Guest editor Danielle Walker Palmour talks to Larry Kramer and Ana Marshall, respectively CEO and chief investment officer of the Hewlett Foundation, about why the foundation is investing its $10 billion endowment for the long term despite immediate needs
Danielle Walker Palmour: To start with, Ana, could you say a little about how your investment decisions are affected by the governance of the Hewlett Foundation?
Ana Marshall: The board delegates to the investment committee which approves asset allocation, benchmarks and any particularly large new investments, but everything else is delegated to my authority. That level of delegation only works as long as there is transparency. In other words, the more transparent I am in my reporting, the more comfortable the investment committee feels. And we do periodic updates to the board.
DWP: What’s your team size?
AM: Eleven. Three investment directors, four investment associates, two investment analysts and our admin. So it’s a very small team for the amount of assets we have. We run a highly concentrated portfolio so we prefer the small lean team.
DWP: In UK terms that is a gigantic team, which shows how little UK foundations value internal investment management. Most have it delegated out. There’s a foundation – not as big as yours but probably with assets of several hundred million pounds – which has one internal person and 62 managers.
Larry Kramer: We’ve never changed the formal governance structure as we’ve never found it necessary. But we did have three serious discussions about impact investing with the board, discussing different ideas about how we might approach it. Each time, the board said no, partly because they felt it would need a big internal team and there is a strong commitment across the whole foundation to lean staffing. So we can only make investments of $50-100 million, we don’t have capacity to do underwriting or one-offs or that sort of stuff. I am profoundly sceptical about mission investment firms who say, ‘We’re putting 100 per cent of our assets to use’, but then you see that 50 per cent is in public equity. That’s not impact investing, that’s doing nothing. Obviously if there was a clean energy fund that produced the kinds of returns we need, we’d invest in it. But the few that apparently produce those returns are not large enough to take investments of the size we need to make. There is also the problem of managing an endowment when you have to invest in external fund managers. All of us are aware of these debates and we’re trying to be responsible about them. If you change your investment strategy to favour one particular issue area because it seems a compelling case, what are you going to say to all the others? How do you say no to the BDS people, to the soft drinks people, to the people objecting to private prisons, all of whom have equally compelling cases. You can’t have negative screens on all of them and any kind of coherent investment strategy. It’s those concerns and staffing constraints that explain why we’re not in ESG funds. Most of them are too small, and most of the ones that are big enough don’t produce adequate returns.
The E [Environmental] is the most quantifiable. G [governance] has been happening a long time, but the S is so subjective and so changeable that you would narrow your investment universe far too much.
Ana’s team is talking to our managers about how they are incorporating sustainability into their strategies, because that’s a much more sensible way for us to work. Similarly the environment team talks to the investment team on climate, who in turn talk to their managers, about how it is likely to affect investments, policies and so on.
DWP: You were saying, Ana, that you’re a concentrated investor. What does that mean?
AM: For public equity, about a third of our portfolio, we have 11 managers. Our hedge fund portfolio has about 20 managers and our private portfolio has about 30 managers. The bulk of those relationships have been in our portfolio for over 10 years so we can talk to our managers about sustainability, as Larry said, and we take a very investment-related approach. As to ESG, it took performance presentation standards about 20 years in the 1980s and 1990s to get a set of agreed-upon standards. We are nowhere near that yet on ESG, so there is a lot of greenwashing of funds, that charge very expensive fees compared to index funds just for the sake of saying they’re ESG, even though technically they aren’t.
DWP: One of the themes I’m really interested in is the foundation’s capacity to engage with global capital markets and to get responses.
AM: We get responses by having a cooperative partnership with our managers. We’re not trying to say you need to do this because it’s the right thing to do, we’re looking at sustainability as an element of a company’s competitiveness that we have found engages on a much deeper level.
DWP: On the ESG thing, with three foundations in the UK, we put a bit of money up to a transparent process to say ‘tell us what best in class looks like in ESG’. Sometimes, what was put forward as best in class, by very large funds as well as tiny boutique ones, were very good, sometimes they really weren’t.
People have to recognise that it’s a choice – between people today and people in the future and there’s no way around that choice.
AM: I think the problem with the standards is a lot of it, especially in the S [Social]. The E [Environmental] is the most quantifiable. G [governance] has been happening a long time, but the S is so subjective and so changeable that you would narrow your investment universe far too much.
DWP: On the interplay between investments and grants, to what degree do the funds available drive what you do in your programmes?
