Leena Bhutta is the chief investment officer for the Doris Duke Foundation.We live in interesting times. Much has been written about the rise of social media, its effects on democracy and the implications for discourse. Everything has become a fight, and all forces coming at us want us to choose left or right, red or blue, us or them.
The investments field, especially institutional investing, is unfortunately not spared this fate either. For instance, this may have been the first presidential primary debates season where BlackRock’s investment strategy was a talking point! Twenty-two states have introduced some form of “anti-ESG” regulations, with more than 75 bills pending in various legislatures. The Fearless Fund, a venture capital fund focused on supporting Black women entrepreneurs, has faced legal challenges, stemming from the Supreme Court decision on affirmative action. Prominent hedge fund managers, amid very public social media meltdowns, are waging war against diversity, equity and inclusion.
In this polarized environment, investment professionals at mission-oriented organizations may be tempted to shy away from the noise and “stay in their lane.” However, for those within organizations striving to effect real change, divorcing capital management from societal challenges, whether climate change or systemic inequity, seems shortsighted and unsustainable. While mission-driven investing may be getting maligned from different directions, many investors will forge ahead with existing strategies while some will quietly forgo the emphasis on mission. Maybe what all the drama should compel institutions to do is to examine if current strategies are the most effective or if there are other ways to achieve similar goals.
At the Doris Duke Foundation (DDF), we have re-examined what we mean by mission-aligned investing, what it aims to achieve and how, as well as what it precludes. Our impact investing program began in 2019 with the mandate of investing up to 10 percent of the endowment over 10 years in investments that align with DDF’s mission areas — performing arts, medical research, environment, child well-being, and building bridges. The premise was that impact investments will range from very concessionary returning investments to market rate opportunities and everything in between. The experience over the past five years, along with the rapidly changing environment, has led us to a new and clearer approach.
Framework for a New Approach: Integrated Impact Investment
The medical research mission at DDF has been an interesting case study for us as an example of a field where impact outcomes and return outcomes work in conjunction with each other. The programmatic side’s long-term objective is to advance the prevention, diagnosis, and treatment of human disease through medical research. More recently, a new strategic priority of this program has evolved in the direction of maximizing support for scientists who are pursuing creative, innovative research with high potential to improve human health. Both the broader mission and the new targeted strategic priority line up well with the private markets associated with life sciences venture as well as with the opportunity associated with companies establishing more effective patient care practices.
The life sciences venture ecosystem takes risk capital and invests it in promising cures for diseases affecting large populations. The therapies that succeed go on to commercialization, either as stand-alone entities or with partnerships with large pharmaceutical companies that bring their scaling expertise to these cures. Backing life sciences venture firms that focus on very early-stage ideas and incubating companies around those research ideas until they reach some commercial potential is an example of an investment out of the endowment that has the potential of achieving both high returns and high-impact and commercial-scale cures for disease.
This experience, along with both investing in or unsuccessfully looking for investments aligned with our other mission areas, has led us at the foundation to codify some of the interesting lessons of impact investing:
- Economic rents correlating to the provision of a social good are possible but not universal. Therefore, not all programmatic areas will have the opportunity to invest in productive impact investments.
- Where concessionary capital is needed, rigorous questions have to be asked and answered — whether a concessionary return or pure grantmaking is the right approach. Often, the “middle approach,” i.e., hazier impact objectives and below-market returns, is not an optimal use of either endowment capital or programmatic budgets.
- If the endowment aligns with its values but only looks in areas where there are private market rents, then an artificial cap on aligned investing is not necessary. Instead, these mission-aligned investments should be subject to the same portfolio management constraints that any other investment would be subject to.
Leaning on these insights, we have established a framework at Doris Duke Foundation for how we will align the investments and the mission and values of the foundation:
We aim to pursue an approach we call integrated impact investing. We define integrated impact investing to be the application of investing concepts as a strategic tool for maximizing the mission-aligned impact achievable by all the foundation’s assets and activities.
