Cause investing—the directing of one’s investments to companies that directly promote or embody through their conduct a particular social good—is becoming more and more prominent, especially among not-for-profits. But as organizations implement their cause investing programs, they need to be sure the relevant decision makers are all on the same page. The author discusses the different types of cause investing, providing examples of how different organizations define and implement them, often in an overlapping manner.
CPAs are often exposed to investing and investments through their clients—auditing the disclosure schedules they provide, getting comfortable with valuations, and dealing with matters concerning ownership, for example. There has been a tremendous increase in institutional investors pursuing their mission through their investments. What makes this a challenge is that there are many ways of doing so: by divestment (screening out certain “unacceptable” investments); positive screens (actively seeking investments that support an initiative or mission goal); or looking at the structure of the entities in the investing chain (advisor, consultant, manager, administrator) and applying a diversity, equity, and inclusion (DEI) framework to staffing.
The investing landscape is changing, and there is a role for CPAs to be helpful. As management considers its approach to cause investing, it becomes apparent that the language and metrics used are not universal, and may not even be consistent within an organization. Cause investing can be of interest to any business, but may especially be of interest to not-for-profit entities with greater investing activities, such as foundations (private, operating, community) and college endowments.
Many entities will likely embrace cause investing, but what each means by that term will be different, as seen with the move to outsourced chief investment officers (OCIO). Each organization will likely define it in different ways and implement it in myriad frameworks, but a central taxonomy will allow for better discussion through the use of a commonly accepted nomenclature. This nomenclature does not have to be universally accepted—as long as the decision makers within an organization agree on what the terms mean (to them and their organization) and the investing implications for each, they can have meaningful conversations. The purpose of this article is to offer a common ground to facilitate such discussion.
Types of Cause Investing
Some of the popular examples of cause investing include the following:
- Mission-related investing (MRI)
- Program-related investing (PRI)
- Environmental, social, and governance investing (ESG)
- Impact investing
- Sustainable investing
- Socially responsible investing (SRI).
Each type refers to a particular investing strategy with a specific purpose. There can be overlap, and some organizations will use different terms to describe the same approach. Consistency between organizations is not as important as consistency within the organization.
Every nonprofit has a mission, and mission-related investing (MRI) is choosing investments that further the organization’s mission. The translation of the mission into an investable thesis is easier for some missions than others. The operationalization of the mission into a set of companies for consideration for investment involves understanding the nature of the operations of a company that would further the promotion of the mission.
The IRS provides guidance on jeopardizing investments and the Uniform Prudent Management of Institutional Funds Act (UPMIFA). The guidance provides that an organization “may consider the relationship of a proposed investment to the foundation’s charitable purpose when determining whether an investment is prudent” (Celia Roady and Matthew R. Elkin, “IRS Provides Guidance on Mission-Related Investments by Private Foundations,” Morgan, Lewis and Bockius, Sept. 29, 2015, http://bit.ly/2T2A8Dm). This is welcome relief for institutions that undertake MRI.
The John D. and Catherine T. MacArthur Foundation has a thoughtful treatise on mission-related investing. They provide a chart of how they conceptualize what they term “mission investing,” shown in Exhibit 1. It is instructive to note that mission-related investments come under the heading of “impact investing.” The term impact investing can have many meanings (as discussed below); here it is used more in the vernacular of “investments that will have an impact that is related to the mission.”
The MacArthur Foundation also provides a good narrative on how it uses the term “mission-related investments”:
Organizations may pursue mission-related investing for a variety of reasons and under different philosophical rubrics. Some view impact investing through a programmatic lens, believing that it is most usefully thought of as another tool in the philanthropic toolbox. By selecting this tool, an organization may gain more flexibility in achieving its desired program impact because it can use MRIs where the legal requirements governing program-related investments would prevent the investment from being made or where a grant would be less impactful. Other organizations may view the strategy primarily through an investment lens, believing that such investments can achieve market rate returns while also achieving social impact. Regardless of the philosophical underpinnings for the strategy, an organization should be cognizant of the legal framework. We also offer suggested terms for a policy specific to mission-related investments. Not all provisions will be relevant for each organization, but it is prudent for a governing board to consider these provisions while deciding upon the policy and the terms most appropriate for its organization and its philosophical approach. (http://bit.ly/2Hs9O32)
MRI can be implemented in several ways:
- When organizations have an expertise based on their mission and can leverage this expertise into selecting companies that should perform well
- When organizations can identify companies whose operations support their mission, investing in these companies will help further the mission (positive screen)
- When organizations can identify companies whose operations are contrary to their mission, avoiding investments that include these companies (negative screen).
