Foundations pay out only a tiny proportion of their asset value, typically around 5 per cent, in the form of grants. This begs the obvious question of what happens to the other 95 per cent. Could it be put to some use that would further the foundation’s mission? As yet, few foundations have developed clear policies on using their assets to achieve social as well as financial returns. Alliance talked to three firms of investment advisers that advise UK foundations on their investments and asked them why they think this is.
The central message that emerges from their answers is that it’s not their role as advisers to encourage social investment; it’s up to the foundations themselves to start this particular ball rolling.
SORP: a matter of interpretation
The new Charities’ Statement of Recommended Practice (SORP) encourages trustees of UK foundations with investment assets worth above £2.8 million to publish information about the extent to which they take account of social and environmental considerations in investing their assets.
Has this affected the advice investment advisers give their clients? For Mercer Investment Consulting, the answer is yes. Their understanding is ‘that charities must report the extent to which they take environmental, social and ethical issues into account in their investment process’ and they ‘are able to help Trustees formulate and report their policies’. Cambridge Associates take a different view. ‘We do not believe the new SORP requires charities to take social and environmental considerations into account when making investment decisions, nor does SORP seem to require charities that do not have social investment policies to disclose the fact that they do not have them.’ The SORP has therefore had no effect on their advice to clients regarding social investment.
Is there a growth of interest in social investing?
Cambridge aren’t sure, though they have noticed certain issues becoming more prominent among would-be social investors. They have, for example, noticed increased interest in programme-related investments and other targeted investments such as microfinance, particularly those that are intended to support underserved communities, and an upsurge in interest in climate change and renewable energy.
Neither Jewson Associates nor Mercer Investment Consulting feel that investment managers are asking for more advice about social investments. ‘To date,’ say Mercer, ‘we have seen little demand for it.’ However, ‘we do expect to see charity clients begin to increase their knowledge of the wide range of options that are now available to them.’ If the demand arises, they will consider whether and how they can extend their expertise to cover it. At present, they point out, they provide advice on socially responsible investing (SRI) not social investing, and here they have noticed a growth of interest. The UN Principles for Responsible Investment are a sign of this, and they expect to see institutions beginning to assess their investment policies in light of them.
In 2004, Mercer took the strategic decision to develop a specialist global business unit to provide specialist advice and develop intellectual capital on issues relating to SRI.
As Mercer explain, SRI does not simply mean screening out investments in undesirable companies or products. They provide advice on a range of other approaches. These include what they call ‘best in class’, where a manager invests in companies that are ‘leading performers in their sectors on a range of social, environmental and ethical criteria’; engagement funds, run by investors who attempt to use their influence as shareholders to change corporate behaviour; and themed funds in areas such as renewable energy, water, technology or health.
What exactly is a social investment?
None of our respondents regard social investments as a distinct asset class. According to Cambridge, they have no intrinsic defining characteristics. ‘Are investments in clean technology “social investments”?’ they ask, and answer: ‘not if an investor undertakes them exclusively for profit.’ They point out that ‘what are normally thought to be “traditional” investments also generate social returns by creating jobs and helping bring to market goods and services that meet people’s needs and desires.’ What makes an investment a social investment, they suggest, is ‘the intention of the investor’.
Mercer see mission-related investment and social investment as ‘making a direct investment in organizations or individual projects such as a loan or an investment in a local housing project’ but, as already seen, this is not their focus.
Why isn’t social investment more prevalent?
The investment advisers cite a number of factors which might prevent foundation investment managers from putting what seems at first glance such a good idea into practice. For one thing, suggest Jewsons, they have had more urgent matters to occupy them. ‘Market volatility in the last five years has forced foundations to concentrate on big strategic issues.’
Then there are legal considerations. ‘The mission set out in some foundation trust deeds is often very onerous,’ say Jewsons, ‘and trustees could be considered as irresponsible from the point of view of not properly diversifying their investments if they concentrated excessively on the social aspects of their portfolios.’ Cambridge say almost the same: ‘From a legal perspective … it is not clear to us the extent to which charitable institutions can knowingly engage in investments that are at higher risk of earning below market rate returns due to constraints imposed by social or environmental considerations.’
There are also questions of capacity. ‘As a rule of thumb,’ Mercer suggest, ‘the larger the asset base of the institution, the greater its ability to incorporate and diversify high-risk opportunities into its overall portfolio’ – and mission-related or social investments, they believe, are likely to fall into this high-risk category. In addition, they ‘are likely to require a specialist skill set and be more resource-intensive to implement and monitor’. These capacity issues might effectively limit the number of foundations for which social investment is a realistic option.
Finally, the organization’s mission may affect the number of opportunities for investments that serve both revenue generation and mission. ‘For example,’ say Mercer, ‘an institution whose mission is to promote the shift to a less carbon-intensive society is likely to have more investment-related opportunities available to it because of the rise in renewable energy technologies and renewable energy funds.’
