Freeing foundations to invest for impact
INVESTMENT RULES SHOULD ALLOW FOUNDATIONS TO PRIORITIZE SOCIAL GOOD
Canadian charitable foundations manage assets worth more than $60 billion. That pool of money could make an enormous difference if invested in projects like affordable housing, clean technologies or support services to help disadvantaged Canadians find secure jobs. Although charitable foundations exist to further exactly these kinds of social causes, most of that $60 billion is currently tied up in conventional stocks and bonds.
The reason: While a range of impact investing activities are currently permitted, regulations tend to discourage foundations from investing in some ways that maximize their social impact, and indirectly prohibit others.
Until recently, foundations were not permitted to invest in limited partnerships – a type of vehicle commonly used for impact investments – because under the law they would be deemed to be running a business, which created legal and tax complications. In 2015, the federal government committed to changing the rules to allow such investments.
However, other legal and regulatory hurdles remain. A key one is the interpretation of the “prudent investor test.”
The trouble with prudence
Each year, charitable foundations must disburse 3.5 per cent of their assets as grants to good causes. Under current rules, the remaining 96.5 per cent must be managed “prudently” – a nebulous term that most investment managers interpret as a duty to maximize financial return. Impact investments that are expected to provide a substantial social dividend but a slightly lower financial one are a grey area and foundations are wary that they may fail the prudent investor test.
For example, under our current system a cancer charity foundation could be considered prudent for investing in a tobacco company yet imprudent for taking a stake in a social enterprise that promotes healthy eating.
We believe that this should change.
In our view, giving consideration to both the social impact and financial returns of an investment is a highly prudent action and foundations should be encouraged to think in this way. We recommend that Canadian provinces, which are responsible for regulating these investments, clarify the rules by creating a “safe harbor” provision for impact investments.
One option is for this provision to exclude impact investments that relate to the foundation’s stated social mission from the prudent investor test – giving investment managers confidence that they wouldn’t fall foul of the rules in taking such opportunities.
If foundations moved just 10 per cent of their assets into impact investments that would release billions of dollars to support projects that are making a difference to communities across Canada.