For more than 80 years, the Ford Foundation has fulfilled its mission to reduce inequality worldwide by paying out 5% — or about half a billion dollars — of $12 billion in assets in the form of grants and other philanthropic vehicles, while investing the rest in traditional vehicles to maximize returns.
In April, the foundation said it would take up to $1 billion from the traditional investments side and invest it over 10 years into mission-related investments (MRI) — those that yield good returns while making a positive social impact, such as funds that invest in efforts to improve education, provide affordable housing or offer financial services to the underserved. It is the largest commitment ever made by a foundation to MRIs.
Overseeing the MRI investing team is Xavier Briggs, the nonprofit’s vice president of economic opportunity and markets. He spoke with Knowledge@Wharton to explain the foundation’s strategy.
Knowledge@Wharton: Could you give me a sense of why the Ford Foundation decided to get into impact investing and what some of the objectives were?
Xavier Briggs: We have been doing impact investing since the late 1960s, but only from our program monies — the side of our work that is considered charitable. In other words, our reason for being. What is new is making impact investments from our endowment. Traditionally, there was a very strict line between those two. Like other institutional investors, in particular endowment-based investors, we interpreted fiduciary duty to focus on the most attractive financial returns within ethical boundaries, but not to specifically pursue social impact through endowment investing.
We are seen as leaders in impact investing and have been for a long time, but always in the form of what are known as program-related investments. This is a distinction given to us by the IRS; it’s not a Ford invention. Program-related investments must meet a charitable test, or a charitability standard, whereas mission-related investments from the endowment have to meet a prudent investor test. So, it’s the mission-related investments, the investments from the endowment that seek both financial return and a social impact, that put us in a category with many other institutional investors who are likewise looking at this question and figuring out what is right for their institutions.
Knowledge@Wharton: Could you explain why the distinction between program-related investing and mission-related investing is significant? I know that you described it as the next generation of innovation in philanthropic impact.
Briggs: Under IRS guidelines, private foundations are required to pay out 5% of their assets each year. That’s to ensure that they’re actually implementing a charitable mission for which they have a special tax status. Though some of us pay out more than 5% — Ford has historically exceeded that threshold — it nevertheless is the more limited part of your assets in the corpus. Ford went to the federal government in 1967 to specifically seek to do permission to do PRIs.
That was based on a lot of work we were doing to revitalize declining American cities, to support working families, the comeback of neighborhoods. We were running into the limits of what you could do under charitable guidelines, and out of that need the PRIs were born. Ford pioneered that, and then it grew in the field, and other institutions have done very innovative things. [PRIs are charitable investments in the form of loans, guarantees and equity. Unlike grants, they are expected to be repaid but allow for lower investment returns, according to the foundation.]
“We have been doing impact investing since the late 1960s. … What is new is making impact investments from our endowment.”
While we’re pleased about all of that, [Ford Foundation President] Darren Walker in his essay described this as the next great innovation because clearly much more capital is at stake in the 95% category as compared to the 5%. We concluded that this was important for us as a matter of consistency with our mission, and that the marketplace is ready. Metrics have evolved, investible opportunity has grown and evolved, the number of funds has grown and grown, the number of fund managers with a track record and a seriousness about measuring non-financial returns — all of that has evolved quite a bit.
In addition, under the Obama administration, the IRS issued updated guidance to make clear that the federal government sees it as perfectly consistent with fiduciary duty to pay attention to or to consider mission-related impacts or social impacts. That answered the question about fiduciary consistency and consistency with law. Uncertainty about that had been a barrier in the field for private foundations in particular. Some had made MRIs, but it was relatively few.
We wanted to join them, and to do so with a large-scale commitment. This is the largest ever that we are aware of by a private foundation — $1 billion over 10 years. We hope in doing this to construct a successful portfolio and to accelerate momentum in the field, to inspire and encourage other institutions likewise to find their own way in the space.
Knowledge@Wharton: You have two initial areas of focus: affordable housing and access to financial services in emerging markets. Why were those areas identified as the most important?
Briggs: We identified them as the two best places to start for our effort for two reasons. One is alignment with our larger strategy to combat growing inequality in our world. The second reason is investible opportunity. In other words, the first was a threshold test, but the second was necessary as well. We didn’t want to begin in areas where there are for now fewer investible opportunities, though as I said the marketplace will continue to evolve. I think institutional investors should be encouraged by that. There will be more opportunities going forward in a greater range of sectors and markets, both in the U.S. and the emerging markets.
But why the alignment? What is that alignment all about? Affordable housing in the U.S. has emerged really over the last several decades as a critical area for providing families, including the disadvantaged, with a critical platform for a successful life. Not only having shelter, as we all know that it is a basic human need, but access to decent, safe, affordable housing, including if you are on the bottom of the economy — affordable rental opportunity.