Program-related investing (PRI) usually does not come under the purview of the investment team, but from the grants side of the organization. PRIs usually involve an investment in a company with the hope that the money will be returned, often with interest or capital gains. The initial investment is treated like a grant for tax purposes, and any return of funds is treated like a grant refund.
The IRS provides some context and examples for PRI on its website, while a good example of the conception and implementation of a PRI strategy is given by the Surdna Foundation, making it very clear how the organization defines and implements PRI. Both of the above are presented in the first sidebar.
Environmental, Social, and Governance Investing
ESG investing references qualities that a company should possess in order to be considered for investing. Investing according to an ESG mandate can include looking for investments where the company under consideration has diversity (among the board, management, staff, and suppliers) or is pursuing ecological friendly initiatives such as LEED [Leadership in Energy and Environmental Design] building, clean water, and recycling.
CFA Institute has an extensive write-up on ESG, but one section is particularly illustrative:
There is no one exhaustive list of ESG issues. ESG issues are often interlinked, and it can be challenging to classify an ESG issue as only an environmental, social, or governance issue. (https://cfa.is/2VWgfzH)
The institute also provides a chart that helps illustrate ESG, seen in Exhibit 2.
ESG considerations can be used as a positive screen (for example, selecting companies that have board diversity or whose operations involve water pollution treatment) and as a negative screen (for example, not investing in companies that have a poor environmental record or labor violations).
Impact investing is described by the Global Impact Investing Network (GIIN) as “investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return” (http://bit.ly/2u9Y1il). In 2009, GIIN created the IRIS catalog to “support transparency, credibility, and accountability in impact measurement practices across the impact investing industry” (http://bit.ly/2TwdDLR). GIIN and IRIS have together added structure and consistency in defining and providing metrics related to impact investing.
Impact investing takes on many forms for different organizations. The Omidyar Network describes impact investing as follows:
Impact investing seeks to generate both social change and a return on capital. It ends the old dichotomy where business was seen solely as a way to make a profit, while social progress was better achieved only through philanthropy or public policy. At Omidyar Network, we define philanthropy more broadly. We believe all individuals and institutions can contribute to the well-being of society, whether they operate as a for-profit business or a nonprofit organization. Leaving the markets out of our efforts to tackle society’s most intractable problems ignores a powerful force for identifying viable solutions that can scale to help millions.
Omidyar Network employs a flexible capital model that includes impact investments alongside traditional grants. Based on our experience, impact investments are most valuable at the earliest stages of innovation. It’s a time when outcomes are the least certain and entrepreneurs need the most help. By infusing a start-up with financial and human capital, we give the entrepreneur the time and resources they need to test the market viability and social impact of their model. We have a particular focus on supporting entrepreneurs who have the potential to impact entire industry sectors, demonstrating the opportunity for others to follow. (http://bit.ly/2VPoAVJ)
The Rockefeller Foundation has a somewhat different approach to impact investing:
As we urgently address the fundamentals of people’s well-being through initiatives focused on health, energy access, jobs, food, and cities, we are also looking toward a future that will grow from the rapidly evolving trends we observe today. To prepare for that future, we will make bold bets on disruptive solutions that will allow us to leapfrog current approaches. The first area will focus on radically accelerating the pace at which private capital can be deployed towards social challenges. The second area will focus on the ubiquitous and rapidly evolving data and technologies that permeate every aspect of society. The third area will focus on the Foundation’s longstanding belief in science to develop new knowledge and insight that can eventually be applied to improve people’s well-being. (http://bit.ly/2EQFNHy)
These approaches are similar in that they realize just making grants to charities is limiting in its effect. While in no way diminishing the importance of grant making, organizations can further leverage their ability to impart change by also making investments that support and extend the initiatives they pursue.
Many organizations are devoted to developing a sustainable investing framework that will be familiar and accessible to CPAs. These organizations are good starting places for trying to understand sustainable investing.
The Sustainability Accounting Standards Board (SASB) has developed standards for sustainability accounting. The mission of SASB is to “establish and maintain disclosure standards on sustainability matters that facilitate communication by companies to investors of decision-useful information” (http://bit.ly/2TvKdxH). A resource for newcomers to sustainable investing is the “materiality map” available on the SASB website, which provides topic information across industries (http://bit.ly/2SUeZLm).
