‘Changing the way we do business’ – community foundations, national donor-advised funds and the chase for charitable assets

Originally introduced by community foundations, donor-advised funds (DAFs) have become extremely popular with US donors in recent years and are now also sponsored by financial institutions such as Fidelity.[1] According to Emmett Carson, President and CEO of the Minneapolis Foundation, the success of DAFs sponsored by financial institutions is to blame for an ‘identity crisis’ among US community foundations. However, some community foundations are turning this challenge into an opportunity to reposition themselves and to develop their unique role as intermediaries between donors and the community.

This article highlights two approaches to this challenge – a collaboration between 42 community foundations and the financial management company Merrill Lynch, and a renewed focus on donor education that establishes close links with donors and helps them to shape their own giving plans – and analyses some of the obstacles community foundations will have to overcome in the face of the success of DAFs sponsored by financial institutions.

The role of community foundations

Since Frederick Goff set up the first community foundation in Cleveland in 1914, community foundations have become an important feature of philanthropic giving in the US and overseas. Despite their success, they currently face a number of challenges:

• to continually increase their assets and to develop their financial resources through new contributions from a wide range of donors;
• to develop grantmaking programmes which are of benefit to the local community while being attractive to current and future donors;
• to provide leadership on problems facing the community and to act as a moderator in dialogue with other local initiatives, non-profit organizations (NPOs) and foundations.

As can be seen from the above, community foundations have to serve three constituencies: charitable donors, NPOs, and the community as a whole. Their role vis-à-vis these constituencies has continuously expanded:

• Like fundraisers, they have to understand the needs of the donor.
• Like consultants, they have to help NPOs build capacity.
• Like think-tanks, they have to help set an agenda for issues facing the community.
• Like lobbyists, they have to argue the community case with local and regional governmental agencies.

One strength of community foundations is their deep involvement in the community – through the provision of technical assistance, training, information and networking connections. This has enabled them to have an impact upon the community as a whole, at times contributing heavily to its development – ‘you can’t have strong neighbourhoods without a reasonably high quality of jobs and certain quality of life amenities’.[2] Unlike some private foundations and family foundations that lack the staff to undertake research and provide leadership, US community foundations often act as important sounding boards for donors in developing projects benefiting the community and matching donors’ interests.

Socioeconomic developments in the 1980s and 1990s made community foundation assets grow at a hitherto unprecedented rate and led some to speak of the ‘golden age of philanthropy’. This asset growth also mirrored the changing nature of donations: in a 1988 survey from the Council on Foundations (COF), gifts from living donors proved to be the largest single source of community foundation income. This was partly due to the technology boom of the 1990s and the growing number of high net worth individuals wanting to give back to society, but also to the immense popularity of DAFs. DAFs have been offered by community foundations since the late 1970s and allow donors to give cash, stock or other assets, claim a charitable deduction on their federal income tax, then advise how the money held in the fund should be distributed.

DAFs sponsored by financial institutions

For the new generation of donors emerging during the technology boom of the 1990s, for whom ‘hands-on’ involvement with their grantmaking is very important, a DAF becomes a highly attractive alternative to setting up a private foundation. It allows the donor an ongoing role in advising on the use of their money while providing a range of financial and administrative benefits. In contrast to private foundations, DAFs are quick and easy to set up, and allow donors to centralize and streamline their charitable giving, spreading distributions over several years. The organization handling the DAF does all the paperwork, freeing the donor from having to monitor grants and fulfil federal and state reporting requirements. These features have made DAFs popular not only with community foundation donors, but also with financial institutions such as Fidelity Investments. It is interesting to note that just as mutual funds opened up the stock market for a large section of the population, DAFs have opened up philanthropy to a growing part of society.

With the technology boom in the late 1990s, DAF assets exploded. By 2001, assets at 75 DAFs held by community foundations, financial investment companies and other organizations totalled $12.3 billion, with $2.2 billion being awarded in grants to charities. Since then assets have fallen but the number of donors setting up advised funds is steadily rising, testifying to the continued attraction of this giving vehicle.

In 1992 Fidelity sponsored the most successful national DAF (NDAF) to date, a public charity named the Fidelity Charitable Gift Fund (CGF). Its number one position has not been challenged, even at the end of the financially difficult year 2002. Although its funds have declined by 9.8 per cent since 2001, at the end of last year the CGF still held a staggering $2.4 billion in assets and had over 30,000 donors.