LK: The starting point is at the other end. We have adopted a set of practices designed to minimise competition among programmes for resources. I can’t think of anything more destructive for an organisation like ours than creating a system in which the programmes are competing for resources. Programmes work within their budgets. The programme budgets index with the overall endowment, and so they grow by the same amount every year, more or less, unless there’s a special consideration. We designed a response to managing downturns so the programmes wouldn’t have to index down unless there’s a really massive economic crash. In addition, to avoid competition between the programmes, we created a large pool of unallocated funds that are used every year for specific things. Then, if there are no specific things, these funds are distributed proportionally among the programmes.
DWP: Can you tell me more about your response to downturn?
LK: In 2009, the foundation had to cut grant budgets by something like 40 per cent, which was brutal for our grantees. I didn’t want us to be in that position again, so as the endowment started to grow again, we allocated the growth 60 per cent to programmes, 40 per cent to create this pool of flexible funds, which would be our cushion if we hit another downturn. Then Ana came to me two years ago with an idea to formalise that.
AM: In the US we have the three-year rolling spending rules, which we’ve always used for setting the grant budget. My proposal was that if, in any year where there’s a negative return, next year’s budget is set using the new lower NAV, it will allow us to course-correct more quickly and avoid overspending. When you make grant awards, you’re paying about 60 per cent of them in the present year. So adjusting the grants budget is the only way in a down year to not have too much cash out the door. That is when the biggest damage happens to endowments, when they have to sell assets to fund grants when the market’s in a crisis. It takes a very long time to recover from that, so my theory was, if we could minimise that damage, we would be able to regain our capacity faster.
The incentives are all to spend more now and it takes a degree of discipline to resist that if you think the foundation as an organisation will do more good over time by being restrained now.
LK: Something has to give when there’s a downturn. You’re either going to maintain your current support at the expense of the future, or you’re going to invest in the future and hurt your current grantees, and we found this middle way which was to give up our flexibility to do new and additional things for a couple of years. Although this downturn is not yet playing out as badly as everyone thought it would initially, we’re now being told it’s not enough to maintain spending, we should increase spending. Our plan doesn’t allow for that. I don’t say we’re right and they’re wrong. But people have to recognise that it’s a choice – between people today and people in the future and there’s no way around that choice. We adopted an approach that enables us to preserve our capacity to help people in the future while maintaining our support for current work.
DWP: One of the elements in this is perpetuity which is important from Friends Provident Foundation’s perspective. We’re not perpetual so we did feel like we wanted to increase spending, but the choice that we’re making involves our survival.
LK: Technically we’re not either. It was pretty clear that Bill and Flora Hewlett assumed that we would be but they’ve left us the power to spend down if we chose to. The perpetuity/spend-down issue depends what kind of problems you’re working on. Some problems are best addressed with large infusions of cash now and others require you to be there for a really long time. That’s why I don’t see there’s a right choice, there are different choices. Most of the problems we work on are of the second type. It’s important to recognise, again, that you cannot escape the choice between people today and people in the future. The easier course is to spend more today: we can do that and have everyone praise us and why should we care about people in the future or our successors? The incentives are all to spend more now and it takes a degree of discipline to resist that if you think the foundation as an organisation will do more good over time by being restrained now.
The other argument people make is that if your investments are good, you can grow your endowment back. But even assuming we could, it will always be smaller than it would otherwise be because we have a 5 per cent payout requirement and, with inflation, you’re starting at a 6-8 per cent hole. So you’re only going to grow back to the extent that you can systematically do better than that. Over the last 15 years, foundation returns sector-wide have been losing ground because of the 5 per cent payout rule. The only thing I know for sure is that there are way more needs today than I can fund, and if I spent the whole 10 billion dollars, there still would be more, and no matter how much good I do today, there are going to be more needs in the future. So my seat of the pants judgement is that chipping away at problems over many years at 5 per cent will do more good at the end of the day.
DWP: What about climate? I guess that’s not the case with that issue.
LK: We’re spending $120 or $130 million a year on climate but increasing our funding would not make a big enough difference. It’s not more money alone that we need, but more people, more funders with new ideas and approaches and capacities. If there were a particular opportunity like leveraging a billion dollars or catalysing some agricultural innovation, then I would ask the board to spend more, because I could be confident the extra spending would make a meaningful difference.
Thinking you change the system by impact investing is just nibbling around the edges while buying into the basic structure, and it’s the basic structure that needs to be rethought.
DWP: You were saying your sustainability conversations are very much about business sustainability. Do you talk about climate in some of the conversations?
