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You can learn a lot about a car by looking under the hood. When it comes to philanthropy, it also pays to look beneath the hood, with “the hood” in this case being how foundation money is invested while being held in corpus.

Typically, with foundations, the focus is on the bright, shiny object—the grantmaking side. This is true even for philanthropy’s critics. Megadonors are criticized for using their donations as an exercise of power, and foundations are called on to increase the amount of their giving and to give grants with fewer strings attached. Some even call on foundations to cede grantmaking authority from the boardroom to frontline communities.

But while you can hear “impact investing” noises here and there, the 90–95 percent of assets that are not given out in grants are still—13 years after the phrase “impact investing” is said to have been coined—largely ignored.

So, the 2019 Council on Foundations’ Commonfund Study of Investment of Endowments for Private and Community Foundations (hereafter “COF report”), which was published last month based on a survey of 178 private foundations and 87 community foundations with $104.7 billion in assets, is well worth reading. As the title suggests, the foundation data is based on 2019 figures—that is, before the pandemic hit. Even so, the study does also address the role of philanthropy in the pandemic, and the tradeoffs inherent in increasing drawdown rates to meet heightened nonprofit and communities.

More on that further down. But, first, back to that impact investing question.

Imagine this. A community foundation meets with a local high-net-worth donor and makes the following pitch: “Support your community by giving to us. We’ll steward your money and make sure at least a fifth—maybe a quarter—of what you donate is taken out of our community immediately and invested abroad.”

That might sound like an odd pitch for a community foundation to make, since its mission surely involves reinvesting in the local community. Yet here are the data for the investing profile of the 87 surveyed community foundations:

Community Foundation data

based on 87 foundations, 2019 data, asset distribution

  • US equities: 33%
  • Fixed income (e.g., bonds): 18%
  • Non-US equities: 24%
  • Alternatives (e.g., hedge funds, private equity, venture capital): 23%
  • Short-term securities, cash, other : 2%

Even if we assume all of the surveyed community foundations’ non-stock investments are domestic, the above chart clearly tells us that 24 cents on the dollar are invested abroad.

Of course, foundation investment officers would inform anyone who asked that they were applying modern portfolio theory to diversify their holdings across uncorrelated assets and thereby maximizing their risk-adjusted rate of return. But this poses a question—namely, for what purpose? The answer, of course, is to maximize the money for grants.

The same logic, of course, applies to 178 surveyed private foundations, although these foundations most often lack a geographic-specific mission, so the impact questions would be different. In the report, the surveyed private foundations invest more heavily in alternatives (42 precent) and less heavily in stocks and bonds. The figures for the other categories for these foundations is domestic equity 27 percent, non-US equity 18 percent, fixed income nine percent, and cash four percent.

NPQ has written about impact investing and mission-related investing before, as with this classic article by Rick Cohen dating from 2013. But progress is slow.

Of course, sometimes maximizing the risk-adjusted rate of return makes sense. Take pension funds. Employers like state and local governments that offer traditional pensions make a financial promise to their employees. Earning the money to meet that promise is critical. Even here, there are many examples of pension funds that make economically targeted investments that support local community investment priorities with a portion of their assets, justified in part by the notion that the investments will boost the local economy and therefore, through the tax revenue those investments generate, as well as direct returns, help the pension fund meet its commitments.

But with foundations, is maximizing the dollar value of grants the right goal? Unlike pension funds, whose mission is to generate those financial returns for pensioners, a grant is a means to an end—social impact. The grant is not the end in and of itself.

Let’s say you’re the Chicago Community Trust. I pick them because they are highly prominent, and they are one of the 87 community foundations that participated in the survey. To be fair, they invest less heavily in non-US equities than the field—“only” 15 percent. Their strategic plan calls for a “moonshot” to address the Chicagoland region’s enormous racial and ethnic wealth gap, informed by a vision of developing a “thriving, equitable, and connected Chicago region where people of all races, places, and identities have the opportunity to reach their potential.”

Now ask yourself this: How do you reach the moon? If where you invest does not affect the racial wealth gap, well then, go ahead and invest all of the money for the highest risk-adjusted rate of return, irrespective of location, and address your mission through grants alone.

But if where you invest matters—and to extend the Chicago foundation example once more, their own strategic plan calls Black and Latinx communities “under-invested”—well then, you need to look at the combined impact of grants and investments. The mission objective, in short, ought to be to maximize the risk-adjusted rate of impact, not the risk-adjusted rate of return.

Put another way: if grants are less, but hundreds of millions of dollars remain in the local economy rather than being taken out of it, it is, at a minimum, conceivable that the Chicago community would be better off, and the foundation might be closer to meeting its racial equity goal. The question, in short, is whether the foundation makes it to the moon—or not. Not the number of grants.

Spending Rates: The Intergenerational Question

The above illustrates just one reason why investment policy is too important for foundations to leave the matter in the hands of investment officers. Another issue is time horizon—and here the COF report is quite informative.

