For all their talk about innovation, foundations are in the grip of self-imposed constraints that limit their ability to undertake truly innovative activities.
The problem is that most foundation board members believe their primary role is to uphold their fiduciary duty to preserving a foundation’s assets and to follow a donor’s intentions, when in fact their top allegiance should be to the beneficiaries of their foundation’s work.
It is time for a new interpretation of fiduciary duty that focuses squarely on a foundation’s obligation to its beneficiaries.
If foundations took such a view, they would act completely different. Take decisions about how much of a foundation’s endowment to give to charity every year. The legal requirement to spend at least 5 percent of assets each year is based on the idea that requiring foundations to spend more would mean that some foundations’ assets would eventually run out, and that would be a problem for funds designed to operate forever.
But the real question for foundation board members is not how to meet a legal requirement; instead they must decide whether it is wise to give more to beneficiaries now. Unless the donor has stated that he or she wants to guarantee the foundation will operate forever, there’s nothing wrong with spending more, and perhaps doing so will guarantee that the foundation does a better job of meeting its mission.
A similar situation confronts board members as they contemplate whether to offer nonprofit groups low-cost loans and undertake other so-called program-related investments, finance advocacy work, or support for-profit companies, individuals, or other entities that do not have charity status. Such actions are clearly allowed by law, but foundations are often reluctant to try such tactics because they consider them too risky.
This tension between protecting the organization against risk versus maximizing returns to beneficiaries also exists in the for-profit world. But while corporate leaders may inappropriately take actions with the best interest of their organization in mind, it is clear that their fiduciary duty is to their shareholders.
If the board of a public company finds that it can maximize shareholder value by liquidating or otherwise closing down, its obligation to do so is clear.
Organizations, both for-profit and nonprofit, exist as vehicles to produce value. They have no essential value in themselves.
They are simply useful constructs for generating value to shareholders or beneficiaries.
Asking foundations to change their interpretation of fiduciary duty is no trivial matter. In 1994 a major shift in the approach to making fiduciary investment decisions was ushered in by the Uniform Prudent Investor Act, devised by a group that recommends how states should shape their laws.
The act, which has been adopted by many states, instructed fiduciaries to evaluate the appropriateness of individual investments within the context of a portfolio rather than in isolation. That shift allowed even conservative investment accounts such as pension funds, to place a portion of their assets in risky investments as long as they constructed a diversified portfolio.
Interestingly, private foundations and university endowments have been some of the most aggressive at shifting their approach to investments as a result of this reinterpretation of fiduciary duty.
While historically those groups deployed simple, conservative investment strategies, the new approach to exercising their fiduciary duty transformed their activities.
The financial experts who oversee university endowments in particular are now considered to be some of the most sophisticated investors in the world and deploy some of the most cutting-edge investment strategies.
Why then do foundations approach nontraditional activities that are clearly legal and very much in the best interest of their beneficiaries with such trepidation?
The fact is that the biggest risk of these activities is the foundation’s reputation.
Not pursuing them increases the risk that a foundation is unable to assist its beneficiaries.
Even though many foundations say they are set up to serve “at-risk populations,” the fact is that grant makers who strive to limit risk to themselves are actually transferring risk to the very people they seek to serve—and those who are least able to absorb additional risks.
One of the most basic rules of investing, both for-profit and philanthropic, is that risk and return are correlated. Those who seek to maximize return must be willing to bear additional risk.
Foundations, by virtue of their ability to make decisions without any obligation to answer to voters or shareholders, are in a unique position to absorb risk in the pursuit of social impact.
Just as corporate board members and officers should make decisions based on what is best for shareholders, foundation board members and officers should interpret their fiduciary duty as requiring them to act in the best interest of their beneficiaries.