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CASE: SI-76

DATE: 03/29/05 (R EV’D 09/12/07)

Lecturer Laura Arrillaga-Andreessen and Victoria Chang prepared this case as the basis for class discussion ratherthan to illustrate either effective or ineffective handling of an administrative situation. The Stanford Graduate School

of Business gratefully acknowledges the assistance of Giving 2.0 (giving2.com) in the development of this case.

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CA 94305-5015.

BLENDEDVALUE

In 2000, Jed Emerson founded the Center for Blended Value (www.blendedvalue.org), a think-tank based in Colorado that promoted the concept of “blended value” investments. According toEmerson:

… A growing group of practitioners, investors, and philanthropists are advancingstrategies that intentionally blend social, environmental, and economic value….Corporations are realizing that increasing the positive social and environmentalimpacts of their work can increase (or at least not compromise) shareholder valuewhile simultaneously addressing the concerns of wider stakeholder groups. Manynonprofits are seeing that by incorporating business practices that create economicvalue into their management strategies, as well as by creating new ventures and partnerships, they can better deliver on their social and environmental missions.1

In his work in the philanthropic sector since the early 1990s, Emerson had applied the concept of blended value to criticize the traditionally impermeable wall between foundation investments

and programming. Typically, foundations invested 5 percent of their assets in generatingenvironmental and social value and 95 percent of foundation assets in generating financialreturns.2 In contrast, Emerson argued that foundations should actively align their financial andsocial investments, posing the question: “If a foundation is really serious about leveraging assets,what investor would leave 95 percent of their assets off the table in pursuit of a mission?”

1 The Center for Blended Value, “Blended Value Executive Summary,” October 23, 2003,

http://www.blendedvalue.org/media/pdf-bvm-executive-summary.pdf (July 25, 2006), p. 1. 2 According to the IRS, private foundations are required to distribute at least 5 percent of the value of their non-

charitable assets annually.

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Blended Value SI-76 . 2

Emerson believed that there were five primary ways for foundations to implement a valuemaximizing strategy of financial asset management: (1) engaged investing of mainstream assets(e.g. proxy voting), (2) socially responsible investing of core assets, (3) investment in alternativeasset classes and small and medium enterprises, (4) below market-rate investments, and (5)investment in a way that enabled significant corporate transformation. By 2005, an increasing

number of foundations were working to align their financial investments with their programmaticgoals. Examples included the Nathan Cummings Foundation, the Jessie Smith NoyesFoundation, the Abell Foundation, the F.B. Heron Foundation, and the Rockefeller Foundation’sProVenEx Fund. In planning for the future, Emerson recognized that the blended value conceptstill had a long way to go in terms of its execution. He wondered how to overcome thechallenges associated with encouraging more foundations to adopt a value-maximizing strategyof financial asset management.

BLENDED VALUE IN ACTION

Engaged Investing of Mainstream Assets: Nathan Cummings Foundation

The New York-based Nathan Cummings Foundation was rooted in Jewish tradition andcommitted to “democratic values and social justice, including fairness, diversity, andcommunity.” The foundation sought to “…build a socially and economically just society thatvalues nature and protects the ecological balance for future generations; promotes humane healthcare; and fosters arts and culture that enriches communities.”3

When reviewing grants one year, CFO and investment officer Caroline William noticed asignificant disconnect between the foundation’s mission and its investments. While a selectnumber of foundation grants focused on making big agribusiness environmentally accountable inthe hog industry, the foundation had also made significant investments (through its investmentmanagers) in Smithfield Foods, the largest hog producer and pork processor in the world and onewith a spotty environmental track record. Like many foundations, the Nathan CummingsFoundation granted only a small portion of its funds (6 percent annually) and left the remaining94 percent in the hands of one of its several investment managers, J.L. Kaplan Associates.Williams commented, “I looked at it, and I realized what a great opportunity [it was]. We weregiving grants to people who say the environmental impact of large-scale hog farming is really bad, yet we owned shares in the largest hog processor in the world.”4 When Williams made thisdiscovery, she and the Cummings Foundation president and CEO wrote a letter to the SmithfieldCEO, requesting that a shareholder resolution appear on the company’s proxy ballot.