AM: The two investment directors dealing with this are on the public equity side and the real estate and debt side. They are looking at the effect of climate change on insurance or how you discount the cash flows if there is uncertainty about the terminal value. Again, we’re not saying ‘this is a big emergency, you’ve got to get your act together’, that’s not our role. Because the investment managers are fiduciaries, they can’t make a moral call. They can make dollars and cents judgements, so that’s what we try to help them think about. It’s about getting companies to improve. For example, our managers have dialogues with CEOs about incorporating new designs into the airplane wings or new jet fuel. It’s about dollars and cents, but as that company improves, it’s going to pop up on screens of people who want ESG stocks and you’ll get greater demand for that stock, and it goes up.
LK: Just to add to that. First, it’s an area where we could easily exaggerate our importance. Some foundations with smaller endowments say ‘we’ve been able to divest from fossil fuels and it hasn’t hurt our returns’. That may be true, but because of our size we get access to managers who produce systematically better returns than they get. And those managers have people queueing up to invest with them precisely because they are that good, so the amount of leverage we have over those managers is limited. If we said to them ‘divest from fossil fuels’ they would say ‘take your money elsewhere’. Second, I feel super strongly that we do need to rethink capitalism but this is not the way to do it. Thinking you change the system by impact investing is just nibbling around the edges while buying into the basic structure, and it’s the basic structure that needs to be rethought.
I am perfectly happy to take money from fossil fuel companies and use it to do them in, because I believe grantmaking is going to be more effective in achieving that end than divesting would be. I would press for changing our investment practices if I thought that would have more impact than we have with the current system. It has to be that kind of calculus, it’s not about virtue signalling, of which there is way too much in our field and in our world, and it’s counterproductive. I don’t think on any of these things that we are right and others are wrong in the same way that they think we’re wrong and they’re right. For me, it’s what you want to give priority to and then working out how to move forward. The only time I get frustrated is when I’m feeling judged on our values when it’s really just a different calculus about how to have impact, not a difference in values at all.
DWP: Given your long-standing relationship with your managers, is there a discussion you can have with them about using the rebuilding process from this crisis to change the capital markets?
AM: In private funds, which is about 40 per cent of our portfolio, those conversations aren’t applicable. These are small companies. We have lots of conversations about policies and government programmes on a macro basis with our managers, but not engaging on the capitalism front. I think they would look at me suspiciously if I did.
LK: One of the core problems is the notion that the private sector is the place to find your solutions and to say ‘business you figure out how to solve the poverty and inequality issues that your systems have generated’. I think businesspeople should do what businesspeople do and the question is, how are we going to structure the world within which they do it? I don’t think we can or should look to or expect business to solve that for us.
Most funders give [non-profits] restricted project support that doesn’t even fund the full cost of the project, so what little general operating support they get has been used to make up the gap on their underfunded projects. That’s short-sighted funding.
DWP: It’s like saying to business ‘we want you to be part of it, you’re not the solution, neither are we, we’re just all trying to figure this out’. That sounds like something you have used on climate – talking to them about risks and the way they do their business in relation to the issue –but not dictating the terms. Going back to payouts, what’s your take on the Wallace Global Fund and others’ proposal to Congress to increase foundation payouts to 10 per cent?
LK: I don’t think it’s automatically wrong for people to spend more. It depends on what their plans are. But I think to dictate that to everybody else is short-sighted. It’s discounting future harms against present harms when there’s no reason to think that’s the right thing to do.
I did have some private conversations with members of Congress to walk them through the thinking, because if the proposal seems so appealing – just give more now! There’ll be other people with money later on.
But there’s a more fundamental thing – why do we even have this problem? Because non-profits are not in a position to be resilient. They don’t have reserves, for instance. And why not? Because most funders give them restricted project support that doesn’t even fund the full cost of the project, so what little general operating support they get has been used to make up the gap on their underfunded projects. That’s short-sighted funding. And when they do get extra, most of them grow rather than create reserves, because funders have forced them to be fixated on creating impact now, which is also short-sighted. And then, when a crisis happens, we get still more short-sighted thinking in the form of ‘You should overspend’. You’d think people might have learned this lesson in 2009, but apparently almost nobody did. We changed for just that reason. We do 70-80 per cent general operating support, and we’re true cost funders when we do project support. It’s paying now so when that inevitable future crisis happens grantees are in a position to protect themselves without needing us to sell out the future to help today.
Danielle Walker Palmour is director of the Friends Provident Foundation.