Philanthropic Foundations doing more harm than good?

philanthropyI know, this sounds like a silly question. Does anyone really think that organizations which are giving billions of dollars for good causes are actually causing any harm? Before answering, it is important to understand how private foundations usually operate. To avoid an IRS penalty, these foundations are required to annually distribute 5 percent of their assets towards charitable purposes. They are allowed to give more but usually keep their grants near that mark. The dollar amount represented by this 5 percent is significant. It is the lifeblood for many non-profits to continue doing the important work that they are involved in.

The 5 percent figure is not in question regarding whether or not these organizations are doing more harm than good. It’s the other 95 percent that needs to be scrutinized. Obviously it’s very important that these funds be invested wisely in order to maintain the ability to hand out 5 percent annually without depleting principal. Ideally the assets of these foundations will continue to grow even while giving away the required annual amount. Here lies the issue. The types of companies that foundations are investing in might not necessarily match their philanthropic goals. When ownership shares of a company are purchased (stocks) or money is loaned to them (bonds), these companies are provided with the means to maintain and grow their businesses. If the product or service or management of these companies does not align with the mission of these foundations, then it is possible that much of the 95 percent of the foundation’s assets are actually working towards causes that the founders and the board of directors would not actually choose to support.

The easiest example of this would be a foundation with a desire to support environmental causes with part of the 5 percent that they give away. This organization would likely invest a portion of the other 95 percent in strong dividend paying companies that offer income and possible growth. Fossil fuel producing companies have traditional fallen into this investment space. If just a small percentage of the entire portfolio, let’s say 2.5 percent, were invested in these companies this amount would be equal to half of all annual grants, not just those going towards environmental causes! In this scenario it seems very appropriate to ask whether or not a given foundation is doing more harm than good based on where the greater amount of dollars is placed.

According to a recent survey of 64 large foundations conducted by the Center for Effective Philanthropy, 41 percent said they make impact investments. Not bad, right? But “in practice these grant makers have only dedicated a small portion, about 2 percent, of their endowments to mission-related investments,” according to the survey. The median percentage of program-related investments was even lower, at 0.5 percent!

Now some good news. . . Just last week an IRS ruling helped clear the way for foundations to consider moving more assets into Socially Responsible Investments (SRI). The Chronicle of Philanthropy, in their article on 9/18/15 New IRS Rule Likely to Make Impact Investing Easier , outlined a longstanding roadblock to the use of SRI and how the ruling could affect future investments. “Foundations are taxed on investment gains made when their investment officers don’t use what the IRS calls ordinary business care and prudence to protect a grant maker’s long-term financial needs.” In an announcement on Tuesday, the IRS said that mission-related investments don’t necessarily jeopardize a foundation’s financial future and shouldn’t automatically be subject to a tax.”

It seems likely that this IRS past restriction may have been a major factor in keeping foundations from aligning their investments with their mission. If this is the case, and with grant maker’s dismal SRI past participation rates, this could represent an enormous opportunity and growth driver in the SRI realm. It should also do much towards promoting the objectives of these foundations as they move towards making an impact with 100 percent of their assets instead of just 5 percent.


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