It was the entrance of financial institutions such as Fidelity into the field that helped to make DAFs one of the most popular vehicles for giving to charity. DAFs have become an established giving vehicle in both the non-profit and the for-profit world: last year the 25 largest commercial US DAFs held $3.4 billion in assets, and every year new financial institutions sponsoring DAFs enter the market. The success of these NDAFs sponsored by financial institutions took community foundations by surprise and provided some with a rather harsh wake-up call.

Why has Fidelity’s Charitable Gift Fund been so successful?

The CGF was set up in 1992 after Fidelity’s chairman, Edward C Johnson III, became interested in the idea of how to enable a broader group of Americans to participate in philanthropy. Johnson, who had set up several private foundations as well as a corporate giving programme for his company, felt that philanthropy had become time-consuming and complex, and sought to develop a service which would help donors to accomplish their philanthropic goals while reducing administrative requirements, keeping costs down and maintaining preferable tax benefits. The CGF set out to do exactly that and provides donors with a ‘one-stop’ giving vehicle. Through its service provider, National Charitable Services, the CGF handles all account maintenance, record keeping and tax reporting, keeping donors informed by quarterly statements about account activities. Donors can also check their accounts via a website, which allows them to make grant recommendations. What is more, the CGF allows donors to make unlimited grants, in sums as low as $250, which is especially appealing to donors with smaller grantmaking portfolios.

While the CGF is still by far the largest DAF in terms of assets and grants awarded, its competition has increased considerably. Among the dozen or so companies that provide charitable giving services today are J P Morgan Chase, the Pitcairn Trust Company, the Vanguard Group and the Charles Schwab Corporation.

As one of the first and certainly most successful of all financial companies sponsoring a DAF, Fidelity Investments has had to bear the brunt of criticisms about the ‘invasion’ of for-profits into the non-profit market. One of the main criticisms is that NDAFs do not provide donors with enough information about grant recipients or potential giving opportunities. But most of the criticism has centred on the argument that donors using NDAFs have more control over their contributions than donors using similar funds held by community foundations or other charities, thereby giving the NDAFs a competitive advantage. In the late 1990s particularly, trade magazines and journals were full of articles decrying the ‘murkiness of the law’ that required community foundations to comply with Treasury regulations regarding oversight, due diligence and community benefit of their grants that were allegedly not enforced to the same extent for NDAFs.

Some materials distributed by the CGF at its outset may have invited the kinds of criticism mentioned above. A 1992 article on the CGF by its Marketing Coordinator at the time, Susan Devey, contrasted the pros and cons of setting up a private foundation versus opening an account at Fidelity’s CGF, listing the fact that self-dealing rules didn’t apply.[3] The CGF subsequently made several amendments to their operations. In addition, a group of NDAFs, including the CGF, started to think about voluntary self-governance and in February 2002 published a document outlining ‘Common Operating Procedures’ of DAFs. Because of their immense success, the Internal Revenue Service (IRS) has repeatedly shown an interest in DAFs. Despite this, no legislation has so far been enacted.

The speed and efficiency with which donors’ grant recommendations are handled is part of the CGF’s recipe for success. By tapping into a niche market of donors who know exactly whom they want to give money to, the CGF has become the largest grantmaking entity only ten years after the IRS approved it as a public charity. However, the CGF insists that it has no desire to build up an endowment. Donors are encouraged to name a successor as soon as they open an account, and successors are given full decision-making powers over which grants to recommend. Most importantly, the successor to the ‘original’ donor can name a successor, who will then also be able to name a successor and so forth.

Proponents of DAFs sponsored by financial institutions say that they have helped to ‘spark a boom in American philanthropy’, helping to tap into a new group of donors. According to a survey by the CGF of its donors, nearly two-thirds of respondents claimed that they gave more money to charity after opening their DAF there and one-third said they gave money to more charities than before. Dorothy Ridings, President of the Council on Foundations, concurs with this positive assessment: ‘It’s really clear they’ve brought some new people into philanthropy that weren’t there before.’[4]

Collaboration with Merrill Lynch

Community foundations have reacted in different ways to the growing competition from the for-profit sector. One of the earliest attempts to strengthen the community foundation movement was the formation of Community Foundations of America (CFA), whose aim was to help create a ‘brand identity’ for community foundations. At the same time, CFA wanted to help community foundations better understand the changing financial marketplace and, as it says on the CFA website, to ‘change the way we do business’.

Shortly after the CFA was set up, the Council on Foundations made some major changes: a community foundation leadership team was established and senior staff were hired to run the community foundation department. Both greatly helped to establish the Council as a major resource for community foundations and as an advocate and facilitator in matters such as discussions between investment banks and community foundations.

