Beats | October 2, 2015

IRS Gives Green Light to Foundation Investments for Impact

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The Obama administration has removed an obstacle that had blocked some private foundations seeking to use their full range of capital to pursue their missions.

The new guidance from the Internal Revenue Service could help unlock for so-called “mission-related investments” some of the $650 billion in assets warehoused in the endowments of U.S.-based private foundations.


“This guidance is not about telling you what to do, or what not to do with your endowment or investing policies, but it is an attempt to let you know that we’re not in the way of you making prudent decisions that can span the whole range of investments,” said Ruth Madrigal, attorney-advisor at the U.S. Department of Treasury, who led the work on the new guidance, on a recent call to discuss the implications of the ruling.

The new guidance, which was part of an impact investing policy agenda announced last year, was seen as part of the Obama administration’s effort to clear regulatory obstacles that have slowed the growth of impact investing. Next up, according to John Griffith of Enterprise Community Partners and Tom Woelfel of PCV Insight: expanding federal support to Social Impact Bonds (SIBs) and other pay-for-success initiatives, and clarification of fiduciary rules governing private pension funds to encourage more economically targeted investments.

[blockquote author=”Paula Goldman, the Omidyar Network” pull=”pullleft”]The implications are significant: foundations can carve out a piece – or even all – of their endowments for mission-driven investments.[/blockquote]

In technical terms, the mission-related investment ruling deemed the use of mission-related investments — investments made from a foundation’s endowment assets seeking to generate social or environmental impact alongside a financial return — as “non-jeopardizing.” That means that an investment in a for-profit enterprise creating jobs in low-income communities, for example, won’t be seen as irresponsibly putting the foundation’s financial needs at risk.

“When exercising ordinary business care and prudence in deciding whether to make an investment, foundation managers may consider all relevant facts and circumstances, including the relationship between a particular investment and the foundation’s charitable purposes,” declared the IRS statement.

“Foundation managers are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity so long as the foundation managers exercise the requisite ordinary business care and prudence under the facts and circumstances prevailing at the time of the investment in making investment decisions that support, and do not jeopardize, the furtherance of the private foundation’s charitable purposes.”

Mission-related investments, or MRIs, are different from program-related investments, or PRIs. The latter, which come from foundations’ grant-making budgets, have been allowed since 1969 and have been used to make below-market guarantees, loans, and equity investments targeting social and environmental impact. PRIs, unlike MRIs, count toward foundations’ annual payout of approximately 5 percent of their total assets.

Until last week, the IRS had not weighed in on whether foundations could make such investments using other ninety-five percent of their assets. Prior to the guidance, “it was uncertain whether private foundation managers could select an investment whose primary purpose was to accomplish one or more charitable purposes where the production of income or the appreciation of property was also a significant purpose, making the investment fall outside of the definition of a PRI,” writes non-profit attorney Gene Takagi in a post on LinkedIn.

“In other words, it’s not a lack of reasonable business care and prudence (and therefore not a jeopardizing investment) merely because the private foundation managers consider the social impact return related to the foundation’s mission as well as the financial return the investment may produce in selecting an investment.”

The Detroit-based Kresge Foundation, days after the IRS ruling, announced a $350 million commitment to PRIs and MRIs. A wave of foundations including FB Heron, McKnight, and the Wallace Global Fund has gone further, committing to fully investing their endowments in mission-related investments.

One implication of foundations’ having the legal cover to commit larger sums to impact investments is their ability to “crowd in” private capital to the impact investing marketplace. As the Chronicle of Philanthropy reports, “By setting aside a large sum, the [Kresge] foundation will be able to attract a broader spectrum of financial players, including other foundations, investment banks, and institutional investors who usually commit only to larger deals.”

According to a recent survey, 41 percent of U.S.-based foundations engage in some sort of impact investing. However, total assets devoted to the practice are minimal. The same survey suggests that the typical foundation had only two percent of assets devoted to MRIs and half of one percent in PRIs.

[blockquote author=”Ruth Madrigal, U.S. Department of Treasury” pull=”pullright”]This guidance is not about telling you what to do, or what not to do with your endowment or investing policies, but it is an attempt to let you know that we’re not in the way of you making prudent decisions that can span the whole range of investments.[/blockquote]

Omidyar Network’s Paula Goldman believes that the new ruling will change this. “The new guidance makes clear that it is permissible for endowment managers to consider mission and values as legitimate factors in their investment decisions. Many would argue that this has always been the case; this guidance removes any doubt, perceived or real,” writes Goldman.

“This is extremely good news for foundations that are eager to more fully leverage their endowments to advance social change. The implications are significant: foundations can carve out a piece – or even all – of their endowments for mission-driven investments.”

As Goldman acknowledges, for foundations that have been practicing impact investing for some time, the guidance, while welcomed, won’t impact their practice much.

MacArthur Foundation General Counsel Joshua Mintz, speaking on the conference call with Treasury’s Madrigal, said, “the announcement, while very helpful, did not change the way that many people had looked at this set of issues. There was a feeling among sophisticated practitioners and some of the larger foundations that you could take into account mission… [regarding the new ruling] I wouldn’t identify it as a kind of panacea, or an excuse to plow head first into something, you still need to exercise care and prudence making these decisions.”

Mintz pointed to a recent post by attorneys Tomer Inbar and Justin Zeremy that outlines a set of practical takeaways for foundation officers:

  • Make sure that your investment policy/statement addresses MRIs in the context of your overall investment strategy and approach, including asset allocation.
  • Articulate the general and/or specific aspects of mission alignment that you would like to see in an MRI or an MRI program and develop a process to ensure that such review is captured (and documented) as part of the investment process.
  • Make sure the people responsible for sourcing and making MRIs coordinate with your regular investment team (if they are different).
  • Lastly, periodically review your investment policy/statement to make sure it is current and reflects the needs (both mission-related and financial) of your foundation.

Federal policy has been essential  in enabling and encouraging investments into high-impact investments, sectors, and geographies. The latest ruling is the latest in a series of policy changes: the Tax Reform Act of 1969 that allowed private foundation to make below-market program-related investments from their required five percent disbursement; the Community Reinvestment Act in the 70’s that helped pave the way for capital to flow to community development financial institutions: and the New Market Tax Credit in 2000 that provided incentives to investors for investments made into low-income communities.