While SASB is focused on sustainable accounting, the Global Reporting Initiative (GRI) has developed standards that “help businesses and governments worldwide understand and communicate their impact on critical sustainability issues such as climate change, human rights, governance, and social well-being. This enables real action to create social, environmental, and economic benefits for everyone. The GRI Sustainability Reporting Standards are developed with true multi-stakeholder contributions and rooted in the public interest” (http://bit.ly/2CeaXbo).
Sustainable investing has a significant overlap with other cause investing areas. For example, McKinsey conflates sustainable investing with ESG:
Sustainable investing has come a long way. More than one-quarter of assets under management globally are now being invested according to the premise that environmental, social, and governance (ESG) factors can materially affect a company’s performance and market value. The institutional investors that practice sustainable investing now include some of the world’s largest, such as the Government Pension Investment Fund (GPIF) of Japan, Norway’s Government Pension Fund Global (GPFG), and the Dutch pension fund ABP.
The techniques used in sustainable investing have advanced as well. While early ethics-based approaches such as negative screening remain relevant today, other strategies have since developed. These newer strategies typically put less emphasis on ethical concerns and are designed instead to achieve a conventional investment aim: maximizing risk-adjusted returns. Many institutional investors, particularly in Europe and North America, have now adopted approaches that consider ESG factors in portfolio selection and management. Others have held back, however. One common reason is that they believe sustainable investing ordinarily produces lower returns than conventional strategies, despite research findings to the contrary.
Among institutional investors who have embraced embraced sustainable investing, some have room to improve their practices. Certain investors—even large, sophisticated ones—integrate ESG factors into their investment processes using techniques that are less rigorous and systematic than those they use for other investment factors. When investors bring ESG factors into investment decisions without relying on time-tested standard practices, their results can be compromised. (https://mck.co/2ERJA7l)
IRS Guidelines for Program-Related Investments
Program-related investments (PRIs) are those in which—
- the primary purpose is to accomplish one or more of the foundation’s exempt purposes,
- production of income or appreciation of property is not a significant purpose, and
- influencing legislation or taking part in political campaigns on behalf of candidates is not a purpose.
In determining whether a significant purpose of an investment is the production of income or the appreciation of property, it is relevant whether investors who engage in investments only for profit would be likely to make the investment on the same terms as the private foundation.
If an investment incidentally produces significant income or capital appreciation, this is not, in the absence of other factors, conclusive evidence that a significant purpose is the production of income or the appreciation of property.
To be program-related, the investments must significantly further the foundation’s exempt activities. They must be investments that would not have been made except for their relationship to the exempt purposes. The investments include those made in functionally related activities that are carried on within a larger combination of similar activities related to the exempt purposes.
Typical examples of program-related investments are—
- low-interest or interest-free loans to needy students,
- high-risk investments in nonprofit low-income housing projects,
- low-interest loans to small businesses owned by members of economically disadvantaged groups, where commercial funds at reasonable interest rates are not readily available,
- investments in businesses in low-income areas (both domestic and foreign) under a plan to improve the economy of the area by providing employment or training for unemployed residents, and
- investments in nonprofit organizations combating community deterioration.
The regulations under section 4944 contain several detailed examples of investments that qualify as program-related investments. Those examples reflect current investment practices and illustrate certain principles, including—
- an activity conducted in a foreign country furthers an exempt purpose if the same activity would further an exempt purpose if conducted in the United States,
- the exempt purposes served by a PRI may include any of the purposes described in section 170(c)(2)(B) and are not limited to situations involving economically disadvantaged individuals and deteriorated urban areas,
- the recipients of PRIs need not be within a charitable class if they are the instruments for furthering an exempt purpose,
- a potentially high rate of return does not automatically prevent an investment from qualifying as program-related,
- PRIs can be achieved through a variety of investments, including loans to individuals, tax-exempt organizations and for-profit organizations, and equity investments in for-profit organizations,
- a credit enhancement arrangement may qualify as a PRI, and
- a private foundation’s acceptance of an equity position in conjunction with making a loan does not necessarily prevent the investment from qualifying as a PRI.
BlackRock also describes sustainable investing in a way that conflates it with ESG:
Sustainable investing seeks to drive positive social or environmental impact alongside financial results, allowing investors to accomplish more with their money. (http://bit.ly/2SUab8R)
BlackRock goes on to give some tips for sustainable investing, such as using exclusionary screening to avoid exposure to companies that operate in controversial sectors, investing in companies whose practices are highly ranked by ESG performance standards, and investing in companies whose products and solutions target measurable social or environmental impact.
