Editor's Note: This article was originally published on April 2, 2018.
Private foundations have been taking bolder steps toward impact investing in recent years. But with more individuals turning to donor-advised funds (DAFs) to facilitate their giving, how can those funds also be invested today to improve the world? That’s an important and intriguing question I’ve heard from donors and leaders in the philanthropy and impact investing sectors.
I spoke with 10 experts to get their thoughts on connecting DAFs and impact investing.
Resources To Mobilize
Today, an estimated $85 billion is sitting in DAFs. That’s $85 billion earmarked for charitable purposes, but waiting to be dispersed to nonprofits. Those numbers are climbing as DAFs continue breaking records with billions of dollars pouring into these charitable vehicles each year.
DAFs function like an individual donor’s personal philanthropy account. Donors put assets into these accounts, take an upfront charitable tax deduction, and then, over time, recommend to their account sponsor how the funds are to be granted to nonprofit organizations. Some of these funds could be in accounts for years or decades until donors (or their successors) recommend specific donations.
Amit Bouri, chief executive officer at the Global Impact Investing Network, told me, “Donor Advised Funds represent a largely untapped opportunity for impact investments, particularly as people investing in DAFs have already set this money aside to have a positive impact on the world.”
Connecting DAFs with impact investing could also unlock diverse types of capital (e.g., higher-risk, long-term patient capital) that are needed as the impact investing market grows. "DAF capital is uniquely flexible. The risk/reward frame may change for donors after putting assets into a DAF, and that may make impact investing more appealing,” said Fran Seegull, Executive Director of the Impact Investing Alliance.
Effectively linking DAFs and impact investing may also address the ongoing concern that DAFs are warehousing important philanthropic dollars. As I’ve examined before, DAFs can be easy and low-cost vehicles for individual donors, though critics have raised reasonable concerns about their rapid proliferation, including sidelining critical resources in investment accounts for years or decades instead of immediately funding the work of nonprofits. “Deploying DAF assets into impact investments may be a response to some of the debate about DAFs sidelining charitable resources. But in order to do that, we have to get the piping of the system right,” said Tracy Palandjian, chief executive officer and co-founder of Social Finance.
Where Are We Today?
No doubt, there is growing interest from donors and investors to better align their resources, including their philanthropic resources, with their values. "We see this trend accelerating, driven by next-gen donors and the rising interest in place-based investing,” Seegull told me.
Indeed, many DAF sponsors, including some of the largest, already offer their donors limited impact investing options. While options vary by DAF sponsor, the entry point for the majority of DAF donors is to select from standard impact investing products available on the DAF sponsor’s investment platform. As Seegull explained, "DAFs are, for the most part, the aggregation of retail [investment] accounts. As a result, the DAF sponsor, in considering what is placed on the platform, decides what will be most appealing to the broadest range of clients. Larger or independently managed DAF accounts are typically granted greater flexibility from the DAF sponsor to recommend investment options beyond standard offerings on the DAF’s investment platform.
Concerns about broad appeal, liquidity, risk, and maintaining low-cost products explain why DAF sponsors are attracted to the public markets, particularly exchange-traded funds and socially responsible mutual funds that proactively invest in companies with strong environmental social and governance (ESG) standards, or screen out certain irresponsible companies or sectors.
"Different donor advisors think about their investments differently. Some require liquidity, others seek high financial returns, some want deep impact,” said Seegull.
Laura Malone, vice president at American Endowment Foundation, a DAF sponsor with $2.1 billion in assets across 5,500 DAF clients, explained that “direct investment in private companies/funds [are] more of a challenge, because often, they cannot create liquidity quickly or may have business operations that naturally generate taxable income to a charity.” She said mutual funds, exchange-traded funds and bonds that create a social impact are “an easier way to participate.”
