I heard the term impact investment and associated it with angel investors out to effect social change while making money. As I researched this growing phenomenon for a client, I was very interested to learn that foundations are also making them, and there are distinct types of these investments with different rules. For researchers whose organizational missions involve impacting how people think and act socially, economically and as citizens, impact investors can be a viable funding source. It benefits us, our fundraiser partners and our donors to be educated about this growing investment trend
Impact investments are defined as any kind of investment by any type of organization intended to provide a measurable social, economic, environmental, or governance benefit and, in some cases, a financial return to the investing organization. There are several types of impact investments that are made by philanthropic organizations: mission-related investments, program-related investments and socially responsible investments.
The F.B. Heron Foundation developed a framework of investments for impact made by philanthropic organizations. The graphic below shows the types of investments and their level of market risk and return. Labels have been added to show the types of philanthropic impact investments were made.
In addition to direct impact investment options, organizations may choose to invest in strategically aligned funds or stocks.
For further information, Boston College’s Institute for Responsible Investment has published the Handbook on Responsible Investment Across Asset Classes as a resource for any type of impact investing.
Mission-Related Investments (MRIs)
Philanthropic organizations of all types make MRIs to increase their financial corpus—or base—and grant capabilities to better serve their constituents and communities. The ultimate goal of an MRI is to contribute to the foundation’s long-term financial stability and growth through market-rate investment returns and repayment, while also creating a good social outcome for its constituents or a cause consistent with the organization’s mission. MRIs can be investments in any asset class, including cash, deposits in community development banks, loans, fixed income, public or private company equity, venture capital and real estate.
MRIs are usually made from corpus assets, reducing the funds available for ordinary investments like stocks and bonds. MRI investments are typically a small percentage of the philanthropic organization’s overall asset portfolio. Management of these investments may be handled in-house by a dedicated professional or outsourced.
In contrast to program-related investments (PRIs), there is no legal definition of MRIs under Internal Revenue Service (IRS) codes, but MRIs have some regulation. They must meet applicable prudent investor standards, meaning they must exercise ordinary business care and prudence to provide for long- and short-term financial needs—just like more conventional investments—and must not jeopardize implementation of the organization’s exempt purposes. If the investment does jeopardize the mission, the investor may be subject to tax penalties under Section 4944(c) of the Internal Revenue Code (IRC).
For IRS regulations, see:
- IRC Section 4944(c), Taxes on Investments Which Jeopardize Charitable Purpose – Exception for Program-Related Investments
- IRS Notice 2015-62, Investments Made for Charitable Purposes
For further detail and considerations in making MRIs, see:
- MacArthur Foundation, Mission-Related Investing: Legal and Policy Issues to Consider Before Investing
- Russell Investment, Mission Related Investing Mission Related Investments
- Rockefeller Philanthropy Advisors, Philanthropy’s New Passing Gear: Mission-Related Investing – A Policy and Implementation Guide for Foundation Trustees
- University of Oregon Business Innovation Institute, Pacific Northwest Capital Scan
Program Related Investments (PRIs)
PRIs are similar to MRIs in implementation but differ in focus and regulation. The basis for PRIs originated with the United States (U.S.) Tax Reform Act of 1969. Unlike MRIs, PRIs are more highly regulated. Their use and limitations are defined in IRC section 4944(c).
Both MRIs and PRIs are made to achieve programmatic objectives and facilitate the philanthropic organization’s exempt purpose. However, while the intent of the MRI also includes generating an income stream, the PRI’s ultimate intention must not be producing income or profit or appreciating asset value. Its sole focus must be on positively impacting the mission. A PRI may be a loan, equity investment or guaranty. The expected investment return may be below-market rate or nothing at all—or there may be an anticipated loss. Market-rate or greater gains are allowed for PRIs as long as that is not the intent of the investment. PRIs may not be used to influence legislation or for political campaign participation on behalf of candidates. PRIs made outside the U.S. must be able to fulfill the same charitable purpose in the U.S.
