Mission Related Investing

Lucy Bernholz suggested recently that we should radically scale back the preferential tax treatment given to private foundations.


And here’s a thought – we should align the tax benefits for charitable giving with the amount of money that actually goes to charity. For example, the full corpus of an endowment is exempt from taxes, even though most foundations only spend a small percentage (around 5%) of their endowment earnings on charitable purposes. So the actual tax benefit ought to align with the charitable dollars – the 5% given in grants, not the 100% of the endowment which is in market rate investment vehicles.

If endowment managers can demonstrate alignment between their investment policies and their charitable missions, then the tax benefit would be extended to those investments. If a foundation invests 10% of its corpus in companies that serve a public benefit purpose in line with the foundation’s mission, then the tax exemption would extend to include the 5% it pays in grants and the 10% of its endowment that it is using to achieve its mission. The other 90% of the endowment would be taxed.

After all, why are taxpayers subsidizing market-rate investment capital? Shouldn’t public benefit tax exemptions be granted for public benefit activities?

I’ve talked a lot about effectiveness and transparency and other issues where I’ve called for change in the way that foundations and philanthropy as field conducts itself. The Aspen Institute Philanthropy Letter has discussed my work as an example of how blogs can be used to criticize foundations. On the other hand, I’ve made a lot of friends at big foundations. The Council on Foundations invited me to cover their conference this year and later said that the Council was “very pleased” with the coverage. Edna McConnell Clark Foundation CEO Nancy Roob has publicly thanked me for my coverage of one of their projects and said she’d “love to continue the discussion” with my readers. I say all this because I don’t think of myself as either a partisan supporter of philanthropy establishment nor am I an active critic.

In the interest of full disclosure, my firm Ensemble Capital provides investment management services for philanthropic families. We do not currently offer Mission Aligned Investing services (for some of the reasons mentioned below) however, over time as the field matures, I’m sure that we will enter this space.

Lucy is someone who I really admire. I think her book Creating Philanthropic Capital Markets is a “must read” and I’ve enjoyed our conversations each time we’ve met. Lucy is a very cutting-edge thinker. Her proposal actually makes some sense to me, but it is probably at least a decade too soon.

Currently US tax law views contributions to private foundations as being tax deductible at the point of contribution rather than when money is sent out to nonprofits. The law actually views contributions to foundations less favorably than those made to public nonprofits, but we can ignore that for this discussion. Assets in the foundation can be invested and face a tax rate of 2% rather than the 15% federal (plus various state tax rates) that capital gains and dividends face outside of a foundation (with even higher rates on interest income). This means that the foundation is viewed as providing a public benefit, not just based on the dollar value of grants they make, but also from the value that arises from having an institution whose very existence is designed to benefit the public.

Lucy suggests that the assets that a foundation invests should only enjoy preferential tax treatment if those assets are invested in companies that serve a public benefit in line with the foundation’s mission. However, the field of Mission Related Investing (MRI) is still in its infancy. There simply isn’t MRI opportunities available to absorb the half a trillion dollars in foundation assets. In fact, there isn’t even a shared agreement about what qualifies as an MRI. For instance would an investment in a mutual fund that tracks the Domini 400 Social Index qualify (a leading “socially responsible investing” market index)? How about an investment in Microsoft, the largest holding of the Domini index? Is there any investment in a for-profit company that would qualify? The law requires that corporations serve the interest of shareholders, so how can they be said to be serving a “public benefit” (I think that for-profit companies can further a foundation’s mission, but working through how to demonstrate this is still needed)? Must an investment be tightly linked to the mission of the foundation? If so, how might a foundation whose mission is very narrowly defined invest all of their endowment in a diversified way?

