Money with a mission
Since the start of the 1990s, foundations have grown significantly in numbers and importance. According to the European Foundation Centre, which represents grant-making foundations and trusts, about half the registered foundations in Italy and Germany have been created since 1990, while countries including Belgium, Finland, France and Sweden have seen the number of their foundations rise between 19% and 29% since then.
But in spite of this increase in their numbers, European foundations are still somewhat conservative when it comes to their investment policy, according to a recent survey.
Less than 20% of respondents to a survey by international consultants Watson Wyatt think that foundations’ investment portfolios should be globally diversified, although almost all agreed that diversification is essential for a sound investment policy.
The Watson Wyatt European Foundations’ Survey 2004/05 was carried out in four European countries – the UK, Switzerland, Germany and Italy. The first three countries, together with Denmark and Sweden, are considered to have the largest number of foundations in Europe, while Italian foundations have one of the largest asset bases in Europe.
The resistance to globally-diversified portfolios is shown in the average asset allocations of the 250 foundations taking part. The report says: “Investors prefer domestic to foreign assets – more for the comfort factor than for reasons of financial efficiency.”
Respondents were asked to choose the composition of an investment portfolio for a foundation similar to their own, from four different options.
For British charities, the most popular option, chosen by 49% of respondents, was a geographically diversified portfolio with a preference of domestic assets. Then came mainly domestic assets (25%), followed by mainly pan- European assets (11%) and a portfolio as geographically diversified as possible (7%), with the remaining 9% expressing no preference.
Italian foundations also showed a domestic bias, with 41% choosing diversification with a domestic preference, although the next most popular category was mainly pan-European assets (26%), followed by domestic assets (10%) and a fully diversified portfolio (15%).
At the other extreme, 47% of German respondents preferred pan-European assets, 16% preferred a fully diversified portfolio and 17% opted for domestic assets. Swiss respondents were divided between 45% in favour of domestic or predominantly domestic assets, compared with 38% in favour of a fully diversified or pan-European portfolio.
But Gerry Salole, chief executive officer of the EFC, says: “It is predictable that there is home bias in investing by foundations. The ability to do things on a pan-European scale is quite new and accepting Europe as a single market is only just becoming a reality. It is also predictable that foundations are investing in domestic markets, because that’s what they see as keeping to the mandates which set them up. These organisations are faced with the question of how they stay true to their mission while also taking on the context of the changing world, which is a huge challenge.”
As with many surveys, it is difficult to apply a blanket generalisation to the entire sample, in this case, four different countries.“Things are not as simple as they appear to be in the survey’s conclusions,” says Salole. “Continental Europe is made up of different regions and each country has its own character. So a continent-wide way of looking at these issues is still a long way off.”
However, Salole says that some foundations are increasingly diversifying their investments in line with the increasing scope of their missions.
“Furthermore, with the introduction of the euro, the fact that some countries are sharing a common currency helps diversification of investment,” he says. “But in some European countries, there are still legal restrictions to a foundation’s investment policies.”
He also says there are layers of complexity involving a foundation’s work in the field, which the survey does not address. “Again, this comes back to the purpose of the foundation,” he says. “For instance, the international diversification of investments might make sense where the foundation’s work becomes more international. If, however, its purpose is the development of the region where it is based, it may be appropriate to invest locally as well.”
Davide Tinelli, chief investment officer, Compagnia di San Paolo, one of Italy’s biggest foundations with e8bn in assets, says: “It may be the case that European foundations have a conservative asset allocation, for instance, with a home bias in equities. But then, if the target – for example in Germany and Italy – is to maintain the real value of the assets, why should they invest so much in equities? In any case, at present UK pension funds – which traditionally have a bias towards equities – are reviewing their fixed income portfolios and buying bonds which yield less than 1% in real terms for 50 years in real terms. So the pendulum could be swinging the other way.”
Compagnia di San Paolo is reviewing its own asset allocation and introducing absolute return strategies which include both hedge fund and long-only managers.
“This changes the framework,” says Tinelli. “It’s not just about equities versus bonds, but about the ability to select active managers.”
One of the issues which differentiates the European foundation sector from what is considered to be its rather more developed counterpart in the US is the relationship between spending and investment policy.
“In order to retain their tax status, US foundations are obliged to pay out an amount equal to 5% of their capital each year,” says Ric van Weelden, senior investment consultant, Watson Wyatt. “That means they have to optimise their returns so they can pay out this amount without undermining the foundation’s long-term financial health.”
In contrast, the survey shows that most European foundations appear not to see a connection between spending and investment policy. Only 28 – 38% of the respondents said that investment performance was an important factor when deciding the level of their disbursements. And around 45% of foundations with target spending rates above 4% of assets indicate optimal equity allocations below 25%, which the survey authors consider to be unrealistic in the current market environment. “This raises the question of whether foundations need more explicit guidance on how to set long-run expenditure targets,” says van Weelden. “Local regulators are looking into making foundations more accountable. But this is a limited area, and would cover endowed foundations rather than fundraising charities.”