What does that mean? Everyone working at the foundation becomes an impact investor. Those working on the investments team are looking for markets where the financial return and the impact objective are correlated, along with other investment areas they are researching. Those working on the programmatic side of the organization think about their fields with a broader toolkit in hand, with PRIs and other forms of concessionary impact investments sitting squarely inside programmatic strategies and teams.
This effort aims to remove the hazy middle — where both the impact outcomes and the return potential are suboptimal and leads to investments that neither the endowment nor the programmatic teams fully own.
Doing the above effectively will require acknowledging the inherent constraints faced by investment capital vis-à-vis non-investment aims. While capital can fund direct programmatic strategies, investment opportunities where both impact and returns are available can often be limited. The limitations typically lie in the absence of economic rents associated with certain sectors. For example, at DDF, the key strategy that is emerging in our child well-being program is to provide an alternative model to the current foster care system, which routinely fails children and families in this country. Both the problem and the solution lie squarely in the policy world. As impact investors, we tend to be hard-pressed to find scalable solutions in the private markets that will create real impact along the lines of this particular problem and its practical potential solutions. Using capital that requires market returns to pursue impact objectives, and not clarifying the goal for that capital nor examining what other types of funding may be better suited to achieve those impact objectives, has the potential of leaving impact investing programs in suboptimal investments.
It is important to acknowledge here that different types of allocators face differing constraints. Pension funds in states with tough anti-ESG legislation will clearly have to make different choices than foundations with big environment programs. Similarly, university and college endowments face different pressures and have to balance the voices of not only different constituents today but do that while balancing the needs of future generations of students. Even within the same space, scale differences will lead to different approaches being relevant. Very large foundations can and have effectively created carved out programs with concessionary impact investments that are moving the needle while not impacting the corpus due to their concessionary nature.
The three-letter word: ESG
One clear target of the pitchforks today is an approach that had gained a significant amount of traction in the responsible investing world – an emphasis on environmental, social and governance principles. Analyzing ESG factors of an investment essentially spawned a whole industry of ESG data measurement companies, research outfits, and ESG-focused funds. In a world of low interest rates, many industries and ideas were doing well and considered a panacea. As markets have corrected in a rising interest rate cycle, ESG’s limitations as an investment strategy also have been made clear. However, the pendulum in sentiment is risking throwing out the proverbial baby with the bathwater.
Although ESG has been used by many private equity firms as a fundraising tool and many politicians as a battle cry, it is neither a cohesive investment strategy destined to outperform (clearly) nor an evil that has befallen the financial markets robbing retired firefighters and nurses of their deserved pensions. ESG is a risk framework, assessing the risks to companies from any or all three of the above areas. All astute managers, whether or not they label their research activities in these terms, are making some assessments on these factors when investing in public or private companies.
According to a study by the Drucker Institute at Claremont Graduate University that analyzes corporate effectiveness data across several management metrics, the biggest gainers in overall corporate effectiveness from 2018 to 2023 also showed the most significant improvements in social responsibility metrics. The findings are quite logical since clearly management teams that are effective at their jobs will also be effective at reducing the negative externalities caused from practices that are unsustainable.
Whatever investors decide to call it, common sense indicates— and data shows — that strong corporate management will work to limit their risks stemming from environmental factors, labor practices, and regulatory trends.
A Note on Concessionary Investing
Another limitation to letting the mission affect the capital allocation is how much concession in returns is accepted and what that does to the long-term health of the corpus. Impact investing programs have often created novel structures and invested in impactful strategies that accept some form of concession in return. The challenge with investing in strategies that by their design accept a concessionary return on investment dollars is the inherent limit to how much of the corpus can invest in such strategies, without impairing the long-term health of the endowment. At the largest foundations, even a small percentage allocated to such projects can move the needle in terms of impact and create substantial opportunity for fund managers raising capital. But as smaller organizations try to decide how much of their portfolios should reflect their mission and values, concessionary returns put real limits on how much can be allocated with that ethos.
