Below are excerpts from the Tides, ImpactAssets, and RSF Social Finance jointly-authored Issue Brief "Ultimate Impact: Unifying an Investment Portfolio Within a Donor-Advised Fund."
Donor Advised Funds (DAFs) have grown in use over recent decades, serving as the core philanthropic vehicle for community and public foundations and, more recently, being offered through commercial investment firms as a philanthropic option for clients. When linked with an impact investing strategy, the DAF may serve as a unique, focused asset management vehicle for creating a unified portfolio generating financial performance with social and environmental impacts. This Issue Brief introduces the concept and structure of DAFs and explores their potential as impact investing vehicles. The DAF as a core component of a unified investment approach is explored together with discussion of why DAFs are especially suited to impact investing. The potential for DAFs to expand options for impact investors is discussed along with possible barriers to their introduction.
IMPACT INVESTING, PHILANTHROPIC CAPITAL AND THE DAF OPPORTUNITY
The term “Impact Investing” has grown in popularity over recent years. Other resources explore the term and practice of impact investing more thoroughly than space allows
us here, but the core aspect of investing for impact may be defined as investments that pursue various levels of financial return together with a defined measure of social and environmental impact. Impact investing may also be viewed as either a broad investment strategy informing how one manages all the assets within a given portfolio or as its own asset class, into which one allocates investments just as one might have an allocation to fixed income, hedge funds or private equity. Regardless of how one executes an investment approach, what is critical is a focus upon intent—that impact is not simply a by-product of one’s asset management approach, but rather a deliberate outcome of one’s investing practice.
While impact investing may embody many aspects of traditional investing, it also has other characteristics. First, it often has a longer term investment horizon—referred to as “patient capital”—than other mainstream investment strategies. The overall goal of impact investing is the creation of long-term, sustainable value for investors, stakeholders and the broader community/planet. Therefore, impact investing vehicles often fill a need for investment capital that is structured with consideration of not short term financial gain, but rather long-term total performance.
Second, since the goal of impact investing is the creation of financial returns with social and environmental impact, it goes without saying that an impact investing strategy values multiple returns. Again, other documents explore this notion in greater depth, but suffice it to say that what level of return is thought to be “appropriate” varies based upon the investor profile and what long term goals are being pursued through this investment approach. Generally speaking, a level of financial return is expected (unlike philanthropy, where the capital of grants are not paid back to those providing them), but that level of financial return may or may not be a fully, market-rate risk adjusted return (meaning, the greater the risk of the investment, the higher anticipated financial returns). The element of social and/or environmental return may also vary depending upon the type of investment (microfinance as opposed to, say, water or sustainable timber), but in either case the expectation is that there is a defined level of impact generated through the investment—not simply a general assumption of “good” or broad sense of “social return.” Again, this is an exciting and complex area of discussion within impact investing, but this general commitment to financial performance with social/environmental returns is consistent across impact investing.
Finally, a third aspect of impact investing is a commitment to take risks, to go where traditional, market-rate capital either will not go or cannot go due to the form of capital it represents. If one thinks of philanthropic capital as being invested in social solutions for market failures and mainstream capital as being invested in market opportunities, impact investing can be considered a bridge across the capital chasm between philanthropic and market rate capital, leveraging the one against the other.
Impact investments often seek out ventures to invest in that have the potential to move toward greater market orientation over time but today are viewed as too risky or ill-defined for traditional capital. For example, for many years microfinance institutions operated solely with philanthropic and development aid support while they refined their model of making micro-loans to small scale entrepreneurs. Over time they created a track record of both knowledge and lending experience; and those involved in microfinance were able to bundle their debt into bond instruments, which could then be offered on the open market—and microfinance exploded around the world. This process of moving from philanthropy to market-rate investing would not have been possible without impact investors placing capital in the middle, connecting the parts into a new whole which is today a multi-billion dollar investment market bringing significant, appropriate capital to those who most need it.
A Donor Advised Fund (or “DAF”) is created when a donor allocates a pool of capital for charitable purpose into a defined philanthropic vehicle. DAFs are managed by a community or public foundation, which may be operated by a commercial market investment management institution, a university or other entity. This philanthropic capital is money committed to “doing good” and creating positive social or environmental value in the world (as opposed to capital you invest in your child’s education which you hope will demonstrate value in the future!). Philanthropic capital may seed new nonprofit programs, support the expansion of existing organizations with proven records, fund public policy advocacy or support high risk research which promises to solve the diseases plaguing humankind. Since it is money dedicated to promoting the welfare of others and our planet, philanthropic capital values social and environmental returns more than financial returns; in fact, when one makes a philanthropic investment one does not expect to receive funds back at some point in the future, but instead entrusts the financial stewardship of that gift to the nonprofit organization receiving support.
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