Diversifying in Philanthropy

The GiveWell blog wrote recently about the trade offs between doing research on multiple charitable sectors or going deeper on fewer sectors.

In the financial markets, the concept of “diversification” says that by adding additional investments into your portfolio (especially when they are “uncorrelated”, or in a different business, with your other investments) you will lower the risk of your portfolio while only marginally reducing your expected return.

“Diworsification” on the other hand refers to when a company enters businesses that are outside their area of core expertise and thereby reduce the returns they can achieve.

Since I often compare philanthropy to financial markets (although I’ve pointed out that business people are making a major mistake when they think for-profit models can be used in philanthropy without adjusting for the different environment), I thought I’d share this back and forth from the comments on the GiveWell post:

Sean Stannard-Stockton says:
February 20th, 2008 at 9:55 am

I think the problem you’re facing has less to do with something innate to
philanthropy or a function of your resources and is more a problem with
the underdeveloped infrastructure in our industry.

Investment managers who run stock portfolios generally hold stocks
across many sectors/industries. But they are not trying to be experts
in every field. Instead, they have access to an army of specialized
analysts who focus on only 5-10 companies and understand all the
dynamics in their sub-industry.

Without these underlying experts, you have to do all the work
yourself. If you look back at the financial markets in the 1920-1950
time period, you would find a similar underlying dynamic. At that time,
investors might have held fewer stocks across fewer industries than
they do today, but I think you would find support for your choice to
focus across a range of “industries” rather than just picking one.

I at least am glad that there is some breadth to your research and
would rather see more causes than a deeper dive on what you’re already
looking at. Hopefully you can do both.

michael vassar says:
February 20th, 2008 at 1:31 pm

The analogies between investment and philanthropy are poor because personal
wealth has strongly diminishing returns so risk aversion is rational
while philanthropic spending has very weakly diminishing returns so
risk aversion is only rational with VERY large portfolios.
Consequentially, rational investors investigate many possible
investments in low depth and choose a large number of them but rational
philanthropists invest a diverse array of approaches but choose only
one until that one is fully funded.

The advantage of focusing on the big picture comes from the fact
that the expected returns in philanthropy, unlike those in fully liquid
investment sectors, varies radically between sectors. There is nothing
like this in liquid investing. Tech stocks might systematically perform
twice as well as industrials, or in another market one half as well,
but they won’t ever have 100X the expected return. If you are committed
to making liquid investments then its more rational to spend the effort
to double your expected returns in a random industry than to try to
find an industry that will do twice as well as another with a bird’s
eye view. OTOH, if you look at non-liquid investments, the birds eye
view becomes relevant. Someone deciding between investments in jewelry,
Florida real estate, timber, baseball cards, great master paintings and
clean energy start-ups may rationally expect the best performing of
these to return 100X as much as the average and 10,000 times more than
the worst. Deciding what broad class of investment to make is likely to
be more important than the decisions made within the class so the birds
eye view is appropriate even if you are risk neutral.

Sean Stannard-Stockton says:
February 21st, 2008 at 9:46 pm

your point about the lack of benefit to diversification in philanthropy
is something I agree with strongly and have discussed in other forums.
My point was not that GiveWell should cover multiple sectors in order
to reduce risk. I was just saying that it is more difficult to cover
multiple sectors in philanthropy because the underlying experts are not
there (or not contained within an easily accessible system).

If GiveWell was only concerned with maximizing the impact of their
own funds (as most foundations are) I would suggest narrowing their
focus. But the part of the GiveWell experiment I find most interesting
is the way it can help inform other donors. If they have a narrow
focus, they will only be a resource to donors with that same narrow
interest. If they have a broad focus, they will be able to attract
multiple donors and more people can learn something from the process.