One such effort is the collaboration between a group of community foundations and the financial management company Merrill Lynch. In 1996, 34 foundations entered into an agreement with Merrill Lynch, which does not sponsor DAFs of its own. Merrill Lynch brokers were encouraged to connect wealthy individuals interested in charitable giving with one of the participating community foundations. In return, the community foundations agreed to invest money from clients with Merrill Lynch, earning brokers a fee for managing the investments. This ‘Community Foundation Alliance’ programme run by Merrill Lynch today includes 200 community foundations.

Cooperation between Merrill Lynch and the community foundations has not, however, been as smooth as both sides had wished for. ‘Each community foundation operates their DAFs differently and the cooperation was sometimes cumbersome for our financial advisers,’ says David Ratcliffe, Director of Merrill’s Center for Philanthropy & Nonprofit Management. However, Merrill was determined to continue its relationship with the non-profit sector and in 1998 started to offer non-profits a range of financial consulting services, arguing that many non-profits were too small to have a sophisticated infrastructure. Merrill Lynch was able to provide a back office facility.

Merrill Lynch has now decided to go one step further. It initially began talking with about 30 of the largest US community foundations about setting up a uniform DAF that would be offered by all community foundations participating in the pilot. The Merrill Lynch Community Charitable Fund (MLCCF) programme was designed to allow donors to invest in any of the DAFs offered by any of the community foundations participating in the programme in the same manner, because each DAF would be set up according to uniform standards. Merrill Lynch would evaluate continuously whether the participating community foundations were adhering to the standards. It would also consult on and facilitate investment management, under the ownership of the participating foundations, and the coordination of assets between different managers.

The initial discussions between Merrill Lynch and the community foundations focused mainly on two issues: which standards should be adopted by the community foundations and how the technological platforms of Merrill Lynch and the participating foundations could be linked to allow for a standardized accounting and reporting system. The latter issue seems by far the more complicated one: community foundations work with a wide range of administrative software and use different hardware standards. Nevertheless, the partners did come up with a solution: ‘There is a high level of mutual commitment,’ David Ratcliffe says.

What’s in it for Merrill Lynch?

At Merrill Lynch there has been internal pressure from financial advisers to offer their own DAF ever since they became such a huge success with donors. According to David Ratcliffe, senior management at Merrill Lynch has so far believed that ‘there are certain things a financial service company like Merrill Lynch can do better than a community foundation, and there are certain things a community foundation can do better’. It found that one of the greatest limitations of NDAFs is that they offer donors little substantive advice. Merrill Lynch’s clients, Ratcliffe says, often don’t have a well-defined list of charities they want to support. ‘They know they want to help inner city kids, but don’t know which charities working in that field are good.’ By cooperating with community foundations, Merrill Lynch helps its clients to get expert advice regarding their philanthropic goals but gets to keep and manage their clients’ assets.

With refreshing directness, Ratcliffe does not hide the fact that the bank’s motivation in cooperating with community foundations is to make money. ‘Let’s be realistic, we’re not doing this out of the goodness of our hearts. Engaging philanthropy is good business. It’s good for the client/donor, as they integrate giving strategically into their overall wealth management plan and meet their charitable intent. It’s good for the non-profit as we are oftentimes able to generate more philanthropic giving and identify new donors. And it’s good for Merrill Lynch as we hope to manage (that non-profit’s) account,’ he said in an interview.[5]

Forging links more widely

With the MLCCF programme, Merrill Lynch is hoping to create a model for collaborations between financial institutions and community foundations. Its focus on 30 community foundations in the pilot project certainly helps to make the development of a standardized model easier. Other organizations like the CGF have so far found that their success presents a formidable obstacle to cooperation with community foundations: 30,000 donors from every state in the US not only make ‘intimate donor relationships’ next to impossible but also present immense challenges to cooperating with community foundations. However, in 2002 the CGF started examining ways to work with community foundations, with a particular focus on providing donor education to those donors who want more advice on which charities to give to.

While some community foundations have started collaborations with investment banks, most have looked upon the competition from NDAFs as an incentive to market their services to potential donors better. ‘It behoves community foundations, rather than try and eliminate the tax exemptions of these funds, to articulate their own advantages in what has become a very competitive field,’ Stephen Mittenthal, President of the Arizona Community Foundation, is quoted in The Chronicle of Philanthropy as saying. Rather than issuing ‘loud lamentations’, community foundations would be better off marketing their services to their own constituency.[6] Allan Parachini, Vice President for Communications at the California Community Foundation, puts it even more drastically: ‘We have to start reacting as if we were a hip, contemporary investment industry and not just a stuffy old-fashioned one.’[7]

This commitment of the donor can become a monetary long-term benefit to the community foundation. ‘The simple truth is that DAFs provide the community foundation with the opportunity to develop a relationship with an individual that can be parlayed into the foundation’s inclusion in that individual’s estate plan, and most discretionary money comes into a community foundation after the death of the donor,’ writes Dorothy Reynolds, one of the foremost experts on community foundations.[8] The success of NDAFs testifies to the widespread appeal DAFs enjoy, Reynolds concludes, and emphasizes the importance of establishing relationships with the donor, as ‘those commercial entities will be more than willing to welcome the donors community foundations choose to ignore’.

