The Answer to Smarter Philanthropy Can Be Found in a DAF Intermediary
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More investors are passionate today about ESG investing — that which considers environmental, social and governance factors, in addition to financial returns — than ever before. But anti-ESG sentiment is also bubbling up as leaders across the political spectrum criticize what has become an alphabet soup of well-intentioned ESG frameworks, applied in sometimes ham-fisted ways.
Throughout my more than a decade of ESG investing, I’ve encountered some of these well-intentioned recommendations myself. For example, in an effort to move a client’s portfolio toward a “net-zero” carbon goal, one portfolio manager suggested to me that the most efficient effort would be simply to move their oil and gas stocks to a donor-advised fund (DAF) or a charitable investment account, through which donors could make deposits and grants to nonprofit organizations.
It certainly sounded like an expeditious way to achieve this goal — simply eliminate unwanted carbon-intensive investments by placing them in a DAF, thereby converting that money into future donations for environmental and other nonprofits. But the move didn’t consider what those DAF investments would be doing, nor did it consider the implications of dedicating a significant chunk of money for charitable giving without any kind of philanthropic strategy.
Though well-intentioned, actions like this have given critics good reason to grumble about perceived conflicts between fiduciary responsibility, impact on ESG and overall philanthropic effectiveness.
But a solution with a proven track record of impact is on the rise — a philanthropic intermediary that can manage both DAF investments and grants for its clients. Rather than passively investing assets in a DAF’s default funds (which may or may not take into account ESG factors), investors are granting their DAF contributions to impact-focused intermediaries, who then do the leg work of finding and executing high-risk, high-impact investments, changing the game for both ESG and DAF investing as they go.
The truth is, investing assets in a DAF today is not having the outsized impact that it should. Typically, when funds are transferred to a DAF, the previous stock is liquidated and invested into a default investment portfolio at a DAF-sponsoring organization. More forward-thinking DAF sponsors are just beginning to allow donors to invest in third-party managed funds with an ESG lens on impact. That means that while DAF dollars are in the account waiting to be distributed, they may still be invested in stocks that have poor environmental and social impacts.
While more and more third-party funds are striving to invest in impact-focused entities, these market rate funds are not necessarily oriented to getting capital into the hands of innovators or solutions that can make a difference. Many early-stage innovators are seeking access to capital, but the market is notoriously opaque.
As such, at MIT Solve, a marketplace for impact and innovation, the value of intermediaries has become increasingly evident. Progressively, we’re seeing early-stage innovators seek out impact-focused investors so that they can intentionally build viable business models with ESG considerations ingrained in their governance structures. But access to those investors is notoriously hard to gain. Similarly, more and more investors seek investments with an impact focus, but aren’t sure where to look to find innovators.
In 2022, over two-thirds of our Solver teams reported that they are currently fundraising in the form of grants, debt or equity. And it’s a trend that is reinforced by the United Nations estimate that the gap to achieve sustainable development goals (SDGs) persists at $4 trillion.
We believe DAF intermediaries have an outsized opportunity to get this capital in the hands of promising innovators. That’s why we have structured Solve Innovation Future, a philanthropic venture vehicle structured as a DAF, to better get entrepreneur-friendly capital into the hands of proximate leaders, who are laser-focused on solving the world’s most pressing problems. Solve Innovation Future is exclusively designed to get game-changing investments into the hands of entrepreneurs.
Unlike indexed funds, where most investments are in companies with broader, less focused ESG mandates, investments out of Solve Innovation Future are specifically targeted at early-stage innovators with a higher probability of outsized impact on the world’s most pressing problems. To date, investments from Solve Innovation Future have unlocked more than six times the investment amount for investees and positively impacted the lives of more than 100 million people.
While this thinking may challenge the status quo, there are ways that multiple parties can accelerate the adoption of these strategies. Advisors can encourage investors to think through their philanthropic investment and grantmaking more strategically, more donor-advisors can ask their DAF sponsors for engagement opportunities, and DAF sponsors can offer more innovative solutions like DAF-to-DAF transfers or direct investments in early-stage, high-potential opportunities.
It is understandable that public scrutiny and evolving attitudes toward ESG, impact and corporate social responsibility are leading many to reconsider even the most under-researched corners of the impact landscape. Policy priorities are also encouraging donors to move more capital via grant to nonprofits.
But as environmental and social challenges around the world continue to evolve, there has never been a greater time for investors, donors and institutions to be more purposeful with their investment strategies. To address concerns that are permeating the landscape, they need to reconsider the strategy driving their financial choices and the potential to increase their impact by working with intermediaries. Not only will their capital align better with their investment priorities, but it will likely have the impact desperately needed to transform ESG investing.
Casey van der Stricht is a Principal at Solve Innovation Future Fund at Massachusetts Institute of Technology.
