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​Finnish foundations active but lack governance, study shows

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Finland’s biggest charitable foundations are active direct shareholders, but many lack strong governance mechanisms within their own structures, according to a survey.

It also showed that the €20bn-worth of assets controlled by Finnish foundations are heavily concentrated within the country itself, with little diversification of direct equity holdings.

The survey, which analysed a sample of 900 Finnish foundations as investors, was commissioned by the Finnish Foundation for Share Promotion in connection with a new law for Finnish foundations, which is currently being drafted.

It is the most comprehensive survey yet of Finland’s 2,850 foundations, covering the 10 years up till 31 December 2013.

With assets of €1.5bn, the largest entity is the Kone Foundation, which promotes Finnish research, arts and culture.

The next biggest are the Aalto University Endowment and the Finnish Cultural Foundation.

The 10 largest foundations all have portfolios worth more than €1bn each, while the 50 largest control 77% of all assets by value.

Typically, the biggest portfolios are made up of 62% in equities (mostly held directly), 17% in fixed income, 15% in real estate and 2% each in alternatives and cash.

And more than 70% of foundations’ assets are invested in Finland – in equities, real estate and euro-denominated fixed income assets.

According to the survey’s author Eeva Ahdekivi, researcher at Aalto University in Helsinki, this is because of favourable tax treatment, since foundations are exempt from paying any tax on investment income arising from domestic equities.

In contrast, foreign dividends may be subject to, for instance, withholding tax.

It is also a result of preference for investment items that foundations can understand and follow over the long term, she added.

“The largest foundations are long-term equity investors,” Ahdekivi said.

“This means they are risk-takers, but they mitigate that by investing close to home so they have local knowledge of companies. They achieve geographical diversification by choosing companies earning a large percentage of their revenue from global sales.”

However, even the largest portfolios contain a maximum of only 60 different stocks, with a median of only nine stocks.

Ahdekivi said this was because the Nasdaq OMX Helsinki Exchange only contained around 125 stocks, and foundations typically only held the largest and best-known companies.

She said that, in contrast with equities, there was more appetite to invest in fixed income abroad, as this was seen as a less risky asset class. 

Meanwhile, the allocation to alternative investments was very low.

Ahdekivi said one reason for this was that income from partnerships may be taxable for investors, which made private equity investments less attractive to tax-exempt foundations.

Average investment returns were also calculated for around half of the Finnish foundations sampled: these were 5.4% for 2012, the latest period for which figures were available.

The largest foundations told Ahdekivi they were incentivised not by dividend yields – as this could lead to value traps – but how strong a company’s value potential was.

These foundations all have consultancy relationships with asset managers, on a consultative rather than discretionary basis.

However, little money is spent on internal financial expertise, and it is often the foundation’s managing director who is in charge of investments.

The survey highlights the absence of strong governance mechanisms within many foundations.

Often, the board is the sole governing body, with no other forms of oversight, as foundations have no shareholders.

Financial information is published on the websites of less than one-fifth of foundations.

And in general, the non-profit sector is not subject to similar transparency requirements as pension insurers or listed companies.

Ahdekivi said most potential problems arising from weak governance were likely to arise among the longer-established, richer foundations.

She said: “Foundations with larger endowments are more open to moral hazard because of their financial cushion, which makes inefficiencies possible.

“For example, the board may be unwilling to carry out much-needed changes, such as a merger with a similar charity, which might improve mission efficiency.”

The new law on Finnish foundations is intended to update and clarify the existing law dating from the 1920s, in line with good practice.

It will include provisions on transparency, including the obligation to publish annual accounts, rules on the general duties of directors and on related party transactions.

There will also be specific guidance clarifying the existing legislation on investing by foundations.

The proposals are currently passing through Parliament, with enactment expected in the next few weeks, and will take effect from 1 October 2015.

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