Impact investing with donor-advised funds can boost clients’ philanthropy
If you have clients who are philanthropic, chances are you’ve heard of donor-advised funds. DAFs are the fastest-growing charitable giving vehicle in philanthropy for a good reason: They offer tax advantages, legacy planning options and flexibility that other giving vehicles can’t. And if your clients know about or already have a DAF, they might also be interested in impact investing. It’s not surprising that the most generous charitable givers might also want to align their investments with their values.
Two trending tools for good in the finance sector, DAFs and impact investments, are converging for even higher philanthropic impact. In the past two years, sustainable, responsible and impact investments have swelled 38 percent to $12 trillion, according to industry group US SIF. Put another way: Impact investments now account for more than one-quarter of professionally managed assets in the U.S.
Many DAF charitable sponsors are offering impact investments so donors can recommend investment strategies that align with their philanthropic goals. For example, if a donor is interested in using their DAF to support environmental causes, they may wish to recommend their DAF assets be invested in environmental, social and governance indexes or cause-specific investments (e.g., renewable energy solutions in North America), thereby having a positive impact before they’ve even recommended their first grant.
Here are a few of the most questions that help investors decide if impact investing is the right strategy for their DAFs:
1. What is the value of impact investing with a DAF?
The primary benefit of impact investing within a DAF is doing good — right away. One of the key features of a DAF is the grantmaking flexibility. Unlike private foundations, which have an annual 5 percent payout requirement under federal tax law, DAFs do not have a payout requirement. In practice, DAFs pay out at a far higher rate (20 percent annually) than private foundations, but if donors are considering their grant-making strategy over time, they can have an immediate positive impact by recommending impact investments within their DAFs.
The purpose of any impact investment is to generate a positive social or environmental return alongside a financial one. If DAF assets are invested in impact investments, in most cases, any financial return is tax-free and can be reinvested or used to make charitable grants.
The benefit of impact investing as a financial strategy is well documented. An aggregated report of more than 2,000 studies found that companies that prioritize ESG issues generate better long-term financial performance and demonstrate less exposure to risk factors like volatility. Applying these benefits as a philanthropic strategy within a DAF can translate into higher, faster philanthropic impact and, ultimately, more charitable assets available for grantmaking. The valuation and performance tracking of the “impact side” of an impact investment has been a more complicated and qualitative endeavor. But the impact investing sector is mature enough now that common platforms like Morningstar give a sustainability rating. There is also solid accounting guidance and numerous resources to help measure impact and the social return on investment.
2. What type of impact investments can I recommend for a DAF?
Like other investments, impact investments are designed in different asset classes for all different types of investors. There are traditional and nontraditional platforms, low risk and aggressive, short- and long-term. The most common options, where investors and their professional advisors often feel the most comfortable, are public investments like ESG portfolios or negative screen investments that avoid industries that investors view as harmful, like fossil fuels or weapons manufacturing. There are also private investments that allow donors to invest directly in companies with missions or business activity that drive solutions to environmental or social challenges, or to invest in private funds with an investment thesis focused on improving their communities and beyond. Recoverable grants, private equity and venture philanthropy funds are also impact-investing strategies that donors may recommend for their DAF assets.
It’s important to understand that risk tolerance often changes with philanthropic capital. Just because your client has a certain strategy for their 401(k) doesn’t mean it will translate to their DAF. In fact, one study from the Center of Philanthropy at Indiana University found that donors are less risky with a philanthropic portfolio than they are with a personal one. More than a quarter (25.7 percent) of donors reported that they were “not willing to take any risk” with philanthropic assets, but only 10 percent reported the same with personal assets.
3. Are there any impact investments I can’t recommend for a DAF?
Each DAF charitable sponsor has its own investment policy. The sponsor will review every investment recommendation for any DAF, be it an impact investment or not, for compliance with their investment policy. In general, DAF sponsors need to ensure there’s sufficient liquidity to satisfy grant-making and fees. This can affect certain types of impact investments, like promissory notes with specified time commitments.
Some smaller DAF sponsors only offer a small selection of traditional investment pools, while others allow custom investment strategies that can include private impact investments.
4. How do I choose a focus area?
It’s as simple as thinking about what investors want to accomplish with their wealth. It’s rare that investors want to build capital just for the sake of building — they want to do something with it. Perhaps the investor who loves to travel would be interested in impact investing that focuses on alleviating poverty in a part of the world that he loves. Maybe the successful business owner wants her investments to align with companies that have women in leadership positions in a gender-focused impact option. Clients who are already philanthropically active likely have a good idea of what causes and organizations they want to support, and it’s almost guaranteed that they can find an impact investment that can amplify their giving.
According to a recent study of high-net worth donors, of those who participate in impact investing, more than two-thirds (68 percent) do so in addition to their regular charitable giving. What’s more, according to the Global Impact Investing Network, investors are happy with their impact strategies. The vast majority report that their impact investments either meet or exceed performance expectations on both the financial side (88 percent) and the impact side (99 percent). There are more than 728,000 DAFs in the U.S. that collectively have $121.42 billion in charitable assets — that’s a lot of potential to double down on doing good.