NPQ has written about the ongoing debate between spend-down foundations and perpetual foundations before. One lesson from Chuck Feeney is that there are ways to ensure perpetuity even while spending down, such as by investing in institutions that last beyond the lifespan of a limited-life foundation.

For the COF study, a specific question is asked: If a foundation increases its grantmaking, as many have, what is the cost in future returns?

This is no idle question. Amid the coronavirus crisis, philanthropy, to its credit, has responded. The COF report indicates that 28 percent of community foundations and 35 percent of private foundations report increasing spending in 2020, while just three percent of community foundations and six percent of private foundations decreasing spending.

This trend is more pronounced among wealthier foundations. The sample size of larger foundations is small, but of the 29 surveyed private foundations with over $500 million in assets, 14 increasing spending and only one decreased spending with the rest staying the same. For the 15 community foundations in that group, six increased spending and nine stayed the same.

To examine the trade-off between spending now and having resources later, the study runs a thought experiment, involving a hypothetical foundation with $100 million in assets and assuming a standard range of market returns.

The results are listed below. 

Foundation spending pattern

(assume 2020 starting asset level of $100 million)

Median value in 2040 (millions)Total spending for 20-year period (millions)
5% spend for 20 years$173.9$135.4
6% spend for 20 years$140.2$147.0
6% spend for 2 years, 5% spend for 18 years$158.9$134.2
6% spend for 3 years, 5% spend for 20 years$157.3$134.6
7% spend for 20 years$112.3$155.4
7% spend for 2 years, 5% spend for 18 years$153.5$133.6
7% spend for 3 years, 5% spend for 17 years$150.2$133.9
10% spend for 20 years$54.7$166.1
10% spend for 2 years, 5% spend for 18 years$137.8$131.8
10% spend for 3 years, 5% spend for 17 years$130.1$132.1

Quite obviously, the more a foundation spends on an annual basis, the less that remains after 20 years. In its report, COF attempts to measure “inter-generational equity”—in other words, will assets 20 years from now be as valuable as today, after accounting for grants, financial returns, and inflation. With a five percent payout, the odds of having as many or more assets in 20 years is 54.9 percent. If payout is doubled to 10 percent for two years and then reverts to five percent for 18 years, those odds drop to 37.1 percent. If payout is made 10 percent permanently, there is a 97.4 percent chance that the foundation’s corpus will be worth less than it was after 20 years.

More surprising, however, is that over a period of 20 years, a foundation with $100 million in assets in year one that spends 10 percent a year in grants will give away $30.7 million more in grants ($166.1 million versus $135.4 million) than the one spending five percent a year. This is true even though, by year 20, the high-spending foundation is likely to have a corpus that is less than one third the size of the low-spending foundation.

In other words, the tradeoff exists, but the rewards of greater spending sooner are significant. For example, take the global climate emergency. If the United Nations is right to consider 2030 a “make or break” year, that’s only 10 years away. The UN also estimates that a mass die-off of coral reefs is likely by 2040. Given this data, a foundation whose mission is to address global heating would fail in its fiduciary duty if it did not raise its annual spend to 10 percent a year.

Yet this logic is not widely understood. A telling quote comes from another report also published by COF last month—this one in partnership with Philanthropy California and Dalberg Advisors. Titled Shifting Practices, Shifting Power: How the US philanthropic sector is responding to the 2020 crises, the report surveyed 250 foundations and had 14 in-depth interviews. In that report, one interviewee reportedly rejects increasing payout because it “could decrease intergenerational equity…. With climate change, many board members don’t believe we have seen the worst yet. The concern is still in front of us, so we want to keep our ability to respond later.”

Cue pulling out one’s hair.

Steps toward an Integrated Approach

Call it what you will: impact investing, mission-related investing, or philanthropic stewardship. The reality is that the old model of looking only at the spending side of the foundation has been outdated for some time. Now, amid the catastrophe that is COVID-19, ideas that have been treated as nice but not particularly central to philanthropic practice—like impact investment—are getting a new hearing.

It is notable that the Council on Foundations is asking these questions. In addition to the two reports mentioned above, it also cosponsored with the National Center for Family Philanthropy the creation of a strategy guide, titled Balancing Purpose, Payout and Permanence, as well as publishing a related discussion guide for board directors. In the strategy guide, the authors note that, “Like any profession, the management of foundations is filled with practices and assumptions that deserve to be re-examined and discussed more openly.” It is encouraging to see discussion in the field open up. At the same time, it’s worth noting that, according to COF’s Shifting Practices survey, only about one in five foundations are actively looking at their investment management practices. There is still considerable room to grow.

Near the end of the strategy guide, Kimberly Dasher Tripp, who founded the consultancy Strategy for Scale, is quoted. She notes that challenges such as COVID-19 and the global climate emergency are forcing many foundations to reconsider their role.

Meeting these challenges, Dasher Tripp contends, requires a change in mindset. “Legacy,” she points out, “has traditionally been framed in terms of the preservation of capital, which has no impact in the community. But [foundations are] now reframing legacy in relation to the problems that exist, and the impact funders may have on them.”

Let’s hope her optimism is well founded. One thing is certain: it’s about time.