As a shareholder of Smithfield, Cummings was a partial owner and entitled to bring resolutionsto a vote of the shareholders through the company’s annual meeting process. Commonshareholder issues included community, diversity, environment, and overseas operations. TheCummings Foundation’s resolution asked for Smithfield management to prepare a report thatdescribed the environmental, social, and economic impacts of its hog production operations.Commenting on the situation, Emerson said he believed that the Cummings Foundation’s actions

3 The Nathan Cummings Foundation, “The Foundation Mission,” http://www.nathancummings.org/ (July 25, 2006).

4 Jed Emerson, “Where Money Meets Mission,” Stanford Social Innovation Review, Summer 2003,

http://www.blendedvalue.org/media/pdf-money-meets-mission.pdf (July 25, 2006), p. 40.

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were “bridging an investment gap—the chasm between the financial capital that foundationsinvest in economic worth and the social capital through which foundations pursue investments insocial value.”5 According to Emerson, “The goal for all foundations should be to bridge thisgap, creating the largest set of overall returns possible—financial, social, and environmental—tomaximize total value and total returns on investments.”

6

In April 2002, the Cummings Foundation board developed a shareholder activity strategy andguidelines that stated, “When a program interest is at stake, the foundation will vote in line withthe program interest. On matters of corporate governance, the foundation will vote in line withthe broader programmatic objectives of accountability, transparency, [and] incentives forappropriate institutional reforms.”7 In addition, proxy ballots went directly to Williams, whothen briefed program directors on their content. “This is fairly new in the foundation world,”Williams said. “Most foundations delegate the proxy voting to the investment managers. Themanagers bought the stock, so they can deal with the paperwork too.”8 On program-relatedissues, foundation management consulted with the program directors. For corporate governanceissues, they consulted with the chair of the foundation’s investment committee. In 2003, the

foundation cast approximately 400 proxy votes on 100 companies.

Williams discussed the impact of proxy voting on the Cummings Foundation:

Simple proxy voting has had some impact, but the real impact has come fromleading shareholder resolutions as part of broader campaigns. The impactfrom the voting of proxies brings issues to the attention of the programdirectors. At the risk of making broad generalizations, much of whatfoundations do is around public policy, and so program directors tend to thinkin those terms and focus on regulation. Seeing the potential issues thatshareholders can bring up in proxies opens up the idea of changing corporate behavior directly. This impact is magnified when we work in conjunction withothers.9

Williams cited an example where the Cummings Foundation worked with pension funds andother social investing funds as part of the Global Warming Shareholder Campaign, which brought resolutions about greenhouse gas emissions to approximately 30 companies in 2004. Asevidence of the campaign’s impact, Williams noted that in 2004 it was able to get Valero, thelargest independent refinery company, to set a target for reducing greenhouse gas emissions as aresult of a shareholder resolution. Williams said, “Our program directors at Cummings see theeffectiveness of things like the campaign, and it opens up new ideas for them. Our board is reallyexcited about the foundation being recognized as a leader in this area. It really reinforces the ideathat we can have an impact.” Overall, Williams felt that proxy voting and shareholderresolutions were “pretty easy for us,” but she cited her investment banking background as anadvantage because she could engage with companies about their business models and had

5 Ibid.

6 Ibid.

7 Ibid. p. 42.

8 Ibid.9 All quotations are from interviews performed by the authors unless otherwise cited.

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knowledge about reading proxies. In addition, the foundation’s board did not include anycorporate CEOs, thus “…there is not what might otherwise be a built-in reluctance to take oncorporations,” she said.

Socially Responsible Investing: Jessie Smith Noyes Foundation

Emerson also advocated that foundations invest all of their assets in a socially responsiblemanner, utilizing a unified investment strategy that went beyond simple financial performance.One approach for accomplishing this was called “positive valuation” frameworks and anotherapproach was called “screens.” According to Emerson, a positive valuation framework “…started with the assumption that within any industry, some companies work to limitenvironmental and other risk exposure, and other companies do not. The investor identifiescompanies within a group that engage in practices decreasing the likelihood that the companywill be the target of lawsuits…. A positive valuation framework assumes that those companieswith better environmental practices would generate greater financial returns by avoiding lawsuitsand penalties.”10 Investors or fund managers then used this information to create optimal

portfolios.