It’s crucial to garnering savings, to having a solid base from which to construct healthy family routines, connect to educators and service providers. It literally is the foundation for successful life, and it’s a foundation that has been slipping out of the grasp of millions of people because of the back-breaking rents, failure of incomes and housing supply to keep up with demand. It’s not a new problem, but it has worsened considerably over the past decade. We have been active in this field for about half a century now, working with partners in the private and the not-for-profit and the public sectors, and we wanted this commitment through the MRI tool to be another powerful signal that affordable housing is vital and investible, and more institutions should commit to solving this truly urgent national challenge.
Knowledge@Wharton: Have you identified some innovative solutions in the area of affordable housing that would extend the impact both socially and financially?
Briggs: The quick answer is we have, and there are several kinds of solutions. We have been particularly compelled by financial innovations — financing solutions that offer the promise of scaling affordable housing supply more efficiently and effectively. One example is the importance of affordable housing preservation. We have seen a new generation of acquisition funds, in some cases structured to enable affordable housing developers working with public and private partners to acquire land as they complete plans and begin construction. In other instances, the funds are used to acquire existing properties, refinance them and put them on a solid healthy financial footing so that they remain affordable to the families that live in them, and upgrade them physically and improve things like rent collection.
“This is the largest ever [impact investing commitment] that we are aware of by a private foundation — $1 billion over 10 years.”
In other words, do a turnaround. You turn around a property that may have been distressed and expiring out of some earlier agreement to maintain affordable rents, making it more financially viable, affordable over the long haul, physically improved, which is important for human health and for other reasons. These innovative funds work on the acquisition and turnaround of existing properties, and that’s tremendously important.
One of the things that has contributed to the affordable housing crisis, especially in terms of rental housing, is the loss of more affordable stock each year than we replace through new construction. It’s a dynamic problem. There’s a hole in our pocket, and there’s a whole lot pouring out, and we have to change that as a country. As part of preservation, we’ve seen real innovations and an increasingly mature group of developers, some not-for-profit, some for-profit, capable of doing the transactions effectively, managing those assets effectively and doing so on a scale that was unknown in the field previously.
The field previously had many small players, and it was harder to get those scale economies in greater efficiencies. This has been a kind of industry evolution so that you have really responsible, mission-driven developers and property managers, whether they be non-profit or for-profit, that can acquire, turn around, manage on a scale of thousands and even tens of thousands of units, as opposed to a few dozen units here and there with many separate operators. You can just imagine the power of that from an investment perspective, in terms of creating opportunity.
The other solutions, while they were sort of embedded in examples I gave you, have to do more with the physical form of housing where we have seen an evolution toward greener buildings, healthier buildings, and also connections to services that come with the apartment as a package and help people to be more successful in their lives. Whether more employable, better connected to local schools, training opportunities, financial literacy building, at the end of the day these things are in the interest of the landlord and the tenant. But historically, as a country, we have not delivered those in a seamless package.
In financial services — or as it is sometimes put, financial inclusion — you may be familiar with the phrase ‘bottom of the pyramid.’ It refers to the enormous number of consumers in the emerging markets that are not served by financial services at all or have not traditionally been a part of the financial system. This goes beyond microfinance. This is not just about credit but also savings and payment products and tools, which we take for granted in many markets around the world, which have not existed for workers and families everywhere.
In this space, it is largely technology-driven disruption and new opportunities for delivering services to much larger numbers of people at lower operating costs that have created new products, new business models for firms. It’s a diverse space and I’m generalizing here, but based on many years of PRI investing in the financial inclusion domain and a careful analysis of the marketplace, we judge that there are significant opportunities here that we want to pursue.
“We hope … to inspire and encourage other institutions likewise to find their own way in the space.”
Knowledge@Wharton: One of the things I noticed in your statement is that capital was going to be allocated to impact funds rather than to individual companies. What criteria would you use to select the funds to whom you would allocate capital?
Briggs: There are traditional criteria that will make sense to any investor: doing careful diligence on the quality of the team, the clarity of its investment thesis and the track record. In some cases, you may have a newer fund but one made up of very seasoned fund managers who are putting together something new. So there are the traditional criteria one would apply, supplemented by the criterion of a clear impact thesis, not just a financial success thesis, and a demonstrated commitment to measuring impact well and working with the companies. Or in the case of a real estate fund, working with the properties in the portfolio to ensure the social impact [is present] in addition to financial returns. Those are the things we will be looking at starting in these two target sectors.
Let me supplement that answer by saying that diversity and inclusion in the investment profession, in the investment marketplace, is something that we are also eager to continue promoting. We have done it in our grant-making and in our PRI investing for a long time. We are very committed to it in MRI investing as well, and that does mean seeking to work with diverse investment teams, asking questions about diversity and inclusion, all along lines like gender, race, caste, persons with disabilities, but increasingly looking to diversify the fund management teams. We’ll be paying attention to who does the investing, not just what they are investing in.
