How Not To Invest $1 Billion in Diversity and Inclusion

By Felix Salmon | April 7, 2017 | 9:12pm

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The Ford Foundation made headlines this week with a grand announcement: It was going to “unleash the power” of its awesome $12 billion endowment, using a large chunk of the 95% of its assets that it doesn’t spend each year to invest in social transformation.

The press release came out strong: Darren Walker, the president of the foundation, made lots of impressive-sounding noises about how he wants to serve his “mission of disrupting inequality” by making “diversity, equity, and inclusion bywords of this investment movement.”

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But there’s a lot less here than meets the eye.

When it comes to the Ford Foundation, and other entities like it, the first thing you always have to remember is that it is at heart a huge pile of money with a charitable arm added on for good measure. The Ford Foundation, which nominally exists “for the general purpose of advancing human welfare,” controls more than $12 billion, at last count, which is overseen by a bunch of extremely well-paid money managers. (The director in charge of hedge funds, for instance, William Artemenko, made over $1 million in 2015, while his counterpart in charge of private equity, Sherif Nahas, made slightly more. Meanwhile, the chief investment officer, Eric Doppstadt, made over $2 million.)

The main job of this pile of money, which isn’t really owned by anybody, is to continue to exist in perpetuity, and ideally to grow over time. Indeed, says Xavier de Souza Briggs, one of the foundation’s vice presidents, the foundation’s trustees have “a fiduciary obligation” to ensure that happens.

The Ford Foundation’s nonprofit status is its main means of ensuring that it will live forever. That’s because when you’re a nonprofit, you pay almost nothing in taxes each year, no matter how well your expensive money managers do. And the ultimate owners of the money don’t pay taxes on the money either, because there aren’t any of them. The foundation is just a tax-exempt, multi-billion-dollar legal entity, getting richer and richer over time: exhibit A, you might say, in the annals of rising inequality.

The U.S. government does require one thing from the Ford Foundation if it is to preserve its tax-exempt status: It has to spend at least 5% of its assets every year in furtherance of some kind of charitable mission. In 2015, it spent an impressive $97,615,873 on eligible operating and administrative expenses (paying its own staff, that kind of thing)–but that wasn’t 5% of its assets. So it also spent $511,984,277 on grants, for a total of $609,600,150 in expenses and disbursements. That’s 4.91% of the $12,400,459,561 it had in assets at the beginning of the year. Close enough.

By spending 5% of its assets each year, the foundation retains its tax-exempt status, which means that, say, if it has invested a bunch of money in rental properties, it’s one of the rare landlords that doesn’t need to pay any income tax on its rental income. And so long as its investments return at least 5% a year, plus inflation, there’s no limit to how large it can grow. On the other hand, if its investments return less than 5% a year, it will shrink steadily over time, which is not a good look when you’re trying to live forever.

This is all upside-down, if you think of the foundation as a place that exists primarily as a philanthropy. The point of a charitable foundation should be charity, not self-perpetuation.

It’s worth noting that the amount of money in charitable foundations is on a steady upward trend: At the end of fiscal 2014, it had reached an astonishing $865 billion, more than doubling in just 12 years. These are assets held outside the tax system, governed by people with no accountability to anybody, effectively untouchable by civil society in any form. The vast majority of those monies just sit there, invested in stocks, bonds, and other standard capitalistic instruments: They do no real good for the planet beyond driving up the price you need to pay for the assets in your 401(k).

And precisely because the amount of money flowing into charitable foundations continues to increase every year, there’s no need for the old ones, like Ford, to stick around for decades or even centuries to come. The world is getting richer and healthier, which means that every year there are more charitable resources addressing fewer charitable needs. If you’re a charitable foundation fortunate enough to have $12 billion to spend right here and right now, it behooves you to spend it as quickly as you can, when it will do the most good, rather than begrudgingly eking it out in increments that barely meet the legal minimum. (Interestingly, donor-advised funds, which have the same charitable intent behind them but no legal minimum to get paid out each year, generally disburse more than 20% of their assets annually. That’s probably a good baseline for charitable foundations, absent the governmental nudge saying “Hey, you can get away with spending as little as 5%.”)

There is one way, however, that a foundation can have its cake and eat it–can do good for the world without giving away its money entirely. It’s called “program-related investments,” or PRIs, investments that further a charitable cause–and it’s something the Ford Foundation is expert in.

