Rethinking How Foundations Invest

To the Editor:

Jed Emerson and Mark Kramer appropriately point out that the historic wall between foundations’ grant making and their investment management unnecessarily constrains their ability to meet their missions (“Maximizing Our Missions,” January 25).

One reason for this divide is the divergent application of the concept of return on investment.

In the corporate sector, success is typically measured by the return on investment of a particular line of business. It is expected that over time the company’s return will steadily grow at a moderate pace as its business model matures and its experience and market share increase. A company hopes for years when its return increases significantly, but those years are the exception, not the rule.

This is no less true of a foundation’s investment portfolio. Most, if not all, foundations seek stable and predictable returns that allow their corpuses to grow and their payouts in total dollars to increase. An 8-percent return generally is a foundation’s target. That allows for a gradual growth of the corpus and a steady 5-percent payout in grants.

During some years, like the dot-com boom of the late 1990s, many foundations experience double-digit returns. They also experience double-digit losses when the booms turn to busts.

Over all, the expectation of such enormous boom and bust years is that they are atypical, and a foundation’s investment portfolio is subject to a “smoothing formula” that accounts for these significant fluctuations and, over time, still results in a return of 8 percent.

Most foundation boards accept this principle as standard operating procedure, as do foundation observers and accountability experts.

The average person understands these principles as we have all been schooled to manage our 401(k)’s in the same manner. We seek steady growth, and don’t expect extreme changes year-to-year in our earnings.

We are also well-advised to diversify our holdings so as to spread our risk across a variety of investments.

However, when it comes to measuring the return of foundations’ grant investment portfolios, expectations are extremely out of sync with the steady-growth, 8-percent, long-term, diversified-risk approach applied to the investment returns on their corpus or on our ordinary 401(k)’s.

Over the past few years as “accountability,” “impact,” and “effectiveness” have become philanthropy’s watchwords, the expectation has developed that each grant should attain a measurably high level of return in a short period of time. This has lead to an unreasonable expectation that every grant, every year, and over time the entire grant investment portfolio, will achieve returns unattainable by any measure of return in the endowment investment portfolio.

Why have foundations typically held their investment portfolios — corpus and grant — to such different standards? Why don’t we consider them one diversified portfolio aimed at achieving the same social mission?

One reason is that the corpus and grant investment portfolio are seldom considered of the same order. One is financial while the other is social. But perhaps they are more alike than we think. The corpus seeks out market successes and opportunities where it can leverage itself to greater gains. Grants, on the other hand, seek out market failures and challenges where there is probably little other investment.

However, a foundation is always seeking to leverage its grant portfolio so that others will be attracted to similar investments and, by so doing, to leverage its initial investment for more support for the project, organization, or cause. All of a foundation’s investments are seeking leverage, but the way that we measure leverage varies depending on the type of investment.

Another reason is that foundations have been very slow to view their endowments as tools to be used to achieve their philanthropic missions.

Many foundations now have social screens for their endowments, including tobacco, alcohol, and firearms. But few take the more extraordinary steps to use program-related investments, double (or triple) bottom-line investments, proxy voting, and other related financial tools to advance and complement their grant making.

A holistic approach to measuring the impact of a foundation’s investments would take into account all of the resources it has to invest in its mission. Grant making is certainly the core business of foundations, but measured in strictly monetary terms, the endowment itself offers significant untapped potential to supplement a foundation’s annual 5-percent payout. Endowments represent the sleeping giant of foundation impact.

Indeed, this holistic lens is the one that the general public uses when it thinks about foundations and philanthropy. The public does not make distinctions as we do between what is annual payout or endowment, let alone how we measure grant outcomes and impact versus the returns on our investment portfolios.

It knows that the Gates Foundation has more than $30-billion in its investment pool, plus several billion dollars a year from Warren Buffett, and will be asking what effect the entire fortune will have, not the percentage that they are legally bound to disburse every year.

Maybe it’s time for foundation boards of directors to realize that as long as capital appreciation is the primary goal of their endowment management, the public and, more important, policy makers and legislators will heighten their scrutiny and their regulation of foundations.

It’s time for all of us in the field to realign how we view all of our philanthropic resources so that they all line up to our missions. Mission-related investing represents both an enormous opportunity to be better at what we do, and to better communicate about it too.

Gwen I. Walden
Director, Center for Healthy Communities
The California Endowment
Los Angeles