Fidelity Charitable is the largest DAF sponsor with more than $21 billion in DAF assets, 180,000 donors and 110,000 DAF accounts. Sarah Gelfand, director of donor programs at Fidelity explained that the “scale and diversity in our donor base presents both opportunities and challenges as we expand our impact investing capabilities.”
Even when these relatively accessible products are available for donors on a DAF platform, serious barriers to adoption remain. Nearly everyone I spoke with said donor and financial advisor awareness and education are still needed (that’s long been a common theme in the impact investing world). “Many of our donors are unsure about what impact investing is—and those who are interested are unsure where to start (as are their financial advisors),” Gelfand told me.
The current offerings are just a first step, and I heard wide consensus and excitement that more can be achieved as the DAF industry moves to democratize higher-impact opportunities for more DAF donors. Some promising examples already exist.
Unlocking Deeper-Impact Investments
In June 2017, Social Finance, a national nonprofit that mobilizes capital for social impact, and its partners closed a $12 million Pay for Success transaction in Massachusetts focused on workforce development. Forty investors participated, including 16 individual investors who utilized their DAFs to support the deal. DAF participants came from four different DAF sponsors: Fidelity Charitable, ImpactAssets, Combined Jewish Philanthropies, and the Boston Foundation.
Because of this investment capital, Jewish Vocational Services will provide services to 2,000 adults in the Boston area including vocational English language classes and job search assistance, and will help documented immigrants and refugees earn higher-wage jobs and higher education. As a Pay for Success deal, investors provide upfront capital to scale a proven program and receive success payments by the Commonwealth if specific, measurable outcomes are achieved.
As it is a private market transaction, we likely will not see this on DAF platforms soon, but the appeal is its deep, place-based and measurable impact. One could understand why more donors would be excited to leverage their philanthropic capital through such a specific investment.
According to Tracey Hsu, a Director at Social Finance who engaged investors in this transaction, “Unlocking DAF capital hinged on two primary factors—visionary donors who were excited about deploying their DAF in an innovative manner, and fast-moving DAF sponsors who were willing to partner on a specific impact investing opportunity.”
One challenge with this type of private transaction is scalability. Recoverable grants may be a potential pathway to scale and democratize this approach for more DAF donors. As Hsu explained, “The recoverable grant strategy resonated for DAF sponsors who had particular legal, business, and tax requirements to meet internally.” Sarah Gelfand at Fidelity Charitable likewise noted that a recoverable grant allows donors “to dip their toes into providing a different type of financial support to nonprofits they work with.”
In another example prime for replication, Calvert Impact Capital, the Chicago Community Trust and the MacArthur Foundation launched Benefit Chicago—a $100 million impact investment initiative focused on Chicago in April 2016. The MacArthur Foundation invested $50 million, and in less than two years, the collaborative raised millions more in investments, mainly from DAFs, including those housed at the Chicago Community Trust.At the launch of Benefit Chicago, the Chicago Community Trust committed $15 million from its regular investment pool, so any DAF donor invested in the pool automatically became an investor in Benefit Chicago.
To help raise the additional investment, CCT directly engaged some of its largest donors and worked to educate them about the opportunity to grow their philanthropic capital while having an immediate, positive impact in the local community. That strategy worked. As Jason Baxendale, chief development officer at the Chicago Community Trust, explained, “Donors love [Benefit Chicago's] ease and simplicity, coupled with its innovative nature. We’ve made it simple to not only invest with impact, but to have it benefit your home community.”
Benefit Chicago has already made $12 million in loans to social enterprises and intermediaries in Chicago and will deploy another $6 million in the coming months. This investment capital supports a range of impactful programs including AutonomyWorks, a marketing and analytics firm that hires adults with autism, and Chicago Neighborhood Initiatives, which is building new retail space for local small businesses.
