Foundations tap into endowments to make ‘mission investments’

When it comes to their endowments, foundations have traditionally kept the management of those funds separate from their grant-making activities. But things are changing. The walls between the “two sides of the house” are starting to break down, with some using their endowments to make “mission investments” that help fulfil their charitable goals.

Of course, the primary concern for most foundations is to generate sufficient returns on the endowment to make grants, to cover operational costs, to account for inflation and to secure the institution’s future. And in the US, to be eligible for tax relief, foundations must pay out at least 5 per cent of the value of their endowment annually.

Maintaining their giving power is not easy. For a start, unless they conduct fundraising activities, foundations have no source of income. And, like all investors, they are exposed to market volatility. “Earning 5 per cent plus inflation is no small feat,” says Bradford Smith, president of the US-based Foundation Center, a philanthropy information service.

“The starting target for all [US] foundations is about a 7.5 per cent return,” says Rob Manilla, chief investment officer at the Kresge Foundation, created in 1924 by Detroit retail entrepreneur Sebastian Spering Kresge. “If we do that, we can live into perpetuity and have the same purchasing power in the future as we have today.”

For the William and Flora Hewlett Foundation — which has assets of about $9bn and long-term grant commitments, many of which support the operations of non-profits — the strategy is to maximise the returns on the endowment with the help of mainstream fund managers.

“The alternatives would mean taking lower returns, and the [social] impact we get by getting the higher returns greatly exceeds the return we could get by shifting fund managers,” says Larry Kramer, the foundation’s president.

However, some foundations are starting to look at their endowment as an additional tool with which to pursue their philanthropic goals and align their investments with their mission.

One option is to exclude from the portfolio investments that might be regarded as unethical, such as arms manufacturers, tobacco companies or fossil fuel-based energy providers.

Some foundations, for example, are joining the global Divest-Invest movement, whose purpose is to divest from fossil fuels and invest in clean energy. More than 125 foundations are now part of the movement.

Others argue that divestment may have more symbolic than material value. The Wellcome Trust, the UK’s biggest charitable foundation, did not sign up to the campaign, saying it has more influence over companies as an investor and that those buying the shares it sells might not care as much.

“Even if a foundation is investing tens of millions or even hundreds million of dollars, there are other much bigger investors who will come in and take their place,” says Smith at the Foundation Center.

Rather than focusing on divestment, some foundations are introducing into their portfolio impact investments, which generate social as well as financial returns. For a foundation combating poverty, this might mean investing in companies that are creating jobs, building affordable housing or providing financial services to low-income communities. For an environmental conservation foundation, it might mean investing in clean energy or recycling companies.

In 2015, for example, the Kresge Foundation announced that it would put $350m, or about 10 per cent of its endowment, into impact investments.

Manilla likens the approach to a target with a bullseye. In the bullseye are investments directly related to improving life for underprivileged urban communities, the foundation’s mission. Around that are investments in areas in which Kresge is active. Investments in the outer ring have a positive social impact but are not central to the foundation’s activities.

The FB Heron Foundation, meanwhile, is working towards aligning all its investments with its charitable purpose, which is to combat poverty. “We’ve broken down the traditional wall that separates the investment side from the giving side,” explains Clara Miller, the foundation’s president.

When Miller joined the foundation five years ago, about 40 per cent of its endowment was aligned with its mission. “We are in the process of deliberately going out and finding out what we own and what underlies those assets,” says Miller. “Now, about 70 per cent has been both examined and aligned for mission.”

Of course, while issues such as conservation, economic development, housing and healthcare lend themselves to this approach, it is not the case for every cause. “Where it’s less clear how impact investing can be relevant is in things like human rights or violence against women,” says Smith.

For now, foundations using a large proportion of their endowments to pursue impact investing remain a minority. When the Foundation Center recently asked almost 700 US foundations if they had any mission investments, more than half said they did not and had no plans to engage in mission investing.

Hirtle Callaghan, a US advisory firm that designs and supervises investment programmes, sees many of its foundation clients taking this approach. “Mostly they advocate following a social mission in their programme activities and keeping the endowment focused on returns only,” says Brad Conger, a director at the firm.

Smith, however, believes the balance will shift as impact investing becomes mainstream. “It’s gaining credence,” he says. “The argument against this was always that there weren’t reliable investment vehicles out there that would give you competitive market rate returns. That’s starting to change.”

This is part two of a five-part series on foundations. Read part one