OPINION: Foundations Should be Investing in Infrastructure

What if there were a way government could boost investments in things like affordable housing and renewable energy without spending a cent? Ottawa could easily redirect billions of dollars toward community infrastructure with a few simple rule changes.

How? By making charitable foundations invest in social impact.

All the government has to do is declare that Canadian foundations must redirect all of their assets toward impact investments, those that generate a positive community impact as well as a financial return. This would mobilize more than $60 billion that is tied up mostly in conventional stocks and bonds. Foundations could be given a deadline of 10 years, after which any returns from traditional investments would be taxed.

Frankly, the way foundations are currently set up is terrible public policy. For all intents and purposes, they are private-investment management companies — only slightly more generous.

Here’s how it works: Anyone who starts a foundation is given a tax break, so someone at the highest marginal tax rate can avoid paying around 45 percent in taxes. In return, the government requires the foundation to donate just 3.5 percent of its assets to charities each year (a “disbursement quota”), meaning up to 96.5 percent is held in conventional investments. These investments usually have no social purpose whatsoever, and yet the returns they yield are also not taxed.

As a society, therefore, in many cases we forgo 45 cents on the dollar in tax revenue — which could be used for social spending today — for the sake of just a few cents of that dollar going toward charitable activities.

How smart is that?

In response, a bold policy announcement could provide what I call a catalytic event, an incentive that triggers dramatic changes on a broad scale.

With a 10-year deadline, foundations would have a reasonable timeframe to make the shift to impact investments without having to do a fire sale of conventional stocks and bonds. Impact investments are those that seek to generate beneficial social or environmental effects — such as clean energy, affordable housing or social enterprise.

This deadline would also allow the time to define what constitutes impact and how to measure it, to ensure the investments are genuinely beneficial. And with $60 billion of assets to be redeployed, a supply of quality impact investment opportunities would be created to meet this huge demand, and a robust network of intermediaries would emerge — like traditional investment managers — to guide foundations in implementing their strategies at a reasonable cost.

Foundations do have a fiduciary duty to invest their assets as wisely as possible: they must follow  the prudent investor rule. Some have interpreted this to mean they must invest in conventional investments because they believe impact investments will not generate the same financial returns.

A number of studies, however, have shown that impact investing can do just that. There are great examples, such as the Heron Foundation in the United States, of foundations committing 100 percent of their assets to impact investments and making competitive returns in the process while significantly magnifying their social impact. Heron has also been publishing its lessons learned, providing a blueprint for other foundations to follow suit.

And when you think about it, how could we ever conclude that the prudent investor rule means foundations must invest conventionally? That would be like saying that it is totally imprudent for a foundation to consider its purpose when crafting its investment strategy, and totally prudent not to consider it at all. Can you think of any other organization or industry that could arrive at such a conclusion?

Read the full column on IRPP’s Policy Options website.