For 50 years, now, Ford has been making this kind of investment; its current PRI portfolio stands at total some $213 million, or about 1.7% of the endowment. It encompasses loans, guarantees, and equity investments in businesses; some of them make a profit, others lose a bit. Overall, they have broken even, in nominal terms, over time. Every so often, the foundation will add a bit more money to the pot, but most of the time it simply reinvests the income it has received in repayments from previous recipients.

The Ford Foundation’s PRIs, which are considered part of the charitable program rather than the permanent endowment, have been a clear success. As Foundation president Darren Walker writes:

We have found PRIs to be one of the most effective arrows in our quiver…. PRIs allow us to take risks consistent with our mission in ways that much larger investors, such as banks and pension funds, often cannot or will not.

It’s perfectly fine for foundations to lend money or make other kinds of investments, rather than just giving away grants. Sometimes, that’s exactly what’s needed. Which means that the Ford Foundation, with its 50 years of experience in doing exactly that, knows precisely what to do if it wants to start using its endowment as a force for good. It just needs to expand the PRI Fund so that it represents a significant chunk of the overall endowment, rather than a mere rounding error.

But that’s not what the foundation has decided to do.

Instead, the Ford Foundation has created a whole new beast, called “mission-related investments,” or MRIs, which are distinct from PRIs, and which, per Walker, “will leverage the power of our endowment,” and which, “unlike PRIs, can bring to bear large amounts of capital in the service of multiple bottom lines.”

This is disingenuous. There is no great capacity constraint on PRIs. In fact, they fill a very important gap in the existing structure of capital markets, since they are one of the few financial instruments that allow places like the Ford Foundation to invest with the expectation of some financial loss. So while MRIs have a relatively narrow scope, since they are constrained by their need to make market-like returns, PRIs offer much more opportunity for charitable investment.

The obvious move here, then, would be to move in the direction of the F.B. Heron Foundation, which has 100% of its assets invested in line with its mission. Ford couldn’t get there overnight, but it could, say, announce a goal of having $1.2 billion invested in the PRI Fund by 2027, adding about $100 million per year every year for 10 years. That would be entirely doable.

And indeed the Ford Foundation is making a $1 billion commitment over 10 years. The difference is, though, that they’re not doing it through the tried-and-tested PRI Fund. Instead, they’re relying on MRIs, which are basically PRIs without any ability to accept low or negative financial returns in the event that the charitable mission would be well served by doing so.

MRIs are a subset of “impact investment,” an increasingly trendy part of the fund-management world. Impact investors seeks attractive financial returns while also improving the state of the world. The size of the impact-investment market is not easy to measure, but depending on the definition used, it’s probably pretty close to $100 billion and growing fast.

Meanwhile, with global interest rates staying stubbornly near zero, stocks looking decidedly frothy, and alternative assets underperforming miserably, the managers of the endowment are naturally getting worried about how they’re going to be able to deliver their mandated 5%-plus-inflation returns. To that end, a bit of diversification makes a lot of sense, and impact investment funds are attractive non-correlated assets, which the trustees would probably want to invest in anyway.

The Ford Foundation has said that its MRI investments will focus on affordable housing in the U.S. and financial services in emerging markets, which are both mature asset classes with track records of generating the kind of returns that the endowment’s managers are looking for. Even if the Ford Foundation had no interest at all in “creating impact through the market,” it would probably want to move into these assets anyway.

What the Ford Foundation is doing, then, with its loud announcement, is attempting to make a virtue out of necessity. But there’s nothing particularly virtuous about perfectly normal asset diversification. Any plutocratic perpetuity would naturally make these kind of investments as and when they become investable.

There’s also nothing particularly virtuous about maintaining the distinction between charitable activities, including the PRI Fund, on the one hand, and investment activities, which are laser-focused on financial returns, on the other. So long as that distinction exists, the managers of the endowment–the people in charge of 95% of the Foundation’s assets–will always put returns above mission.

So let’s not cheer the Ford Foundation’s latest announcement. While it’s good that the foundation is beginning to think about the effect that its investment activities have on the planet, it should have gotten much further than here by now. Let’s push it to put a lot more money into PRIs, a lot more money into grants, and a lot less effort into increasingly desperate attempts at self-perpetuation.

Nothing lasts forever, and nothing should. Let’s encourage the Ford Foundation to maximize the amount of good it can do in the world now. We don’t need 19th Century money to stick around to solve 22nd Century problems, not when there are so many desperate needs for it today.