Investment Management Oversight: Preparing To Invest for Impact

For many years, small-staffed foundations have been at the heart of the impact investing movement, joining with, and at times leading, larger philanthropies.

Small-staffed foundations tend to be more agile than their larger, staffed counterparts; they often have more knowledge on needs in certain issue areas and geographies; they’re better positioned to deploy a greater portion of their resources in support of mission and goals; and their investments can catalyze an enterprise or field.

About one in ten small-staffed foundations are already engaged in some form of impact investing, and many more are well positioned to do so.

Make the Case to Your Trustees

Today’s private foundations are investing for impact in two ways: through program related investments (PRIs)—made with the expectation that the amount invested will be repaid to the foundation—and by investing a portion or even the whole of their endowments in enterprises and funds aligned with their missions.

For foundations, the early stages of adopting a form of impact investing lies with the board. In most cases, board approval is required for a foundation to engage in impact investing, and such engagement often requires ongoing, high-touch engagement from impact investing champions: perhaps a single board member, staff member, or consultant.

Champions must be prepared to help boards understand their options and to allay any concerns by:

• Reviewing the practices of peer institutions to show how impact investing operates
• Describing the capacity required for different impact investing strategies
• Examining the existing literature on impact investing performance
• Identifying examples of impact investing policies and vehicles to illustrate the strategy’s potential

Champions would also be wise to bring in outside experts as needed, and provide opportunities to learn from peers. Information from similar foundations is particularly valuable. If possible, make a site visit to see examples of what impact investing has accomplished in particular communities or areas of interest.

Consider Your Strategy

By articulating your goals before you start investing, you will be able to choose the best approach, plan how best to use your resources, build efficient staffing structures and internal processes, and establish how you will measure impact.

As you consider how you will engage in impact investing, start with these questions:

1. Where will you focus?

You might look for investable opportunities within your grantmaking portfolio. For example, your grantee that is focused on affordable housing might have an existing investment fund or need financing to build facilities, buy land, or launch a revenue-generating enterprise.

You also might reach out to peer funders to learn about any trends in your areas of interest. You then can learn in real time about on-the-ground capital needs and about areas in which there is momentum so that your collective investments have greater impact.

2. What is your risk tolerance?

Impact investing opportunities exist along the entire risk spectrum. Whereas you can make higher-risk private equity investments, many lower-risk fixed-income investments also are available. If you are just beginning to invest for impact, or if you have limited in-house capacity, you may consider starting with a lower-risk fixed-income investment. That type of investment offers predictability and lower-capacity needs.

3. Do you want to invest directly or indirectly?

Direct investments are made directly to organizations, companies, and nonprofits. Indirect, or fund investments, are made into funds that pool capital and then deploy that capital into organizations, companies, and nonprofits.

Direct investments are more resource intensive because they require the investor to have the capacity and expertise to source and structure customized transactions, and stay engaged. Investors tend to make direct investments when they have the internal resources, and when the opportunity directly aligns with the foundation’s goals.

Investors choose indirect investments into funds to diversify their risk and leverage their investment with other investor capital, which increases the scale and impact of the fund’s investments.

Find an Approach That Fits Your Strategy

The following five approaches are common ways foundations engage in impact investing:

• Individual or one-off transactions—Small-staffed foundations can make investments sporadically as opportunities arise that align with their goals. This approach allows a foundation to be flexible; however, it may reveal capacity constraints because since staffing and structures are not designed to support frequent impact investing.
• PRI approach—Some private foundations make only below-market rate investments that count as a part of their 5% annual payout. This approach consistently integrates impact investing into the foundation’s broader strategy while preserving capital. Foundations without in-house expertise can easily fill capacity gaps by bringing on outside consultants and practitioners to support PRI sourcing and due diligence.
• Mission-related investment (MRI) approach—Mission-related investments (MRIs) aim to achieve social and environmental impact while targeting risk-adjusted market-rate returns. In some cases, a foundation’s existing advisor can support those transactions. Foundations commonly use MRIs in combination with PRIs or alongside screens (see next approach); it is less common for a foundation to use an MRI-only portfolio approach.
• Hybrid PRI/MRI with screens approach—Foundations also may integrate socially responsible investments (SRIs) or integrate screens for environmental, social, and governance (ESG) factors. Taking a hybrid approach—incorporating PRIs, MRIs, and SRI and ESG investing—can require significant foundation capacity. In addition, this approach often requires integration and coordination of consultants and advisors.
• Full portfolio activation—Foundations may choose to activate their entire portfolio through PRIs and MRIs, as well as SRI or screens for ESG factors. Full portfolio activation also can require substantial foundation capacity and often necessitates integrating consultants and advisors. In investing their entire portfolio, foundations may encounter challenges sourcing the volume of transactions required to invest available capital. Despite the challenges and capacity requirements involved, foundations that take the full portfolio activation approach are able to use all their available resources to achieve impact while realizing financial returns.

Years of experience have taught small foundations that impact investing is one of many tools we will need to address the complex social and environmental problems we face. The opportunity to do so now is huge.