Major foundations like Ford, Rockefeller and the Gates Foundation use PRIs to further their charitable missions and have specific policies in place to govern their use. For instance, a PRI may be used to stimulate private markets to meet the needs of at-risk and underserved populations for essential goods or services such as access to cell phone service or medical devices. The Gates Foundation has used PRIs to guarantee vaccine purchases and contraceptive implants by public agencies with a goal of persuading pharmaceutical manufacturers to increase production and reduce prices for those in need. In addition, the foundation has made equity investments in biotech startups to encourage research of neglected diseases such as malaria and tuberculosis.
Unlike MRIs, PRIs are considered similar to grants under IRS and U.S. Department of Treasury codes and count toward a philanthropic organization’s required annual qualifying distribution of five percent of its endowment. Principal returned from a PRI must be regranted within a year and PRI income is treated in the same manner as the organization’s regular investment income. PRIs are exempt from the IRS tax penalty that philanthropic organizations face for making a jeopardizing investment that demonstrates a lack of reasonable business care and prudence in providing for the long- and short-term financial needs of the foundation for it to carry out its exempt function.
PRI commitments must be a legal document and specify the purpose of the investment. Additionally, the recipient must agree to use all the funds received from the private foundation only for the charitable purpose(s) of the investment and to repay any portion not used for such purpose(s). U.S. Department of Treasury regulations require a charitable investor to be repaid by an enterprise that ceases the activity for which the PRI was made.
For more information on PRIs and their management and regulation, see:
- Stanford Social Innovation Review, “Investing for Impact with Program-Related Investments”
- IRS, Definition of Program-Related Investments
Socially Responsible Investments (SRIs)
SRIs are also known as sustainable, socially conscious, green or ethical investments, such as investments in for-profit companies with good environmental, social and corporate governance practices. SRIs by philanthropic organizations are based on their values and may have a much broader focus than their mission. Additionally, philanthropic organization investors are using their voices as shareholders to affect corporate policies and practices, and to influence or directly impact positive social and environmental change.
Socially responsible investing may have some origin in religious practices. For example, in 1758 the Quakers prohibited members from buying or selling humans. Around the same time, John Wesley, one of the founders of Methodism, outlined his views in his sermon, The Use of Money. His tenets included not harming neighbors through business practices and avoiding investment in industries that could be detrimental to workers’ health or encouraged harmful behavior like excessive drinking or violence.
Activism in the 1960s added social values like equal rights and socially responsible economic development to investing considerations. In the 1990s, environmental protection and sustainability became part of the SRI mix.
Corporate performance research firm MSCI has developed a standardized index of corporate environmental, social and governance (ESG) factors to evaluate companies and investment funds. ESG ratings are used by investors to determine which companies are in alignment with their socially responsible values. Some investment firms have their own proprietary methodologies for such ratings and for how they develop their portfolios. For instance, Vancouver, WA-based Arnerich Massena, has published several white papers on their impact investment philosophy, the most recent being Impact Investing: Why, What, How?
Because SRIs are a philosophical approach to investing, there is no regulation of how and when investors may invest. For philanthropic organizations, there was some concern about SRIs and PRIs jeopardizing organizational mission and incurring tax penalties; for instance, if a disease research foundation chose to invest in companies researching that disease, but those companies had a rate of return that was below market. In 2015, the IRS issued Notice 2015-62, clarifying that asset managers are not required to solely base investment decisions on the highest rates of return, lowest risks and/or high liquidity, but may make concessionary (below-market) investments as long as ordinary care and prudence are exercised, and the organization’s overall financial health is not impacted.
For further information about SRI and ESG investing and examples of how many foundations are using it to their advantage, see Unleashing the Potential of US Foundation Endowments from the U.S. Sustainable Investment Foundation (SIF).
More foundations and other organizations are using impact investment strategies to effect change—both where they give and through how they invest. For researchers, this is a growing funding source to keep on our radar. Educating fundraisers about impact investing can give them an important frame of reference and language for working with donors interested in these types of change. As investors, our organizations can use the same strategies for endowments to have an impact and as a platform to attract donors.
This article relates to the Campaigns domain in the Apra Body of Knowledge.