What Needs to Be in Place for Effective Mission-Aligned Investing
Whether organizations engage in impact investing or efforts to broadly align their endowment dollars with other values (such as diversity, equity and inclusion), high-quality governance and management structures would have to be in place for the efforts to succeed. Often, the competing agendas inside an organization or confusing governance compels investment teams to retreat and protect — a rational response for fiduciaries whose job is to protect and grow the corpus longer term.
A few key ingredients need to be in place:
1) Governance Commitment
Those of us accountable to boards and investment committees have seen how what gets emphasized at these governing bodies shifts, especially as transitions happen. Some board members care a lot about DEI, others about sustainability, while many may exhort investment teams to just focus on returns. What effective mission-aligned investing requires is a real commitment by the board, usually led by at least one or two champions. Once the commitment and the buy-in is in place, communication becomes very important. The communication between the board/investment committee and the investment team has to be seamless and effective with everyone understanding what the push and pull is in evaluating decisions around mission alignment. Not only does there need to be a shared understanding of what is being invested in and the risks being taken on; there also needs to be a shared understanding of the opportunity costs for the portfolio of the assets or asset classes that will not be invested in. For instance, as a climate funder, DDF does not seek active investments in energy managers. However, it is imperative that we explain to the board (and remind them often) the opportunity costs to the portfolio of doing that in a world where the energy transition also contributes to energy inflation in the medium term.
2) Organizational Buy-in and Integration
What will lead to a coherent alignment between investing activities and mission activities is a consistency to the strategic direction of mission activities. If programmatic strategies zigzag, it would be almost impossible for the investment team to consider making investments that are in alignment and be able to hold them over the long term. Integrating efforts across the organization will lead to more coherent strategies, both on the return-seeking side and on the impact side.
3) Continuous Learning and Commitment to Rigor
As many managers who are either investing for impact or are diverse-owned tend to be newer, there has to be a learning curve associated with identifying and vetting these strategies. Some areas might work well, others might not, and impact investing programs have to be open to the idea of a continuously learning mindset. We have learned many lessons, especially investing in the “hazy middle” — where everyone around the table was excited about the potential of an investment’s impact and optimistic about its returns but when results started coming in, neither the impact achieved was very strategic to the program nor did the investment return earned meet our cost of capital.
Where Can Interested Investment Teams Start?
First, dedicating research time to areas where there may be both desired impact and financial returns seems like an obvious place to start. There are emerging technologies to be understood, for instance, in the energy transition space. Similarly, large swaths of established industries are trying to reduce their carbon footprint. All this change creates investment opportunity for managers looking for ways to create both financial return and impact.
Second, how the investment process is executed can also take into account the mission and values of the organization. The clearest example of where this can have an impact is investing in diverse managers. If we continue to look for cohesive teams that are easily referenced, that have established track records of many years when underwriting new investments, the opportunity for diverse managers to raise capital remains limited. Modifying investment processes to recognize the inherent biases in them but also to rectify these biases is a worthy effort for investment teams representing organizations where the mission and values emphasize a more inclusive society.
Third, portfolio construction can also be designed with flexibility to align with mission-oriented goals, and, in some cases or specific asset classes, may call for a relatively less concentrated approach.
Conclusion
Incorporating mission and values into the investment program of a mission-oriented organization will continue to be hard — the bar is high and appropriately so. There are not many impact areas where return-seeking capital is the right answer, and a lot of prerequisites need to be in place in an organization for this to be a productive pursuit. However, for organizations with multidecade (and longer) time horizons and timeless values that are central to their purpose, falling prey to the news cycle, and the noise around the demonizing of an alphabet soup, is a risk none of us can afford.
Leena Bhutta is the chief investment officer for the Doris Duke Foundation.
