Investing to Spite Ourselves: The Paradox of Nonprofit and Foundation Asset Management
The combined effect of the pandemic and the widespread social unrest after the murder of George Floyd pushed the debate about foundation payouts and timely use of nonprofit reserves to the forefront this year. The tremendous demand for financial support to sustain communities facing economic hardship, and the urgency to advance racial equity, ramped up cries for foundations to give more and for nonprofits to deploy more of their idle reserves. While the debate over payouts and use of reserves is meaningful, asking for incremental increases in either may be distracting us from the paradox that is at the heart of the matter. What good are the underlying assets that fuel philanthropy and make up nonprofit reserves really doing? If nonprofit and foundation assets are invested in institutions built on and benefitting from the status quo, are both sectors in reality investing to spite themselves?
Nonprofit and foundation holdings are massive
According to a recently-updated study of their investment practices, nonprofits in the U.S. (excluding private foundations) held more than $700 billion in endowed assets as reported on their 2018 IRS Form 990s. For U.S. foundations, the estimate of assets held moved above the $1 trillion mark in 2019. With combined assets of this magnitude, how and where nonprofits and foundations invest those resources has enormous consequences. For two sectors that are mission-based, the question is whether enough of those assets are financing community and economic ventures that truly augment their stated missions. Or do traditional asset management practices inadvertently work against the goals of the very organizations holding those assets?
Funding mission goals and social change by percentage
Presumably, nonprofits have their own mission success in mind when choosing how to use reserves or endowment earnings. Similarly, foundations make grants to support nonprofits whose programmatic missions align with the philanthropic strategies of the foundations. Assuming these intents, the earnings on nonprofit reserves and the annual payouts by foundations should be contributing to the mission and social change agendas of the organizations through which the funds are flowing. But is deploying an incremental percentage of those assets enough to effect real change in the world?
The minimum payout versus the status quo
Nonprofits with endowments or any significant financial reserves must choose how to invest those reserves and what to do with any earnings from those investments. Similarly, private foundations face the choice of how much of their portfolios to distribute to nonprofits, starting with the minimum 5% annual payout required to avoid certain tax consequences. Nonprofits are incented to guard their reserves to cover possible shortfalls in annual operating revenue. Foundations are often driven by a mandate to survive in perpetuity. In both cases, the determination to sustain, preserve, and survive can influence decisions about how the underlying assets are invested.
By default, nonprofits and foundations often turn to familiar financial institutions for banking services and wealth management guidance. Mainstream institutions tend to steer assets into traditional securities, mutual funds, fixed income instruments, and deposit accounts. Unless a nonprofit or foundation makes a conscious effort to do otherwise, their asset holdings most likely end up supporting the status quo – in the sense that mainstream institutions generally invest in mainstream economic interests. For organizations interested in effecting change, this may work against their mission goals.
Is it a question of payout?
In response to the pandemic and the social uprisings following George Floyd’s murder, many foundations responded by increasing their percentage payout in 2020. Foundations and coalitions of foundations made funds available for COVID-related emergency grants, new initiatives in racial equity work, and innovations in community resilience. While increased funding has allowed more good work to be done, a question arises. Can simply upping the percentage of distributions produce meaningful mission impact and social change at the desired scale? Will doubling the percentage of grants made or endowment earnings distributed truly counter the influence of the much larger percentage of assets invested in the status quo?
What to do when generosity isn’t enough
Though perhaps oversimplified, the visual comparison of a five or ten percent payout versus the immensely larger portion of assets invested in the status quo makes a point. If just giving more is not enough, then what can nonprofits and foundations do to place their held assets in service of their mission? What can be done to tip the scale in favor of equity and justice?
More and more, nonprofits and foundations have begun to shift where they invest. The Mission Investors Exchange is one example of foundations coming together to actively redirect their assets towards investments that are better aligned with their missions. This collective effort attempts to put the other 90% or 95% of assets held in their portfolios to work in direct support of their values. For example, making alternative investments in small businesses owned by persons of color or providing capital to community development financial institutions has the potential to produce far greater mission return by deploying the much larger pool of held assets. While the financial return may or may not match what could be earned in conventional markets, the positive effect of large-scale investment in communities of color, indigenous communities, and emerging immigrant communities could be transformative.
While foundations and large nonprofits may hold the largest portfolios, decisions about where to bank and where to invest are valid concerns for smaller nonprofits as well. It takes intention and effort to search out banks, credit unions, and financial institutions that are owned by or led by Black, indigenous, or persons of color, or that invest heavily in communities of color or indigenous communities. It takes time to screen investment advisors based on social justice values, environmental stewardship, or other mission criteria. But the aggregate impact of nonprofits and foundations investing their reserves and investment portfolios in social change could far outweigh the effect of any incremental increases in the usual forms of philanthropic giving.
Curtis Klotz is a CPA serving as director of nonprofit innovation at CLA. His writing is inspired by his work in CLA’s nonprofit consulting and business operations practice and more than 30 years of industry experience. Before joining CLA, Curtis was vice president of finance and CFO at Propel Nonprofits, where he was a frequent online contributor to Nonprofit Quarterly and other blogs. He was named Minneapolis/St. Paul Business Journal’s Nonprofit CFO of the Year in 2017, and is past chairperson of the Montana Nonprofit Association. Curtis graduated summa cum laude from St. Olaf College with majors in women’s studies and religion.
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