INCREASING THE FLOW OF CAPITAL FOR GOOD - INVESTING AND GIVING
Should donors front load their giving to meet the challenges of today or create a legacy for future generations?
When Henry Smith, a London salt merchant, died in 1628 he bequeathed £2,000 to a charitable trust to tackle poverty and disadvantage. Nearly four centuries on, Mr Smith’s gift keeps on giving. Last year the Henry Smith Charity gave more than £27 million to charities assisting the poor across the country. Moreover, with an endowment of about £700 million, the Henry Smith Charity looks well set to carry on doing so for another four centuries or more. This achievement is all the more remarkable when you consider that if Mr Smith had put the original gift into a savings account index-linked to the rate of inflation (better than most of us are getting on our savings at the moment) his £2,000 would have grown to just £322,700 today. This really is the epitome of having your cake and eating it: through the centuries the trustees of the Henry Smith Charity have not only given money away to support good causes, they have been able to grow the real value of the endowment. So why are many of today’s donors, from Chuck Feeney to Bill Gates shunning the perpetual endowment model and committing instead to ‘spend down’ their foundation assets during their lifetime, or within a number of years of their death?
Henry Smith may, of course, be an exception. We would all love to know how his trustees managed such spectacular returns on the charity’s investment portfolio. (The initial investments were in farm land in what is now the fashionable London Borough of Kensington and Chelsea but the endowment is now invested hedge funds, stocks, property, and so on.) Until the financial crisis of 2008, through the long stock market boom known as ‘the Great Moderation’ that began in the 1980s, double digit financial returns may have seemed a possibility. But those golden years for investors now look more like the exception than the rule. Sluggish rates of return make it much harder to have your cake and eat it too, as some foundations have had to face a painful choice between preserving the real value of their capital or slashing grant-making. For donors that have the power to make a choice between those objectives (trustees may have their hands tied by the testator), capital preservation can take second place to charitable purpose.
Another good reason for front-loading giving rather than deferring it to the future is what economists call the ‘social discount rate’. The idea is analogous to a discount rate in finance: just as a pound today is worth more to me today than a pound in a year’s time, so a life saved today is more valuable than a life saved tomorrow. Or, in economist-speak, we need to take into account ‘time preference’. Applying a social discount rate is a standard tool in the appraisal of public investments. Current HM Treasury Guidance suggests a social discount rate of 3.5% . Given that a fair proportion of the money sitting in the endowments of charitable trusts has comes from taxpayers in the form of tax forgone on the original gift and/or the investment returns on the endowment, it is not unreasonable to apply the same test to philanthropic investments.
So, doing the maths so far, if an endowed foundation wants to do as much good in the future with its money as it could by spending it all today it needs to, first, protect from inflation (say 3%) and, second, take account of the social discount rate (3.5%), which requires an annual zero-risk nominal return on investment of at least 6.5%. Just to stand still. Worse, there is a decent case to be made that the social discount rate should be set much higher if trying to decide whether to administer a life-saving vaccine in a developing country today rather than tomorrow.
“I’m not sure in the current environment that [endowments] are a means to achieving anything”, observes Ian Marsh, who advises high net worth families, on the basis that most endowments will struggle to achieve a rate of return of more than 6%. “There is no doubt”, he adds, “that some people want to leave monuments to themselves.” So should foundations such as Henry Smith or newer creations, if they aren’t about creating monuments, give up on the perpetual model and join Messrs Gates and Feeney in a big splurge? Should governments cut back on the tax breaks for endowment-building investments to discourage this kind of warehousing of wealth?
The case against spend down is, first, that perpetuity may be a virtue of itself. The Henry Smith Charity was part of a broader trend in the 16th and 17th centuries for British philanthropists to create endowments as a deliberate choice. Their aim was to remedy a perceived problem of previous generations of philanthropists who had created chapels, schools, colleges and almshouses but had made no provision for their ongoing funding. Endowment was a way to spare these charitable institutions from a state of perennial financial crisis. (Lucky them! I hear today’s charity fundraisers cry.) And I won’t even go into the debate about whether private schools and Oxbridge colleges should be a priority for scarce philanthropic pounds. Right or wrong, Renaissance donors thought that this was an improvement on previous funding models.
The second argument against spend down is about whether the money can be spent wisely so quickly. Indeed, it was the problem of making money faster than he could give it away that inspired John D. Rockefeller to implant the idea of the endowed foundation into the giving culture of the United States a century ago. The ‘too much money, too little time’ dilemma is a concern for today’s donors too. George Soros, once an advocate of spending out appears to be reconciling himself to the fact that a fair chunk of his philanthropic capital is going to have to be spent after he has gone.
It is certainly the case that spending down is hard. Chuck Feeney’s Atlantic Philanthropies has not had the easiest of times in its twilight years. Yet there is, so far, a pretty limited evidence base on spending down, because so few foundations have done it.
“The risks are multiplied that you’ll waste the money if you’re trying to get it out of the door”, cautions Professor Joel Fleishman, author of the seminal The Foundation: a Great American Secret, who is currently working on a new project to assess the pros and cons of spend down. “Most of the foundations interested in spend down are new wealth, from the tech sector” he observes. “They are hands on with their businesses and want to be hands down with their philanthropy.” Yet that tech mindset also brings impatience borne of quick commercial success. “Social problems are more complicated,” warns Professor Fleishman. “There is a natural maturing process to solving a social problem.”
This is a fair challenge. Might ‘spend down’ become ‘spend, spend, spend’? Only time will tell as donors experiment with spend down strategies. But Prof. Fleishman’s challenge cuts both ways. There is a difference between taking a long term approach to solving complex social problems and dribbling out a few grants to ameliorate the symptoms of social problems in perpetuity. Creating an endowment should be a strategic choice based on a full evaluation of the (discounted!) costs and benefits of giving today or in the future, including the possibility of squeezing extra impact out of your capital through social investment.