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Many foundations 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 problems a foundation was created to solve are exacerbated or caused by the behavior of businesses found in its own investment portfolio?

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

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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 percent for their minimum charitable distribution requirements are regarded as the “do good” portion of their foundations, the goal for the other 95 percent might at least be to “do no harm.” Hence, their adoption of impact investing.

Growth of the impact investing sector has exploded in the last 10 years. The International Finance Corporation (IFC) reports that $2.3 trillion was invested for impact in 2020, which is equivalent to 2 percent of global assets under management. And a Global Impact Investing Network (GIIN) study reveals a 42.4 percent increase in the sector from 2019 to 2020. Impact investing is a broad tent as well; many different individuals, businesses and organizations claim a seat under its canopy, each employing different tools and approaches.

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As private foundations aim for 100 percent 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
• Mission-Related (or Social Venture Capital) Investing

Part one of this two-part series discusses the first two approaches.

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’ve probably heard of them without realizing that they have a social mission tied to their financial products.

CDFIs are government regulated and government insured, just like other financial institutions. They offer checking and savings accounts, money market accounts, certificates of deposit and all the other usual services you’d expect from a traditional bank. They provide market-rate (or very close to market-rate) interest to depositors and from a consumer’s perspective, are comparable to commercial banking institutions, albeit with a less extensive network of ATMs. 

The real difference between traditional banks and community banks is what they do with the money on deposit. Rather than lend it 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. Many low-income neighborhoods have benefited from CDFIs that use their deposits to build that same community, rather than siphoning funds out for the benefit of outside parties. The Calvert Foundation, for example, directed Calvert Community Investment (CCI) notes to help rebuild communities in the Gulf Coast region devastated by Hurricanes Katrina and Rita. These same notes offer investors a range of terms, including interest rates that vary up to 2 percent payable at maturity.

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 an environmental grantmaker might screen “big oil” out of its portfolio and a health grantmaker might avoid “big tobacco.” Other common screens filter out companies that have interests in gambling, alcohol, pornography, dealings with repressive governments or defense contractors. Because this approach focuses on what an investor does not want to hold in his/her portfolio, tools that help them filter their investments have been dubbed “negative screens.” 

Critics point out 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, and a few conscientious investors selling their stock or just declining to buy it will not affect their share price. And by screening out a whole host of potentially profitable sectors, an investor employing negative screens may be limiting their ability to earn returns on par with the market as a whole. As most investment advisors benchmark performance against broad market measures, portfolios employing negative screens are widely thought to underperform.

In recent years, investors and their advisors have taken a new approach to socially responsible investing, one that involves “positive screens.” Instead of shutting out objectionable companies, a positive screen actively seeks 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.” Rather than focus on what you don’t want companies to do, ESG screening selects companies based on the positive things they are doing.

Some recent studies challenge the widely held belief that one needs to accept lower returns in exchange for socially responsible investing (SRI). ESG-screened companies disprove the myth that SRI isn’t profitable. Some previous research has found no statistically significant difference between the performance of traditional funds and SRI funds. In fact, as The Forum for Sustainable and Responsible Investment reported, a 2012 meta-analysis, by DB Climate Change Advisors, of more than 100 academic studies found that incorporating environmental, social and governance data in investment analysis is “correlated with superior risk-adjusted returns at a securities level.”

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 governments, consumers and investors increasingly penalize companies with poor ESG practices 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.

The third and fourth approaches, program-related investing and mission-related investing, are discussed in part two of this series.

Jeffrey 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.