Commentary: How to approach endowment impact investing — a David Swensen-inspired strategy for social and financial returns

Yale University's former chief investment officer, the late David Swensen, revolutionized endowment investing through his innovative approach that produced unprecedented financial performance for the university during his three decades as CIO.

The core principles of Swensen's philosophy are simple but carry valuable lessons for today's foundations and institutional investors: a combination of conventional and contrarian long-term thinking, rigorous analysis and a healthy dose of common sense to compensate for the flaws and limitations of academic finance theory. The secret sauce is the philosophy's execution by a purpose-driven team.

In the foundation and endowments world, there are few strategies more unconventional and contrarian than an impact investing endowment. Although they are non-profit institutions, few foundations and endowments consider using more of their financial resources for their charitable mission than is legally required. That is disappointing and suboptimal for the institutions and society.

The Ford Foundation's $1 billion impact investing endowment is a case study in how to turn an unconventional approach into conventional financial returns. A few of its specific investment themes — diverse fund managers, multifamily affordable rental housing, and quality jobs — provide a road map for where other foundations could be allocating their endowment capital.

Firms owned by diverse fund managers control just 1.4% of the more than $80 trillion in U.S. institutional assets under management. That paltry figure, combined with investment selection preferences demonstrated by white men, explains the devastatingly destructive lack of access to capital for people of color. I contend it also explains most problems endemic to Black people and other people of color.

In stark contrast to the overall market, Ford Foundation's impact investment endowment has allocated 65% of its capital to diverse fund managers. Over its first five years, the portfolio generated a compound annual return of 28%, three times the hurdle rate or minimum acceptable rate of return for perpetual foundations.

Providing capital to diverse fund managers will help the overall American economy. Research by Bank of America, Citigroup, and McKinsey estimates that tearing down race-based barriers blocking access to capital and opportunity for Black people would generate $5 trillion to the U.S. economy in just five years. Investors and society stand to reap rewards from those savings and gains.

Multifamily affordable rental housing private equity is, in many ways, emblematic of an asset class that might have been on Swensen's radar. The cash flow, inflationary hedge and residual value elements provide the best of equity and bond-like characteristics of any diversified portfolio. The relatively small and inefficient market also presents unusually high possibilities to generate alpha. While it is an overlooked asset class in most foundation and endowment portfolios, the Ford Foundation's impact investing endowment has allocated over 20% of its current commitments to multifamily affordable rental housing private equity.

The traditional late-stage buyout strategy, which has hollowed out the fortunes of America's working class, proceeds along an efficient series of steps: buy a company, cut expenses, increase net income and sell the company — then rinse and repeat. On the contrary, Ford Foundation's investment in quality jobs has proven the potential to generate value to companies, workers and investors through an unconventional strategy: superior operational design and superior human capital investment generates superior financial returns.

Business innovation, productivity and profitability are powered by engaged employees. Current research from Gallup indicates that 80% of employees are disengaged from their employers. That costs an estimated $8.8 trillion in lost productivity, and approximately $550 billion in the U.S. alone. Researchers forecast that a modest 10% improvement in engagement can generate an improvement of $2,400 in profits per employee.

Employee engagement is dependent on the quality of business culture. Business culture is cultivated by a set of quality jobs characteristics, including compassionate management, predictable schedules, on-the-job training, fair wages, good benefits, opportunities for upward mobility, worker voice and employee ownership throughout the company (not just for top executives), which ultimately contribute to a stronger bottom line. Those ingredients fuel a healthy business culture that nourishes and grows employee engagement. Another word for all that is diversity, equity and inclusion or DEI.

This is not to say Swensen's teachings are all applicable to the Ford Foundation's impact endowment approach. Unlike the prototypical fund-of-funds manager Swensen describes in his book "Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment," the managers in the Ford Foundation's impact investing portfolio are purpose-driven, not motivated simply to gather assets and collect fees. Fund of funds can be a way to accelerate prudently our delivery of capital to diverse fund managers. They allow us to put capital to work more quickly than if we did it ourselves so we can help unleash wealth for America in a practical, prudent and expedited way.

The most important lesson I've learned from Swensen? Do not turn your gaze from the north star of informed, moral, common-sense judgment in the investment process.

Roy Swan is head of mission investments at the Ford Foundation. He is based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.