Place-based impact investment could be an important differentiator between DAFs at national, commercial sponsors and community foundations. Beth Bafford, vice president at Calvert Impact Capital, told me, “In general, we have seen community foundations becoming more active in impact investing. For them, it’s a differentiator. They can offer grants and investments that stay local and expand their community impact. It is an attractive value proposition, especially to next-gen donors.” Calvert’s Community Investment Note, a fixed-income registered security that invests in community development efforts like Benefit Chicago, is helping to democratize higher-impact investing opportunities. It’s available to retail investors and on several DAF platforms.
Donors looking for deeper impact in both the public and private markets might best be served by a more specialized DAF sponsor. For example, ImpactAssets has 1,000 DAF accounts, $424 million in assets, and helps donors understand that their DAFs are more than just grant dollars sitting passively in accounts. ImpactAssets has an Investment Committee that searches for impact investing opportunities, but has also sourced 300 impact investment recommendations from its donors.
Challenges to Overcome
Despite the huge potential to better engage DAFs with deeper impact investment, real challenges remain. “There are operational, infrastructure and investor education challenges. But the will to participate in impact investments is there,” Tracy Palandjian told me.
As is true across the impact investing sector, education and awareness remain core challenges. For DAFs, that involves educating donors, their financial advisors and the DAF sponsor about specific impact investing opportunities. Amy Bennett, director of marketing at ImpactAssets, noted that DAFs are “still primarily viewed as a granting vehicle. We need to shift that perception and build awareness and understanding of how to optimize a donor-advised fund for meaningful impact investing opportunities.” Beth Bafford at Calvert explained that there is a “passive nature of the vehicle that donors don’t want to spend a lot of energy thinking about – which makes education an uphill battle.”
Jennifer Kenning, CEO and co-founder at Align, an impact investing firm, has worked with her clients to use their DAF assets in various impact investing transactions. She told me, “It is actually not a lack of investment opportunities that thwarts a donor’s desire to make impact investments inside their DAFs, but rather the DAF platform that a donor chooses to use which often has prohibitive restrictions.” Many DAF sponsors require a certain minimum account size for donors to advise on investment decisions beyond standard offerings on the platform. That makes it hard to link the majority of donors with higher-impact or issue-specific opportunities or private market transactions.
Similarly, some private funds may have high minimums, preventing some investors from participating unless the DAF sponsor is able to pool assets across accounts. But Fran Seegull said, "Over time, the market will democratize access to private debt and equity impact investments in both funds and firms. There will be associated costs of diligence and monitoring that must be factored into the DAF sponsor’s business model." Keeping DAF sponsors’ costs low while expanding into deeper-impact investing opportunities is an important goal for the sector.
Looking to the Future
As demand from donors grows, I asked several experts to envision a well-functioning system in which DAFs more seamlessly engage in impact investing.
They described a market where DAF donors select a portfolio of investments aligned with the values, issues and causes they are passionate about. As Seegull put it, DAF sponsors could “offer their donors impact theme portfolios across asset classes—around real estate, water, health or financial inclusion." Beth Bafford at Calvert envisioned a market with tailored impact investment portfolios: “Each portfolio option would have certain risk, return, impact, and liquidity parameters that would have to be considered by the donor when they choose their allocation.”
Tracy Palandjian at Social Finance imagined a potential world where DAF sponsors offered “investment and grantmaking pools that you could invest in specific outcomes (e.g., improved earnings or increased job placements) and your DAF sponsor send quarterly reports on the impact of your grants and investments.”
While we collectively work to better educate donors and financial advisors, DAF sponsors can lead the way. Here are a few practical ideas that emerged from my conversations: (1) DAF sponsors could proactively suggest and educate new DAF donors about impact investing products already on their platforms; (2) DAF sponsors could report out impact metrics from investments, and not just dollars granted to charities, or (3) DAF sponsors could test tailored pooled funds organized by impact theme or geography, as we saw in the Better Chicago and Pay for Success examples. As a philanthropy strategist, I’m excited for this better functioning DAF market where donors, nonprofits, and communities in need are all better served.