Finding the community foundation niche

The amount of money that, despite the current economic downturn, might become available through the intergenerational transfer of wealth lends a certain sense of urgency to the task of community foundations to reposition themselves.

Building relationships with donors is certainly one of the main challenges facing community foundations in the years ahead. Whereas foundations used to get most of their assets from bequests after a donor had died, the growth of assets in recent years has come from contributions from living donors. These ‘new donors’, which emerged with the technology boom in the 1990s, not only started off the trend for more hands-on involvement in grantmaking but are also trying to push the notion of strategic philanthropy even with small foundations. The new donors are increasingly interested in performance measurement and some are even demanding formal contracts with grantees, stipulating details of the grantmaking process such as what will happen to their contributions should the benefiting charity cease to exist or change its mission, or how proceeds from a research project financed by donations should be split and spent. Some observers fear that this new type of donor is less prone to establishing longstanding relationships with a handful of charities, but instead is inclined to decide even more than before on an ad hoc basis which charities to give to. For Mark Kramer, CEO of the consultancy Foundation Strategy Group (FSG), community foundations should therefore focus on the mid-point between donor engagement and donor services in order to create additional value for donors. For Kramer this means a focus on proactive donor education.

Paul Carrtar, founder and former partner of the Bridgespan Group, a Boston-based consulting firm that specializes in working with non-profits, points in the same direction. He defines four imperatives for turning community foundations into powerful tools for affecting the community:

• the need for some mechanism for establishing a consensus about what is important for the community;
• the ability to identify non-profits that perform well versus non-profits that perform poorly;
• the ability to attract donors by offering them a value proposition;
• connecting donors to giving opportunities.[9]

Carrtar’s final point again emphasizes the importance of donor education, which might be the most important measure for distinguishing community foundations from NDAFs. Suzanne Feurt, head of the US Council on Foundations Community Foundation Program, estimates that most community foundations heavily involved in DAFs so far have only anecdotal evidence on how they managed to link the donor to the community.[10] It remains to be seen how community foundations, especially the smaller ones that are often short-staffed, can build up their competitive strength over NDAFs by combining the benefits of donor services and donor engagement in improved donor education programmes.

With his first imperative, Paul Carrtar points to another important issue: the new generation of donors does not seem inclined to acknowledge the community foundation board as the only entity able to identify important issues facing the community. In line with a more hands-on approach to grantmaking, the new donors consider themselves equal partners in mapping out a strategy for helping the community.

Other challenges

Speed in processing grants
The new donors are attracted by another strength of financial institutions vis-à-vis community foundations: the speed with which some NDAFs process their grants. The CGF and other NDAFs invested a lot in technology early on in order to provide the efficient service that has made them so popular. Their turnaround time for donations is much quicker than at the average community foundation, and few community foundations allow donors to view their accounts and make grants online. Suzanne Feurt therefore considers the update of technology systems one of the most pressing needs for community foundations. Today’s donor expects the sponsoring organization to process funds extremely fast and financial institutions have been setting benchmarks with turnaround times of as little as 24 hours. In contrast, some community foundations still need weeks to process donors’ grants.

Working with financial advisers
The example of Merrill Lynch has shown that another challenge for community foundations will be how to work effectively with financial advisers. As the Merrill experts point out, conversations with donors about their philanthropy have to be embedded in a conversation about their wealth. The question then becomes how to address a large number of advisers and turn them into ‘marketing tools’ for the community foundation idea.

Some community foundations have already experienced the benefits of working with financial advisers. In 2000, the Community Foundation for the National Capital Region, in Washington DC, increased the assets of its DAFs by 150 per cent by approaching new donors through their financial advisers.

Good leadership
To tackle the challenges mentioned above, the key thing community foundations need is excellent staff. ‘Community foundation work is not good for those who need instant gratification,’ Dorothy Reynolds wrote in a paper concerning staff leadership.[11] Asset building takes a long time and too often the staff who initiated contacts with a donor will not be around by the time the assets have grown to a considerable size. It is therefore twice as important to have leaders with a vision about the foundation’s potential, as well as staff that recognize the importance of building strong, long-term relationships with donors – ‘relationship managers’ in the words of Peter Karoff, President of the Boston-based consultancy The Philanthropic Initiative.

