Flashback: Efficient Markets in Philanthropy

It would be naive of me if I ignored the implications of the systemic freezing of capital markets over the past few months for my view of philanthropy. I’ve often referred to the fact that I use a “financial markets frame” when thinking about philanthropy and while I’ve always acknowledged that this is only one frame and not the only valuable frame, I also believe it is a very useful frame for understanding philanthropy at the beginning of the 21st century.

As recently as my debate with Paul Brest I referred to my vision of philanthropy as “capital markets philanthropy”. So as we slog through an era when capital markets are dysfunctional, I thought I should revisit two posts I wrote in January of 2008 (prior to the cataclysmic fall in financial asset prices that occurred over the course of last year).

Efficient Markets in Philanthropy
Originally posted January 24, 2008

In response to my post yesterday in which I discussed the value of information to philanthropy and why donors should desire efficient philanthropic markets, Phil Cubeta writes:

The logic here can become relentless and destructive. What this tends towards a lists, like league tables in a sport, with the best at the top. It leads then to managing a nonprofit by the numbers, to get the rating, and it leads to shutting down those that don’t rank high. We then have the tyranny of the metrics, however much arbitrariness is built into them…

The world you want – are you sitting in corner office reading a spreadsheet?

So are the philanthropic capital markets I envision boring and lifeless with endless spreadsheets and numbers to crunch? Not in the least.

Economics is often called the “dismal science”. I know that many people think that finance is boring. But the vision of financial markets as nothing but numbers and spreadsheets does not capture the reality. Do investors buy stock in Apple because they spent hours and hours processing spreadsheet calculations? No. While at the end of the day, buyers of Apple stock believe that the return on capital being generated by the company will make for a profitable investment, the information they use to determine that are not just numbers. The way in which Apple has captured the imagination of the consumer, (an intangible piece of data that cannot be added to a spreadsheet) is by far the most valuable asset that Apple has and it is a major reason why investors have flocked to the stock.

Have you ever watched CNBC, the news channel of the financial markets? It is far from some kind of spreadsheet crunching lecture. Every day, investors or all types come on the show and make passionate arguments for why certain companies are good investments. While numbers and calculations underlie much of their thinking, it is the story, the human story of the companies they discuss that take center stage.

Warren Buffet is widely considered the best for-profit investor of his generation. Does he sit in a corner office reading a spreadsheet the way that Phil suggests? The quote below is from noted investor Whitney Tilson (Tilson is a huge fan of Buffet and a fellow columnist of mine at the Financial Times):

If the future were predictable with any degree of precision, then valuation would be easy. But the future is inherently unpredictable, so valuation is hard — and it’s ambiguous. Good thinking about valuation is less about plugging numbers into a spreadsheet than weighing many competing factors and determining probabilities. It’s neither art nor science — it’s roughly equal amounts of both.

The lack of precision around valuation makes a lot of people uncomfortable. To deal with this discomfort, some people wrap themselves in the security blanket of complex discounted cash flow analyses. My view of these things is best summarized by this brief exchange at the 1996 Berkshire Hathaway annual meeting:

Charlie Munger (Berkshire Hathaway’s vice chairman) said, “Warren talks about these discounted cash flows. I’ve never seen him do one.”

“It’s true,” replied Buffett. “If (the value of a company) doesn’t just scream out at you, it’s too close.”

Taking liberties with Tilson’s quote, I would argue that donors should not “wrap themselves in the security blanket of metrics” because “the lack of precision around measuring the impact that nonprofits achieve makes them uncomfortable.”

World-class investors do not sit in their office crunching spreadsheets all day. Neither should world-class donors. But the underlying logic of both should be that of achieving the highest return on investment.

Recently Phil commented to Perla Ni regarding her site Great Nonprofits (which offers reviews of nonprofits written by volunteers, donors and the people served by the nonprofit):

Thank you so much, Perla, for setting the record straight. In fact, your site is the exact opposite of a metrics driven exercise. You are bringing together the voices of those who have been touched by a nonprofit. I finally “got” what you are doing.

An efficient philanthropic capital market does not only view numbers as valuable inputs to the decision making process. Sites like Great Nonprofits offer extremely valuable information to donors. This sort of qualitative information is critical to both donors and for-profit investors. Great Nonprofits is not the opposite of a metrics driven exercise. They are both part of the same process of determining where donors and investors should direct their capital.

You can read the original reader comments to this post here.

Disclaimer: Nothing in this blog should be construed as investment, tax or legal advice. This blog is for informational use only.