With the second approach, investment “screens” assisted asset managers in ensuring that they“… do not invest in stocks that run counter to the foundation mission,” said Emerson.“Foundations may engage in the practice themselves or simply invest with managers who seekout companies that promote social responsibility, in alignment with the foundation’s mission.”11 Emerson noted that 18 percent of foundations screened their portfolios for social or ethicalconsiderations in 2002, ranging from tobacco to defense and military issues. State Street GlobalAdvisors reported that 15 percent of foundations screened their portfolios in 2004.12

One example of a foundation that practiced socially responsible investing was the New York- based Jessie Smith Noyes Foundation ($95 million in assets) which had been promoting “asustainable and just social and natural system by supporting grassroots organizations andmovements” since the late 1990s.13 The Noyes Foundation’s funding priorities included protecting the health and environment of communities threatened by toxins, advancingenvironmental justice, promoting a sustainable agricultural and food system, ensuring qualityreproductive health care as a human right, and fostering an environmentally sustainable NewYork City. The foundation clearly stated its investment philosophy and fiduciary responsibility:“We recognize that our fiduciary responsibility does not end with maximizing return andminimizing risk…. We believe that foundations [should see] their mission not only in terms ofthe uses of income to fund programs but also in terms of the ends toward which endowmentassets are managed. We believe that it is essential to reduce the dissonance between philanthropic mission and endowment management.”14

10 Jed Emerson, op. cit. p. 44.

11 Ibid.

12 State Street Global Advisors, “A Case for Socially Responsible Investing,” Council of Michigan Foundations

2004 Conference Recap, http://www.cmif.org/Old/Conf2004/Docs/Case%20for%20SRI.pdf (July 25, 2006), p. 3.13 Jessie Smith Noyes Foundation, “Home,” http://www.noyes.org/ (July 25, 2006).14

Jessie Smith Noyes Foundation, “Investment Policy,” http://www.noyes.org/investpol.html (July 25, 2006).

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The Noyes Foundation discussed the concept of “screening” on its Web site:

[The foundation] views its investments as an integrated component of itsoverall mission. The foundation’s values are reflected in its funding programsand carried out through its grantmaking activities. The foundation’s

investment portfolio is also designed to support its mission and funding programs in two ways. First, the portfolio provides investment returns tosustain grantmaking activities. Second and equally important, the portfolioaligns the foundation’s investments with its funding programs through the useof exclusionary screens to avoid companies engaged in practices that areinconsistent with the foundation’s values and mission and qualitativeinclusionary screens to include companies that have both strong investment potential and practices consistent with the foundation’s values and mission.15

If the foundation decided to own shares in certain companies whose actions were contrary to itsstrategy, it utilized the opportunity to influence the behavior of such companies by becoming an

active shareholder.

In addition to screening, the Noyes Foundation also sought to invest in companies under a positive valuation framework, seeking out firms that were committed to the environment,sustainable natural resources, and a safe and healthy workplace. According to Woody Tasch, previous treasurer of the Noyes Foundation, “Noyes had placed about $5 million of its corpuswith the Winslow Management Company, a small venture capital portfolio that was dedicated tocompanies that furthered the foundation’s mission. Examples of investments included VestasWind Systems A/S (a leader in the development of wind power), FuelCell Energy (a developerof clean and efficient power generators), Stonyfield Farms (organic yogurt company), and WholeFoods Market (the world’s largest retailer of natural and organic foods).” As Victor De Luca, president of the Noyes Foundation, said, “We try to use 100 percent of our assets to promote ourvalues.”16

Investing in Alternative Asset Classes: The Abell Foundation

According to Emerson, “The main drivers of job creation and market innovation are found in aregion’s small and medium enterprises (SMEs). A foundation concerned with a given geographicarea—and seeking to create greater economic opportunity for residents or to diversify the overalleconomy of a region—might identify and invest in emerging SMEs willing to locate in targetedareas. Such firms often require capital on terms that the mainstream market does not provide.”17

The Baltimore-based Abell Foundation followed the strategy of investing in alternative assetclasses that focused on serving the needs of the disadvantaged in the Baltimore area.Specifically, the foundation focused on public and private educational institutions, humanservices organizations and programs, and cultural organizations. The foundation also supported

15 Text originally from the Noyes Foundation Web site in March 2005 (no longer available on the site as of August

2006).16

Jed Emerson, op. cit. p. 45.17

Ibid.

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initiatives to conserve Maryland’s economically significant and endangered natural resources.Commenting on the foundation’s philosophy, Abell President Robert Embry said, “If you try togive away more than [5 percent of the foundation’s assets each year], it reduces the size of yourcorpus and eventually leads to going out of business. We think we not only have an obligation totry to benefit society through our giving but also through our investments, which are 20 times as

large.”

