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Is Investing Five Percent Enough for Charitable Organizations?

October 2005

STANFORD GRADUATE SCHOOL OF BUSINESS—Because they do admirable work and contribute to important social causes, philanthropic organizations often are not scrutinized about their allocation of funds in the same way as for-profit businesses. A charitable group may be cited for blatant misuse of assets, but few have been challenged to consider metrics like return on investment or depreciation of assets.

Luther Ragin, vice president of investments at the F.B. Heron Foundation in New York, made a strong case for a new model of charitable investing focused on maximizing results.

He called on the philanthropic community to rethink the 95/5 model so popular in grant making today, in which 95 percent of a foundation's funds are invested each year and 5 percent given away. That model helps ensure the availability of funds well into the future, but Ragin said it also means that foundations are little more than private investment companies that allocate a small portion of excess cash flow to charitable causes. His Oct. 25 speech was part of the Philanthropy Discussion Series sponsored by the Business School's Center for Social Innovation.

Key to determining whether 95/5 is a proper balance is calculating the value of a dollar today versus 5, 10, or 100 years from today. Ragin suggested that would require some sophisticated financial modeling that the philanthropic world has not yet conducted.

"There are some studies that have looked at the productivity of dollars invested, but I would honestly say that the metrics of social productivity are hard to quantify," he said. "It's an area that needs greater attention in order for us to make precise judgments and evaluations."

Although individual foundations have every reason to use their money in self-preserving ways that will sustain them over the long term, society may be losing out, Ragin said. Since most of the largest charitable foundations in the world today did not exist 100 years ago, and some did not exist even a decade ago, setting up a foundation to exist into perpetuity is not necessarily the most practical approach.

"We could point to many lives that have been touched and enriched by our work, but we could also do better," said Ragin. The Heron Foundation, he said, selects grant recipients with a strong track record of building wealth in low-income communities by encouraging home ownership and enterprise development. Ragin argued there are ways besides straight grant making to align a foundation's spending with its mission, including investing its assets in one of the growing number of socially conscious private equity funds.

In addition to providing grants to nonprofit housing groups, the Heron Foundation buys asset-backed securities issued by Habitat for Humanity to help expand that group's self-help housing programs. It also buys taxable municipal bonds that provide mortgages for low-income, first-time home buyers. Currently, Heron estimates that some 24 percent of its assets are allocated in accordance with its mission-based investment goals.

Most important, Ragin said, foundations need to more carefully examine the worthiness of potential grant recipients, not just in terms of how badly they need the money but how likely they are to use it effectively.

"Part of mission-related investing is making hard decisions," Ragin said. "If deals don't measure up, maybe they should not be done. There are scarce dollars allocated for critical social needs, and everyone in the foundation is a steward of those dollars."

As the Heron Foundation has become more focused on the results generated, it also has focused on recruiting staff members who are skilled with numbers and financial analysis.

"Increasingly, it is important for foundation staff to be familiar with accounting," he said.

—Andrea Orr

Related Links

Audio Program

Center for Social Innovation

Other speeches on philanthropy