Socially Responsible Investing
SRI is another broad category that overlaps with others. Essentially, entities engaging in SRI are seeking to invest in companies for financial return as well as to support activities that they consider in society’s best interest. The overlap between SRI and ESG can be seen in the Forbes article “Socially-Responsible Investing: Earn Better Returns From Good Companies”:
ESG investing—which accesses companies based in part on their environmental, social, and governance policies—is a fast-growing segment of the financial landscape. Importantly, socially responsible investing is not just a strategy to feel good about how your money is investing. Many experts—including the three here—argue that an ESG strategy also leads to better returns. (Aug. 16, 2017, http://bit.ly/2SYw9rl)
The Episcopal Church does an excellent job of describing the foundation for its SRI program and the implementation thereof:
The Episcopal Church has made socially responsible investments at least since the 1960s—and we continue, following a trinity of avoidance, affirmative action, and advocacy.
- Avoidance: Not investing in companies whose activities are contrary to our social and moral values.
- Affirmative Investing: Investing in institutions that can provide financial resources to underserved communities.
- Advocacy: Voting proxies and activism that focus on constructively influencing corporate behavior. (http://bit.ly/2XZHFGG).
The church further provides lists of companies it does not invest in; its policies, procedures, and guidelines; and recent investments and transactions. This is a clear and transparent way to convey what SRI means and how it is implemented.
Pursuing Cause Investing
For organizations that want to pursue cause investing, it is important that the decision makers share a common language. It would be understandable if a particular term were to be interpreted differently by different individuals, but in order to effectively implement an investment program, it is imperative that all parties understand what is meant. Without a common taxonomy, an organization cannot properly implement the program.
Although this article does not prescribe a taxonomy, it attempts to provide clarity so that each organization can develop the language necessary for all stakeholders to understand its investing goal, and to create metrics to measure and track the entity’s progress toward that goal. Cause investing originates in the mission of the organization, and expands and is overlaid with societal good (such as diversity, equity, and inclusion). Having clear definitions, goals, implementation plans, and monitoring will increase the probability of success for the organization, as well as the reach and efficacy of its mission.
Surdna Foundation PRI Strategy
The Surdna Foundation’s board of trustees established an $18 million Program Related Investment (PRI) revolving fund which began investing in 2014. The Fund supports the foundation’s mission of fostering just and sustainable communities by providing investment capital to fund innovations that use market-based approaches to address economic, cultural, and environmental challenges.
A new tool to increase impact
PRIs will increase Surdna’s ability to achieve programmatic results. By using its capital in a different way, the Foundation is able to tackle specific programmatic challenges through market-based solutions. Providing funds at below-market rates can be particularly useful when capital is needed to start up, grow, or sustain a social enterprise, or when results cannot be achieved with grants alone, or can be achieved more effectively with PRIs.
Generating social and financial returns
PRIs, which are typically loans or loan guarantees or other similar loan/bond-type vehicles, are designed to generate both social and financial returns. Like grants, PRIs are vehicles for making inexpensive capital available to organizations that are addressing social, cultural, or environmental concerns. They can be used for charitable purposes including supporting community development finance institutions (CDFIs), affordable housing developments, energy efficiency programs, sustainable agriculture, cultural organizations, entrepreneurship, and micro-businesses in our respective fields. Once repaid, the money can be recycled into new charitable purposes, extending the reach and impact of the foundation’s programs.
Strengthening social ventures fostering innovation
By using PRIs, Surdna can help social ventures to strengthen their business practices so that they can attract capital from private sector investors seeking market rate returns. The Program allows Surdna to offer debt financing at a critical early stage when investment capital is especially difficult to secure.
Strategy and guidelines
Innovation: The PRI Program will focus on demonstrating the viability of new innovations, rather than expanding or replicating successful ones.
Intermediaries: The PRI Program will typically work with and through intermediaries, rather than investing in projects directly.
Alignment with Surdna’s programs: In developing PRI opportunities, the Foundation will follow Surdna’s program strategies. Any PRI has to be a fit within those program guidelines.
The Surdna Foundation makes program-related investments by invitation only to for-profit businesses and non-profit organizations for select ventures that are designed to promote the work of one of our three program strategies.