18

Beginning in 1998, the Abell Foundation invested 15 percent of its assets ($30 million)for venture investments in SME startups to entice such businesses to locate in Baltimore. Thefoundation’s rationale was to create jobs in Baltimore and promote the foundation’s socialobjectives such as increasing energy efficiency and producing alternative energy.

For example, the foundation invested $2.5 million in Guilford Pharmaceuticals, a startupcompany engaged in the research, development, and commercialization of products that focusedon neurology and hospital markets. The Abell Foundation made its investment contingent uponGuilford locating its corporate headquarters in Baltimore. By 2005, the company had $45 millionin revenue and was profitable, with 266 employees. Other Abell Foundation venture investmentsincluded CeraTech, a company that developed an environmentally friendly material that was

superior to conventional concrete yet made of 70 percent waste materials. It also invested inPAICE, a company that had developed a powertrain system which virtually eliminatedemissions.

Below Market-Rate Investments: F.B. Heron Foundation

Regarding below market-rate investments, Emerson stated, “As a complement to its market-ratefinancial investments in for-profit enterprises, a foundation pursuing a unified investmentstrategy views its grantmaking and below market-rate capital activities with nonprofits and for- profit social ventures as an integral component of its overall investment portfolio.”19

The New York-based F.B. Heron Foundation was a foundation with $257 million in assets(2003) that was dedicated to “supporting organizations with a track record of building wealthwithin low-income communities … by advancing home ownership; supporting enterprisedevelopment; reducing the barriers to full participation in the economy by providing qualitychild care; employing comprehensive community development approaches with a strong focuson the wealth-creation strategies; and increasing access to capital.”20 Prior to 1997, the HeronFoundation granted 5 percent of its assets per year. However, Luther M. Ragin, Jr., vice president for social investing at Heron, explained that in 1997 the organization consciously madea shift to explore ways to use more of its assets in support of its mission. The foundation calledthis mission-related investing: “In addition to grants, the foundation seeks to accelerate the levelof its assets invested in efforts with strong social and financial returns.”21

Examples of mission-related investing included:

18 Ibid.

19 Ibid.

20 F.B. Heron Foundation, “Home,” http://www.fbheron.org/ (July 25, 2006).21 F.B. Heron Foundation, “Program Guidelines,” http://www.fbheron.org/prog_guide.html#types (July 25, 2006)..

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(1) Program-related investments (PRIs),22 or low-interest senior or subordinated loans (loanrecipients thus needed to pay the loan back) to nonprofit or for-profit organizationswhose work corresponded with the foundation’s programmatic interests.

(2) Market-rate insured deposits in community development credit unions or communitydevelopment banks.

(3) Private equity and fixed-income securities achieving market rates of return whilesimultaneously achieving social benefits to low-income families and communities.

PRIs ranged from $250,000 to $1 million, and in 2002, the foundation had approximately $14million in 40 program-related investments, representing 6 percent of its total assets. By 2003,PRI investments totaled $17.2 million out of $49.6 million in mission-related investments; andthat figure remained steady through 2004 at $17.7 million out of $63.4 million in mission-relatedinvestments.23

One example of a PRI was the Community Loan Fund of New Jersey, a nonprofit communitydevelopment financial institution that made loans for predevelopment, construction, renovation,

or “gap” financing for child care centers and family-based child care providers in New Jersey.Through 2013, it planned to lend more than $20 million to support 2,500 new child careopenings. By 2003, it had provided technical assistance and training to 112 centers serving 7,500children. More than 80 percent of the centers assisted by the Community Loan Fund werelocated in low-income neighborhoods and served children from low-income families. The HeronFoundation provided a $500,000 eight-year loan at an average interest rate of 3 percent tosupport the Community Loan Fund’s loan program, as well as a general operating grant of$75,000.

