John D. Rockefeller would never have considered abandoning the oil business. But that is exactly what some of his heirs did last fall. The Rockefeller Brothers Fund, a family foundation with $860 million in assets and a long history of supporting environmental causes, announced it would divest itself of all fossil-fuel investments.
The decision was not just about a family moving away from its legacy but a sign of a broader trend in philanthropy.
The conventional approach private foundations have used ever since Mr. Rockefeller created his philanthropy was simple: Invest the assets and then distribute a portion every year. But in today’s world, this structure faces some challenges. The intersection of private wealth and public accountability is more complicated, prompting many in the foundation world to operate in new ways — and with approaches that could eventually turn the entire way philanthropy operates upside down.
Among the cross-purposes that are raising questions:
- Federal law requires grant makers to distribute at least 5 percent of their assets every year, but this coupon-clipping leaves the other 95 percent of assets disconnected from the foundation’s mission. In fact, the investments often are in direct conflict with the mission, as the Rockefeller Brothers Fund felt.
- Foundations that are established to operate forever set their investment strategies to make sure they will always have enough money. That drives boards and donors to decide how much to spend based on investment policies rather than on the urgency of the problems their foundation wants to solve.
- With the focus on perpetuity, things can get even worse when the economy is in a downturn, as we learned in the Great Recession: Charities are in more desperate need of money from foundations, but grant makers are generating less income so tend not to give as much lest they risk going out of business in the future.
- Foundations are created mostly by the 1 percent — America’s wealthiest — as a tax-savvy place to park surplus wealth. They don’t exist solely, or even mainly, to achieve social good, yet that is what society expects from them. We could view today’s golden age of philanthropy as the result of a new gilded age of inequality.
The Rockefeller Brothers Fund is but one of many foundations seeking to address the disconnect between their endowments and their social goals.
These foundations are frustrated by the size of the problems facing the world versus the amount of money put into solving them. As new donors get involved in philanthropy, they increasingly want to put more of their assets to work right away. And both veteran foundations and new ones are seeing impact investing as a way to generate both a strong financial return and a social return by placing capital in socially oriented businesses and business-minded nonprofits.
But even for foundations that are ready to put more of their endowments into socially or environmentally friendly businesses, it’s not necessarily easy.
That’s in part because of how foundations are structured.
They hire technocrats who are focused on social science and policy to make the grants and on technocrats who understand money and capital markets to invest. The grants executives and the investment executives work in different units and report to different people with the idea that this specialization leads both to better grant making and to sharper investing. But if we learned nothing else in the recession, we should have learned that we need stronger connections between the money managers and those who care about the whole of society.
Even at foundations that want to merge the mission-oriented people with the stock pickers, the hurdles are significant.
As Clara Miller, president of the F.B. Heron Foundation, and Jean Rogers, chief executive of the Sustainability Accounting Standards Board, wrote in the Stanford Social Innovation Review, foundations must deal with complex regulations governing their uses of assets, perceptions that social investments lead to lower returns, limited expertise in impact investing among the banks and other organizations that manage endowments, and the struggle to measure the performance of an investment with social returns. What’s more, they note, many foundations and their boards take a very conservative view of fiduciary responsibility — one focused on preserving and augmenting the endowment, not one based on what a foundation does with its assets to improve the common good.
Such concerns are important for foundations to weigh because before they undertake impact investing, they need to understand their appetite for risk and how willing they truly are to use their resources for maximum impact now and how much they are motivated by preserving assets for activities tomorrow.
We believe most foundations could develop a balanced way to look at these issues, one that gives them more latitude than the traditional approaches that have long been common in foundation boardrooms. And in some ways, foundations may find they have little choice: The century-old approach to foundation management, with its silos for investments and mission, may soon become obsolete because of the growing intensity of the problems facing the world.
To move forward, foundations need to examine their mission and values, figure out where they most want to achieve an impact, define what it takes to get there, and set an investment policy that focuses on those targets from the start of a deal to the evaluation of its results.
In our work, we have identified common steps foundations take in impact investing. They include:
- Making efforts to change the culture and deal with internal staffing issues to ensure the foundation has people with the necessary skills working together.
- Devising an investment policy and strategy (not just what causes to focus on but what asset classes it will invest in and how it will maintain a proper balance) and setting criteria for what risks it wants and what return is required.
- Assessing sources of money for investments and scale of resources that will be committed to impact investments versus more conventional investments.
- Identifying investments and learning to do due diligence on a different kind of investment than might have been done in the past.
- Monitoring investments and figuring out how to deal with those that, inevitably, will flounder.
While impact investing is in vogue among foundations, not many have been doing it for very long. Only half the foundations that the Foundation Center says make program-related investments (typically loans that charge below-market rates) have been offering loans for more than five years. That is barely sufficient time to evaluate progress of any investment, so we must be careful about drawing conclusions.
But more important, the lack of activity shows how strong the tension is in the world of philanthropy between financial investments and social ones. A few foundations have made the leap to look at investments in a holistic way, but simply mixing philanthropy and investment has not magically led to better financial and social outcomes.
The appeal of impact investing for foundations is based on the idea that their capital can be a catalyst that bursts open a piñata of commercial and public money — attracting incremental capital at scale to innovative and effective projects and enterprises.
That idea opens up an important conversation about where the market stops and the public sector starts — a contentious discussion, for sure. Which capital actually is playing a catalytic role and which is not, and who decides? And can capital alone make a difference in solving social problems?
In the past, when business caused a problem to society — be it polluting the air or denying minorities access to housing — the solution was to add new regulations and put teeth into enforcing them. Investing more in groups and businesses that would provide clean energy or create colorblind neighborhoods is no substitute for regulation.
Impact investing needs to be judged based on how much incremental capital it attracts and the social results it creates. It’s time to stop worrying about being a catalyst and instead discover and track the opportunities where impact investing is the best tool for solving a problem. Impact investing can’t resolve the cross-purposes that are inherent in the way today’s foundations operate, but it will become the must-have app if philanthropists expect to stay relevant.