Donor-Advised Funds Are an Untapped Source of Impact Capital

The National Philanthropic Trust’s (NPT) 2017 Donor-Advised Fund Report found that the capital housed in donor-advised funds (DAFs) across the United States exceeded $85 billion in 2016. This represents an almost 10-percent increase since 2015 and a 28-percent increase since 2012.

Nick Salter, founder and principal of the advisory firm Progressive Philanthropy Group, noted that most of the $85 billion housed in DAFs is philanthropic capital used solely for grantmaking.

However, Salter said, there is a “huge missed opportunity to move DAF capital into impact investing.” Using capital from DAFs to fund impact investments in addition to or instead of grants heightens the impact of that capital since it can be reinvested over time.

A DAF, defined by NPT as a “philanthropic giving vehicle [that is] administered by charitable sponsors,” acts as a personal charitable investment account.

Philanthropists establish DAFs at public charities including community foundations and nonprofit organizations. These organizations also include the charitable arms of commercial investment firms like Fidelity, Schwab and Vanguard. These entities, called DAF sponsors, house and administer fund contributions based on their clients’ instructions.

Upon contributing funds to a DAF, donors can take immediate tax deductions on the full amounts they contribute. Donors are then able to invest those funds in charitable organizations of their choosing at any time. Contributors cannot benefit personally from the returns on DAF capital once resources are transferred to fund administrators.

Surge in Performance

The National Philanthropic Trust’s report links the recent surge in capital housed in DAFs to strong stock market performance, as well as growth in the number and average size of DAF accounts nationwide.

According to Salter, growth in DAF capital is primarily driven by funds administered by commercial sponsors. However, he said the number and size of DAFs sponsored by community foundations and nonprofits are also growing.

Sally Boulter, senior engagement officer at the financial services firm ImpactAssets, attributes the growing popularity of DAFs to the ease with which these funds can be set up and managed over time. “You just need your name, address, and [an idea of] how you want your money allocated and you’re good to go.” DAFs are easy options for donors in the long term too. DAF sponsors take care of ongoing administration.

For many of the donors Salter works with, DAFs present a “less bureaucratic option than setting up a private foundation.” Additionally, DAFs are less expensive to establish and manage and don’t require an annual payout of five percent like their foundation counterparts do.

Unlike foundations, DAFs can also be set up anonymously. Boulter considers this a selling point for many donors. “With the growing wealth disparity, there are fewer people with means - and they might not want to be known or recognized.”

While Salter said the total dollars housed in DAFs are increasingly driven up by large donors opening multi-million-dollar accounts, DAFs also provide an opportunity for donors along the socioeconomic spectrum to invest charitable resources.

According to Boulter and Salter, these funds can have a democratizing effect on impact investments, making it possible for people of multiple socioeconomic backgrounds to engage in mission-driven investing.

Investments with Impact

As the capital housed in DAFs nationwide continues to grow, these resources are increasingly being deployed to fund impact investments.

“This work has taken off,” Boulter said. “We’re past the inflection point and it’s more and more mainstream. Most financial firms at least offer environmental, social and governance-screened mutual funds now.”

Tracey Hsu, director at Social Finance, said she attributes this growth to broader trends in individual philanthropy. “There is energy around charitable giving generally, and around the notion of solving for risk and return as well as impact.”

In the wake of these trends, investor demand for impact investing products is mounting. In January, Fidelity Charitable launched investment options for donors who “seek strategies that consider social and environmental factors, while also emphasizing financial returns.”

Boulter said she is hopeful that Fidelity’s new offerings will pressure the rest of the field to offer similar options to DAF-holders elsewhere.

Challenges to Scale

While DAF capital is increasingly used to fund impact investments, the scale of untapped potential for work in this area remains enormous.

“You’d think donors would have a different risk-reward metric [with DAF capital] than with their own money, but that’s not happening,” Salter said.

For this work to take off, Salter said, there needs to be “more direction and encouragement from DAF sponsors.” Sponsors could prompt donors’ awareness and interest by introducing DAF-holders to impact investing options upfront, pairing donors with financial advisors who understand the charitable issues they care about, and crafting products that meet individuals’ philanthropic goals.

Hsu said education efforts can also help prevent donors and advisors from parking capital in DAFs for extended periods of time without deploying it for impact.

Salter and Hsu said achieving and demonstrating the “deep impact” that mission-driven investors desire can also be difficult, so they hope to see more products on the market that connect donors to deep investing opportunities with measurable impacts. For them, that means opportunities that go beyond environmental, social and governance mutual funds.

However, defining and tracking impact remains a challenge. Social Finance focuses much of its work on linking demonstrable social and financial returns – an “act of translation” that Hsu said is “both an art and a science.”

Hsu said this work requires the field to ask big questions such as: “What is impact? What are we looking to achieve? Over what period of time? And how do we tie impact to financial returns?”

Hsu and her colleagues address these questions with their work to segment and define impact investing products by evaluating donors’ interests, identifying desired outcomes, and gauging interest in impact investing.

In the long-term Hsu hopes that this work improves donors’ abilities to articulate the impacts they desire at the outset and prompts donor demand for impact investing products.

Funding Land Conservation

In Vermont, the Vermont Land Trust (VLT) and Vermont Community Foundation (VCF) have put this work into practice. VLT uses capital housed in DAFs at the VCF to fund land-acquisition projects throughout the state.

Once land is acquired, VLT places conservation easements on these properties and resells the land to mission-aligned buyers. Funds from the sales are then used to repay investors at a below-market rate of return.

VLT has paired funds from DAFs housed at VCF with other resources, growing the total revolving capital on its balance sheet to approximately $8 million.

According to Nick Richardson, president of VLT, “we haven’t had to use land trust funds to acquire land because we have a pool of lenders” who provide low-cost, patient capital. This revolving fund allows the land trust to act quickly when property goes on the market and to purchase priority parcels without risking the organization’s financial health.

The growth of the program itself and the accelerated pace of conservation it has enabled are major successes, Richardson said. In addition, this work has helped VLT to accelerate the pace of transitioning agricultural land in VT to new farmers. This is an investment in the future vitality of the state’s working lands.

According to Richardson, it took a lot of players on different sides to bring this concept to fruition. Leaders from the land trust and community foundation, as well as donors, advocated for and collaborated around the idea. After four years of working together, Richardson said VLT and VCF’s partnership has “opened new possibilities for us to work together on more complicated financing ideas in future.”

This model as potentially replicable for land trusts across the country, Richardson said. The first step is for land trust leaders to get to know their local community foundations. After this relationship has become strong, “there may be a role for land trusts that are interested in activating and accessing capital for conservation to help community foundations understand that they don’t have to make up something new… There are good examples of this work elsewhere.”

Richardson said land trusts can play a role in connecting community foundations to peers like VCF that have pioneered this work as well as building bridges to help them reach other resources.

As DAF sponsors, community foundations are naturally well-positioned – more so than commercial firms with a global reach – to help donors achieve local place-based impact.

However, Richardson said, in some instances a shift in community foundations’ mentality is required. Foundations need to pursue their missions “with an urgency and boldness that will lead to more interesting thinking about who their partners are. This requires a move from a capital preservation model to a capital activation model.”

Note: Three quotes by Sally Boulter and one quote by Tracey Hsu were edited on 8/28/2018 based on source feedback.

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