advised fund, the philanthropic world tends to manage assets in a way designed to preserve fund corpus while generating enough growth and/or income to achieve the 5% grant level necessary to maintain tax-free status. However, what has evolved from this mindset is a bifurcated structure where grant programs are expected to be the sole means of performing the mission while the asset management function focuses on optimizing returns.  In fact, people speak of a firewall between these two activities.  Unfortunately, this leaves much of the talent (and operating expense) dedicated to investment work that does nothing to further the organization’s mission.

More problematic, asset managers can and do end up making investments that generate a good rate of return but support companies that happen to work at cross purposes to the mission.  This sort of problem was brought to light a couple of years ago when the LA Times questioned why the Gates Foundation would invest hundreds of millions of dollars in companies generating toxic pollution blamed for sickening people living in communities receiving tens of millions in Gates-funded medical aid. Setting aside the moral implications of this situation, it’s irrational to allow the two parts of any organization to work at such obvious cross purposes.

What seems to make sense is a holistic view of foundation management that considers all investing to be mission related investing with the result that all cash outflows balance risk, return and mission impact. This approach implies five categories of investment along the continuum of philanthropy:

1. Program Grants: Currently maintained at a nominal 5% of total assets, these investments are absolutely certain to produce a negative 100% financial return.  So perhaps it would make sense to take this allocation to a lower percentage to make room for other investments that carry better returns (you can’t do any worse after all) and a different type of impact.  Perhaps even a more lasting and healthy impact.
2. Program Related Investments: Nell had an excellent post on this topic.  Deployed as loans at below-market yields, the risk-adjusted returns over time might be zero or negative but still better than the negative 100% generated by Program Grants.  Structured correctly, a PRI is counted by the IRS in the required 5% and if it were taken to a level of just 10 or 20 percent of the Program Grant spend it could transform the relationship that foundations have with their investees.  After all, in the right situation, a loan to support a move to self-sufficiency can be healthier for the recipient than a handout that creates a cycle of dependency.
3. Mission Related Investments: This category comprises mission-directed investments that fall outside the limits of what can be considered part of a foundation’s 5% qualifying distributions.  In aggregate these MRIs would target, on a risk-adjusted basis, just a return of capital or perhaps a small return beyond that, but still a below market return in exchange for driving a substantial mission impact.  Investments in this category could provide a tremendous boost to the nascent social business space.
4. Mission Aligned Investments: After evaluating for ROI potential, investments would get priority in this segment given the degree to which they enhance the mission.  A good corporate citizen in a country where the foundation does work might be enough to tip the balance in favor of investment.  Over time this could become a significant percentage of the income-producing portfolio and given the magnitude of dollars involved it could encourage corporate behavior to move in positive directions.
5. Mission Neutral Investments: The lowest social standard of the five, investments in this category would be held after ensuring that a reasonably sound “doing no harm” standard is upheld.  Verification of the standard would of course be subjective and based on limited insight into the business, but perhaps even such a sniff test is better than no test at all.

So consider a typical foundation that during the course of a year has 95% of its assets spread among the usual allocation of bonds, equities, and a smattering of alternative assets, leaving 5% to be distributed as grants.  If this allocation produced a 9% blended return on the investment portfolio, then net of Program Grants the overall annual rate of return would be 3.55%.

Now consider what happens if this foundation makes 2 small changes:

1. Program Grants are reduced to 4% with 1% going to PRIs that generate a negative 10% annual rate of return, and
2. 2% of the 95% portfolio goes into MRIs that only return capital.  The remaining 93% remains allocated in the same proportions as the 95% was before with the same 9% rate of return.  These changes produce a 4.27% rate of return: an overall improvement of about 70 basis points.

Starting with a $10 million foundation and compounding this difference over 10 years, this new allocation would mean the foundation would end up about $1 million larger than if it had stuck with the traditional 95/5 split.  More importantly, such a foundation would have been deploying 7% of its assets in mission-focused work instead of 5%, a $3 million aggregate difference over 10 years.  About 40% of that money would have been in the form of loans which, properly chosen and structured, enable local ownership and sustainable employment capable of going beyond where charity too often ends.  Replicated gradually across the trillions of dollars locked up in philanthropic corpus, such a rethinking of foundation asset management and mission investing could produce dramatic results.

Tags: financial return, foundation, Gates Foundation, mission related investing, PRIs, social return, Triton Ventures