Tinelli says that statements of investment policy start from the liability side of foundations.
And he says, “At the end of the day, people running pension funds work with money in their professional capacity, so that goes for their trustees as well. In contrast, professionals running foundations have expertise in the relevant areas such as health care, so their trustees may be far removed from the world of investing. But things are improving a lot.”
Salole says: “We welcome this kind of research, as we need to better understand foundations’ investment policies in practice. However, the organisations in the sample are too different for this level of comparison. Over 40% of the sample relates to fundraising charities and therefore too large a slice of the sample does not generate income from investments. On the other hand, many UK charities have diverse sources of income, so that explains why they are more likely to have diverse portfolios.”
He says that different foundations value their assets in different ways.
“You need to look at how they carry out valuations before you calculate their expenditure,” he says. “For instance, book value and market value are very different. And some institutions have assets in very different kinds of fields, such as real estate in very different contexts – some very profitable and others in depressed markets. Therefore it is not easy to predict any payout that emanates from these assets.”
The survey found that less than 40% of respondents saw maximising return as a key role of fiduciary board members. Instead, they considered alignment with the corporate mission and safekeeping, as more important.
“The responses showed that foundations need to be more effective as individual entities,” says van Weelden. “Investment performance must improve if you sharpen your investment efficiency.”
But it is not just about increasing the rate of return, says van Weelden. “People should be aware of the amount of sub-optimal risk, and should optimise performance as a unit of risk taken.”
Salole says: “It’s not just a case of maximising return. Some foundations are looking at their mission, and looking at the resources they put into the field in a responsible way. If they were only interested in raising as much money as possible and then not spending it on their requirements, they might end up spending for spending’s sake to meet an artificial expenditure rule. But some foundations have a very wide mandate and also have to look at their core values, mission and donor intentions. So there is a need for further research in terms of how return relates to the organisation’s general inputs and mission, for example, its stance on sustainable development or civic rights.”
Furthermore, Salole challenges the assumption that in the US, there is an obsessive drive to maximise return.
“Even in the US, foundations do not always think that financial efficiency is paramount,” he says. “Very often non-financial factors could play as great a role as does financial efficiency, and that can have an effect on the charity’s investment programme. And if the institution is operating in the same areas from where its resources come, that introduces another set of issues, some of which may conflict with the ideal of financial efficiency.”
Tinelli says: “Italian foundations have a legal requirement to safeguard the real value of the assets they possess. So it is not our mission as such to maximise returns. Our foundation has targets over a long-term horizon to ensure we do not spend too much money.”
Meanwhile, van Weelden says there are historical reasons for some of the perhaps old-fashioned attitudes of foundations.
“Some organisations are blissfully unaware of the need for diversification – for instance, many German foundations invest in just one company, which is run by the family that set up the foundation in the first place,” he says.
And van Weelden explains that in Italy, many foundations were funded by the demutualisation of savings institutions in the early 1990s. This has meant that many of them hold assets made up largely of shares in banks.
But in the mid-90s, the Italian government passed regulations to encourage foundations to invest outside the banking system.“Some foundations have made major allocations away from that, but others still invest in the local bank,” says van Weelden.
This lack of sophistication is not surprising, given that only 5% – 13% of respondents said that investment policy was often discussed in the boardroom. This compares with the 88% to 92% of respondents who said that their foundation’s operations were often discussed.
“What they should be doing is what Myners recommends for pension funds – they have to be aware of investment efficiency, what they should be doing internally and what should be outsourced,” says van Weelden.
Asked whether key investment decisions should be delegated to experts, the survey shows a noticeable split on national lines, with 67% of the British and 54% of the Italian foundations agreeing. But 62% of the Swiss and 47% of the Germans disagreed that these decisions should be outsourced.
The report considers that one reason for this split is that both Italian foundations – respondents in the sample were largely of banking origin – and UK charities are subject to more transparent reporting standards which put the spotlight on board members if investment decisions turn out to be wrong, or when investment performance is disappointing compared with their peers.
“Unlike UK charities, most continental European foundations feel that internal expertise is preferable to external advice,” says van Weelden. “But if they don’t want to delegate, do they have the resources to build up their portfolios? Things will slowly change, however.”
For those foundations which do outsource their investment management, there is a sharp difference between UK and continental European entities.
In Europe, brand recognition plays an important role when selecting fund managers, whereas in the UK, the track record, as well as “people” factors, topped the list of preferred criteria.
“This emphasises the issue of how foundations should choose the right mix of ‘hard’ and ‘soft’ factors when picking external fund managers,” says van Weelden. “The question is whether they have enough internal expertise to process large quantities of complex information, or whether they simply follow what their peers are doing.”