The question of measurement
Performance does not seem to be a factor in restraining foundations from social investing. According to Jewsons, there is ‘no strong evidence that this area produces greater or lesser returns’, while Cambridge consider that ‘because “social investing” covers such a broad array of issues and approaches, and may touch on every asset class, it is impossible for us to make a blanket statement about the likely performance of social investments’. Mercer are in broad agreement, though they note that ‘we do see a slightly higher level of volatility associated with socially responsible investment’.
What will be important, say Cambridge, in determining whether social investment becomes more prevalent is ‘whether the social returns generated are more valuable – however such value is measured – than the social returns generated through simply spending on charitable purposes, if such investing brings with it higher risk of underperformance.’ So if a foundation makes a social investment, the financial return on which is less than on a more traditional investment, it has to decide whether that money, spent as a grant, would have bought more social benefit than the investment. If the answer is yes, then the investment was a bad one.
It will be for foundations themselves to decide how social value is measured. ‘You can evaluate these [social] investments using traditional financial metrics, and straying from them will often lead to disaster,’ say Jewsons, the clear implication being that advisers confine themselves to the financial aspects of such transactions – something which Cambridge make explicit (see below). In a sector where the question of measurement remains a vexed one, this is likely to exercise some deterrent influence on foundation investment managers’ decisions.
Advising on social investments
Both Jewsons and Mercer say that they make clients aware of social and environmental considerations and ask what constraints their investment policy should take into account. While both Jewsons and Cambridge have given advice on social investments, this is not an everyday matter. In the case of Cambridge, ‘we have focused on the financial characteristics of these investments, and secondarily strive to be aware of the arguments for how a given investment may or may not achieve intended social returns.’
In circumstances where any financial loss on an investment is outweighed by its social benefits, they say they ‘would … encourage institutions to consider the degree to which social investment objectives may arguably be aligned with financial objectives. Then, to the extent that these objectives are not in harmony with one another, investors should assess the relative value of achieving programme goals through investments versus achieving them through spending.’
Do advisers actively bring social investment options to the attention of foundation investment managers? No. Again, they see it as foundations’ business to seek, rather than to be led. As noted, Mercer concentrate on conventional and SRI investments and feel that any move into advising on social investments would come from clients – though they add that ‘it is an important strategic decision for charity and foundation clients if they want to adopt more social or programme-related investment options’.
Cambridge take a similar view: ‘We do not intend to proactively raise the issue, other than to let clients know that we are here to help them in this area if they are interested.’ However, they believe that they are prepared, should the demand arise. Cambridge ‘has enjoyed a long history of service to clients engaged in social investing’.
Whether foundations are prepared is another matter. Cambridge ‘would encourage clients to clearly articulate the social return objectives they hope to achieve through their social investment programmes, and to hold social investment managers accountable for achieving these social objectives. In our view, too little attention is spent on evaluating the degree to which social investment managers are actually able to achieve social returns.’
The future of social investing
Will social investment grow in importance in the future? While Jewsons believe that ‘it will continue to be one of the major factors in constructing an investment portfolio’, Cambridge point out that changes in public opinion are likely to make some social investments more attractive and bankable and increasingly likely to ‘register on investors’ radar screens’. They cite climate change and alternative energy as potential examples here.
In the long run, say Cambridge, whether social investing will grow in importance depends on ‘the degree to which certain social and environmental issues correlate positively with financial performance. The ‘perceived efficiency of using investing, rather than spending, to achieve programme goals’ is another key issue.
For their part, Mercer note that ‘there is recognition among many foundations that they are likely to consider social investment more seriously in the future, as the opportunities in these areas increase’. Ultimately, they point out, the decision to make social investments will involve a change in attitude: ‘The traditional approach has been to establish an endowment which is invested to produce income, and it is this income that is then delivered as grants to support its institutional mission.’
Any decision about whether and to what extent to make social investments will involve considerations of efficiency, capacity, and the degree to which a foundation’s constitution permits potentially riskier investments. Here the advisers can offer only limited advice. It will be for foundations themselves to decide whether they can and will make social investments, and to balance straightforward money-making, which is then translated into more grantmaking, against using their assets to produce social benefits by other means.
‘We do not believe it is appropriate,’ say Cambridge, ‘for an investment adviser to make a recommendation regarding whether, for instance, the social benefits derived from a below-market rate investment instrument are sufficient to offset the institution’s lessened ability to spend on other social programmes … this type of cost/benefit analysis is more properly the purview of a subcommittee of the board of trustees.’
1 Cambridge Associates’ responses are based on experience in the US as well as the UK.
Alliance would like to thank the following, on whose contributions this article is based:
Kyle Johnson and William Vincent Cambridge Associates
Tim Brown Jewson Associates
Edward Jewson Jewson Associates
Alasdair Gill Mercer Investment Consulting
Emma Hunt Mercer Investment Consulting