I understand Lucy’s urge to suggest radical changes to accelerate the advancement of philanthropy. But the danger in her argument is that if we require things from philanthropic entities before an infrastructure is in place, we will do nothing but water down the very concepts we hope to support. Imagine what would happen if a new law was announced that levied a special tax on non-organic food? Would we see a huge shift towards organics? No, the country is simply not currently able to make that kind of move over night. Instead, we would see a dramatic decline of what the word “organic” even meant. As food producers struggled to move towards organic food, they would have an incentive to get the definition of “organic” to be as broad as possible. When new concepts are forced into adoption too quickly, they always get watered down.

MRI is an exciting area. But we are years away from having the shared infrastructure and vocabulary we need to have widespread adoption of the concept. I’m don’t think I would agree with Lucy’s suggestion even if we did have all the needed elements in place. But I am sure that we are far too early in the evolution of MRI to contemplate making it mandatory. Doing so would hurt the MRI movement, not accelerate it.

I met Stace Lindsay at the Investors’ Circle conference. Stace has been hired by the Blue Moon Fund to help them move to having 25% of their endowment in MRI investments. Stace gave an incredibly humble presentation at the conference where he discussed the process he is going through to try to develop an effective strategy. At 25%, Blue Moon would be a leading MRI foundation. Rather then threaten foundations with new taxation, let’s find ways to support the efforts of people like Stace and develop this exciting practice together as a field.


  1. Alex Carter says:

    Sean: Thoughtful comments on a a fascinating topic. While I haven’t fully delved into Ms. Bernholz’s arguments, I view the general proposition of taxing some portion of foundation endowments an excellent arrow in the quiver of those who argue that foundations should not continue to exist in perpetuity.

    The prospect of taxed endowments creates a powerful incentive for foundation boards to spend down over time, thus putting more money into the sector, rather than keeping it locked up in the market.

    I look forward to the evolution of the conversation.

  2. Thanks Alex. I enjoy thinking through these issues and look forward to a more dynamic conversation evolving as well.

    Perpetuity is an interesting question. I tend to think the choice to be perpetual or not should be up to the board and not enforced via taxation. However, I don’t think enough thought goes into creating a strategic time horizon for the foundation. I’m hearing more foundations, large and small, talking about not wanting to exist forever.

    Thanks for your comment. Any thoughts you have on these issues is appreciated.

  3. Neesh says:

    “There simply isn’t MRI opportunities available to absorb the half a trillion dollars in foundation assets.”

    This is a good point, but I’m not sure Lucy is implying that there are such opportunities–her argument is simply: No favorable tax rate for non mission-aligned investments. She’s not suggesting that foundations be required to invest in such a manner–just that, if they don’t, they get taxed.

    I mean, the dollars foundations must pay in taxes still go into the public coffers–that’s still an okay from the public standpoint, right?

    Good point from Alex about more incentive to spend if there are no tax advantages.

    I wonder about this point:

    “This means that the foundation is viewed as providing a public benefit, not just based on the dollar value of grants they make, but also from the value that arises from having an institution whose very existence is designed to benefit the public.”

    Now, do foundations really provide a public benefit just by existing? Or does their public benefit more closely track with the money they give away?

  4. Holden says:

    I don’t think it will ever be feasible to legally force foundations to do MRIs. The reason is that that would require a federal code determining what is “mission related” and what isn’t. If you’ve ever taken a good look at what it takes to qualify as a “charity” according to the IRS, and seen the NRA and the Golf Association and the Beef Association and everyone else, you know that this isn’t a reasonable burden to place on the govt.

    The IRS does review whether grants are mission aligned … but (a) I don’t exactly feel secure that they’re keeping all the foundations in line; (b) it would get infinitely more complicated if profit were allowed to be part of the justification for a grant/investment.

    I’d personally rather just see foundations have to pay taxes on investment income like everyone else. I think any favorable treatment should be given only for what they actually do to improve the world. You may disagree with my mentality of wanting to push them to “use it or lose it,” but keep in mind that taxing investment income would merely be returning the system to NEUTRAL (currently, it is giving them favorable treatment for spending later instead of now – who can defend that?)