To mitigate the risks of PRIs, as well as other mission-related investments, the Heron Foundationestablished performance benchmarks for each asset class in its mission-related portfolio. Thefoundation’s goal was to meet or exceed these performance benchmarks over time for each assetclass. For example, the benchmark for deposits was the national average for two-year jumbodeposits as reported by BanxQuote. In 2003, the foundation’s mission-related deposits earned aweighted average return of 2.27 percent compared to 1.53 percent for the benchmark. In 2003, itsmission-related fixed-income portfolio produced a total return of 4.04 percent compared to 4.10 percent for the benchmark. For PRIs, the benchmark was the long-term inflation rate + 1 percent.In 2003, the weighted average interest rate for the foundation’s PRIs was 2.9 percent comparedto the benchmark of 3.2 percent.24

The construction of a mission-related portfolio required changes within the foundation:

This has meant significant training and development for both our program andinvestment staff. It has also meant the creation of new networks of third-party

22 Interest-related proceeds from The Heron Foundation’s PRIs were not used to support endowments but rather to

support a grantee’s direct charitable activities.23

F.B. Heron Foundation, “New Frontiers in Mission-Related Investing,”

http://www.fbheron.org/viewbook_frontiers.pdf (July 25, 2006), p. 2, and interview by authors with Luther Ragin,

vice president, investments.24

“New Frontiers in Mission-Related Investing,” loc. cit.

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due diligence providers and investment advisors and heightened engagementand learning for our Board and Investment Committee. These costs—bothfinancial and human—are not insignificant. They have been largely offset,however, by the foundation’s decision to use index products for its coreholdings in its traditional investment portfolio. This has allowed us to manage

our total investment expenses… without discernible impact on investmentreturns and freed our Board and investment staff to spend more timeevaluating how effectively our program and investment activities complementour mission.25

Investing for Significant Corporate Transformation: ProVenEx Fund

The Rockefeller Foundation’s Program Venture Experiment (ProVenEx) fund, launched in 1998,made investments to further the foundation’s programmatic goals with the objective of achieving both a social and financial return on investment. Investments were structured using market principles and included loans, equity investments, and loan guarantees to for-profit companies,

nonprofit agencies, and community development investment funds. In 1998, the RockefellerFoundation allotted $18 million from the program budget of the foundation to the ProVenExfund (the foundation had endowment assets of approximately $3 billion and an annual program budget of approximately $150 million). By 2004, the fund had made 11 investments totaling$12.5 million. ProVenEx was the vehicle through which the foundation worked directly with the private sector to help further its mission of improving the lives of the poor and marginalized.

One of ProVenEx’s early investments was a $3.5 million investment in Biosyn (through asubsidiary), a Philadelphia-based pharmaceutical company developing microbicides, intravaginalgels that women could apply to prevent the transmission of HIV and other sexually transmitteddiseases. This was an example of a high-risk investment that more traditional venture capitaliststypically would not assume. Biosyn had since been acquired by a publicly traded company, andits lead product was in the final phase of clinical trials in Africa. Another ProVenEx investmentwas a guarantee to the Calvert Social Investment Foundation that would allow Calvert toincrease its issuance of Calvert Community Investment Notes to retail investors. Calvert used the proceeds from these notes to onlend26 to community development institutions building affordablehousing and providing access to credit for poor people in the U.S. and developing countries.

ProVenEx investments were managed separately from the foundation’s endowment assets.Jackie Khor, associate director for program venture investments, said. “By combining ProVenExfinancial investments with ‘smart subsidies’ through the foundation’s grantmaking, we are tryingto be both a catalyst and a source of leverage to mitigate risk in order to facilitate the deploymentof private capital towards an unmet need in one of our program areas.”

THE FUTURE

In reflecting on the future of blended value, Emerson stated that foundation professionals “could just think about managing their assets for maximum financial return… but anyone who begins to

25 Ibid., pp. 2-3.

26 To lend funds that have been borrowed from one party to a third party, often within a short space of time.

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think more deeply realizes that holding investments in companies that you’re simultaneouslymaking grants to NGOs to try to confront is a contradiction.” He wondered how to overcome thekey barriers to promoting and implementing the blended value concept within a greater numberof foundations, including assessing the trade-offs between the costs and benefits associated witheach value-maximizing approach and developing and disseminating strategies for mitigating

various risk factors. Emerson also recognized the importance of creating effective metrics forassessing the economic, social, and environmental value of the blended value proposition, notingthat existing market-based metrics had taken decades to create.

ASSIGNMENT QUESTIONS

1. What are the costs and benefits of applying a blended value approach to financialmanagement, both for a perpetual foundation and a foundation sunsetting over 15 years?

2.

According to the blended value model, there are five primary ways for foundations toimplement value-maximizing strategies of financial asset management. For each of the

blended value strategies from the case, discuss the potential for social impact versus risk.How might potential risks be mitigated?

3. Reviewing the examples from the case, what metrics could each of the foundations use toassess its social return on investment?

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