The above suggests numerous challenges for the management of community foundations. It is imperative that the board understands the motivation of new donors and the differences, competitive strengths and weaknesses of the financial sector, and tries to build links between new donors and the community. In addition, modern management methods, financial skills, long-range planning abilities and marketing/communication skills become crucial to successfully running a community foundation. Emerging community foundations face a special dilemma. While it is ‘the caliber, vigor, dedication and prominence of the new community foundation Board’ that is ‘probably the single greatest contributor to success of a new community foundation’, an emerging organization without a track record will find it hardest to attract ‘and energize’ top community leadership.[12]

Conclusion

It has been estimated that over the next 50 years at least $41 trillion will be passed on from one generation to the next. The prospect of being able to channel some of this money into philanthropy is already leading some observers to talk about ‘the golden age of philanthropy’. But the impending transfer of wealth also represents an enormous responsibility for those receiving a share of the money. If community foundations manage to tackle the challenges outlined above, I believe that they can become a major force for a revitalization of communities throughout the world.

In the last couple of years, the role of community foundations has already changed far beyond their traditional role of simply building a charitable endowment that serves as a ‘savings account’ for future community needs. Community foundations have become a bridge by moving regional agendas on to the state level and by helping communities to ‘think regionally and act locally’, as the author Alicia Philipp succinctly put it. They have been uniquely positioned to build local NGOs in ways neither governmental agencies nor private foundations are able to do.

The competition from NDAFs sponsored by financial institutions has forced community foundations to re-evaluate their mission and the role they are playing in society, and as such has already been of great benefit. While a great deal still needs to be done to refine their new strategy for the future, community foundations can be confident that if they turn the competition from NDAFs into an incentive to reposition and reorganize themselves, they will be hard to surpass in their ability, to quote Peter Hero, ‘to forge collaborations, motivate key stakeholders, link up the leadership and the assets of a community, and articulate and promote its shared values’.

1 The financial institution sets up a public charity (eg the Fidelity Charitable Gift Fund), which then offers the donor-advised fund. These are referred to as ‘national’ DAFs because the public charities offering them are not limited geographically as most community foundations are.
2 Joanne G Carman (2001) ‘Community Foundations, A Growing Resource for Community Development’, Nonprofit Management & Leadership, Vol 12, No 1, Fall 2001, pp7–24.
3  Susan Devey (1992) ‘Fidelity’s New Fund For Donors’, Philanthropy, Vol 6, Fall 1992, pp6–7. Self-dealing means that a director or trustee of a fund/foundation, the donor or the donor’s family derives personal benefit from the foundation/fund they administer, which is forbidden for all foundations.
4 Quoted in Robert Franklin (2001) ‘Top 25 Grantmakers’, Star Tribune (Minneapolis, MN), 23 December 2001.
5 Information from King McGlaughon (17 June 2002) and David Ratcliffe (8 September 2003).
6 Stephen G Greene (1998) ‘Fidelity Gift Fund Modifies Guidelines to Appease Critics’, Chronicle of Philanthropy, 30 July 1998.
7 Tom Billitteri (2000) ‘A Run for the Money’, Chronicle of Philanthropy, 20 April 2000.
8 Dorothy Reynolds (undated), ‘The Case For Donor Advised Funds’, Council of Michigan Foundations Enhanced Technical Assistance Project.
9 Conversation with Mark Kramer, CEO and Founder of the Foundation Strategy Group, Boston, 22 May 2002, and Paul Carrtar, Founder and former Partner of the Bridgespan Group, Boston, 21 May 2002.
10 Conversation with Suzanne Feurt, 16 May 2002.
11 Dorothy Reynolds (1999) ‘Practical Considerations Concerning Staff Leadership Of A Community Foundation’, Council of Michigan Foundations Enhanced Technical Assistance Program, Community Foundation Issues Series #5, May 1999.
12 Peter deCourcy Hero (1999) ‘Early Stage Development of Community Foundations: Challenges to Growth’, in Bertelsmann Foundation (ed) Community Foundations in Civil Society. Gütersloh: Bertelsmann Foundation Publishers, p76–77.

Dr Felicitas von Peter is CEO, of Active Philanthropy. She can be contacted at vonpeter@activephilanthropy.org. This article is based on a paper prepared as an International Fellow for the Center for the Study of Philanthropy at CUNY, New York.