Knowledge@Wharton: Financial returns are relatively straightforward, but I find it difficult to understand how one measures social impact. Help me understand how you think about measuring the social impact from your investments.
Briggs: You know, it depends in part on the sector, on the underlying investments themselves, and sometimes very much on the particular market, including the geography in which you are investing. In the case of affordable housing in the U.S., there are very well-understood sets of metrics for who is served that, in some cases, increases in affordability based on where a tenant is moving from, a difference you’ve made in their pocketbook based on being able to offer them an affordable rent.
There is increasing sophistication in tracking other sorts of life outcomes beyond merely the housing cost into financial literacy, indicators of financial health such as being able to garner savings. And there are a host of physical metrics. The physical performance of buildings, the financial performance of portfolios, rent arrears — all of those things that ultimately predict both the financial impact and the social impact as well. That is a field, again I called it mature, that has been evolving for roughly half a century in part through superb evaluation work, including randomized controlled trials in some cases of housing work and a mix of metrics that run from the physical to household finances to … broader success in one’s life.
Before I say a word about financial inclusion, it is certainly true that non-financial impacts or social impacts are not generally reducible to a single metric, let alone a single number in the way that one measures. That’s a completely fair point. When it comes to something like financial inclusion, and just to offer a point of contrast, we helped to build the field of microfinance. We were some of the angel investors in Muhammad Yunus’ then-radical idea in the mid-70s that poor people could be solid credit bets if you knew how to underwrite it properly, if you knew how to work with a different process, different product to serve these groups. We supported the field [of microfinance] for many years.
One of the final chapters of Ford’s work in microfinance was to support the creation of something called social performance standards. It was done in partnership with the microfinance institutions. It has been embraced by other donors. It is being adopted in the microfinance field. Essentially, it was to provide an actionable set of metrics that microfinance lenders could adopt to ensure that they were targeting in line with their missions, targeting the very groups of consumers or segments that MRIs were created to serve. That was deemed very important, and it didn’t grow up overnight. It was years of careful work, and it was a response to a particular problem in the field that microfinance institutions, in some cases, had become very successful financially but arguably had strayed from their early targeting of the poor.
“We have been particularly compelled by financial innovations.”
Creating standards was a way to get back on mission, to more transparently indicate who these institutions were actually serving, and help their managers help their own staffs to serve those consumers in the most effective way. All of this is to say that we confirmed with partners that it is very possible to measure both who is being served and to collect additional forms of data that get to the impact of what you are doing in the interest of financial inclusion.
Knowledge@Wharton: What are the biggest risks with mission-related investments? And what are your plans to hedge those risks?
Briggs: The most precise way of saying it would be to mitigate and manage them. There are risks as in any kind of investing, so we’ll be mitigating and managing rather than formally hedging in the sense that is sometimes used in the investing world…shorting something or whatnot. We have no plans along those lines. But what are some key risks and how will we manage them? In brief, there are a set of commercial risks that go with making any investment, and that is where very careful diligence comes in. Not just understanding immediately what is someone’s impact thesis, but doing a reputational assessment, understanding the track record, beginning where we have relationships. And it helps enormously that we’ve worked in these target sectors for a very long time, so we have deep expertise and also a staff around the world to help with our intelligence network.
A second kind of risk that is probably less obvious, unless you do endowment management for a living, is liquidity risk. As we make mission related investments beginning in the private markets and the portfolio begins to scale, we are going to be committing foundation assets to investments that are more liquid, relatively speaking. It will be a range, but they are less liquid than certain other kinds of investments that are more readily tradable, like fixed income and equities.
“The board is managing for liquidity risk … [to ensure nothing] would put the long-run and short-run financial viability of the institution at risk.”
So, we modeled the financial scenarios very carefully. I did it working with our chief investment officer and our chief financial officer, and we did this in dialogue with our trustees. We modeled various scenarios for the wider marketplace. It is very important for us that we have a liquidity target as an institution. We believe we need a certain amount of cash on hand and also investments that are convertible to cash over a certain period of time to make sure that we’re never in a fire sale mode, that we can meet our operational costs, etc.
We modeled that out and took specific steps to mitigate liquidity-related risk. For example, we will invest toward the $1 billion over 10 years gradually, the trustees will define annual commitment caps for us, and they will make these decisions in an integrated way. They will look at the operating cost needs of the institution, they will look at the performance of the larger endowment, they will look at how the MRI capital deployment is coming along, they will consider our current and needed liquidity. They pull all of the levers, in other words.
We thought through very carefully how we wanted to ensure that they could do that with the committee of trustees overseeing the MRI investments and approving every single one, working with us very carefully to provide that oversight. But at the same time, the board is managing for liquidity risk and managing more broadly for the overall health of the institution so that nothing about our investment strategy, whether in the main endowment management or on the MRI side, would put the long-run and short-run financial viability of the institution at risk.
Article by Knowledge@Wharton