What Can Private Foundations Invest In?

What can private foundations invest in? There are many different rules governing how private foundations can invest their capital. So, this post describes some of the basic principles that might guide a foundation’s investment strategy.

Steward the Endowment

One of the main reasons to create a private foundation is to hold an endowment that may grow and earn income to fund charitable gifts. The income earned from the investments owned by a private foundation are not subject to income tax like they would be if held by an individual or a for-profit corporation. Therefore, by holding a portfolio of investments within a private foundation, the investment gains can be directed entirely towards charitable purposes instead of taxes.

Disbursement Quota

No matter what a private foundation invests in, it must always meet the basic requirement of an annual “disbursement quota”. At the time of writing, this means most private foundations must give at least 5% of its assets to other registered charities (known as “qualified donees”) each year. Any investment strategy a private foundation undertakes must consider the disbursement quota requirement.

Update on the Disbursement Quota.

What Does the CRA Want?

Generally, the CRA encourages charities towards owning transparent easy to value gifts and investments. Cash is easy to value, but so are publicly traded investments such as stocks which have a price determined by an open market and cannot be influenced by any individual or group. So, CRA’s rules generally favour investments that are liquid and easy to value.

Avoid Conflicts of Interest

Private investments that are not valued by open markets can be held by charitable foundations, but the CRA has rules about which of these investments are qualified. The general principal is that any investment a charity makes must be done at more than “arms length”.

The CRA says “non-qualified” investments are any investment that is “non-arms length”. So your private foundation cannot own shares in your own business or own any asset that may benefit someone connected to the foundation.

Stick to the Public Markets

In many ways, the CRA encourages foundations to invest in public securities as much as possible because the opportunities for conflicts of interest in the public markets is greatly reduced compared to private market investments.

Mind the Prudent Investor Rules

Other than non-arms length investments, private foundations have wide latitude to make investments if they remain a “prudent investor”.

A “prudent investor” must always act in the best interest of the charitable foundation. There are some guidelines that foundations can follow the support prudent investor rules. Including drafting investment policies that align with the objectives of the foundation.

Create a Diversified Portfolio

Putting the entire portfolio of a private foundation in one illiquid asset such as gold or bitcoins is not prudent but having a portion of the portfolio invested in various diversified assets is. Holding a portfolio of mortgages might be a prudent investment for a foundation but lending the entire portfolio of the foundation to an individual for their home purchase is not prudent, its risky.

Seeking Impact is Good, But Remain Balanced

Today, impact investments are growing in popularity. Many private foundations want to invest in things that might not only produce an economic rate of return, but also directly support their charitable goals. Therefore, many private foundations make impact investments, so long as they are arms length and prudent.

Prudent investors should consider a portfolio that mixes some less liquid “impact investments” with liquid public investments to balance the risks and liquidity across all investments.

What can private foundations invest in?

Here is a list of the most common types of investments private foundations make:

• Cash deposits (high interest savings accounts at banks and credit unions)
• Money market funds and GICs
• Stocks (listed on designated exchanges)
• Bonds
• Preferred shares
• Mortgages (pooled mortgage funds, MICs)
• Real estate investment trusts (“REITs”) (often ones traded on Canadian designated exchanges)
• Impact investments (like loans to other charities that are arms length)
• Pooled funds and mutual funds
• Exchange traded funds

Here are some investments that private foundations might make but may not be as prudent (or common). Your private foundation should approach these types of investments with caution:

• Private mortgages (not inside mortgage funds)
• Impact investments (or various kinds)
• Venture capital funds
• Private equity funds
• Directly held real estate and land
• Bitcoins and other cryptocurrency
• Gold and other precious metals
• Anything that is illiquid or difficult to value

Document the Strategy

Private foundations should document their investment strategy by drafting an investment policy. The investment policy outlines objectives, risks, asset allocation, qualified investments, and how investment decisions are made. With a documented investment policy, private foundations can easily avoid conflicts of interest and make prudent investments.

What can private foundations invest in?

Effectively managing a private foundation’s investments requires adhering to a set of rigorous standards and regulations to ensure both compliance and desired returns. Foundations benefit significantly from strategies that prioritize transparency, avoid conflicts of interest, and align with prudent investment principles. By crafting a diversified investment portfolio that includes both liquid public investments and impactful private investments, foundations can sustain and enhance their charitable contributions over time.

It is crucial for private foundations to document their investment strategies meticulously using an investment policy statement. Doing so will support regulatory compliance and also making informed, strategic decisions that align with the foundation’s goals.

Family offices such as ours, play a pivotal role in supporting private foundations by providing essential services such as bookkeeping, policy drafting, and administrative support including tax return preparation, etc. For private foundations looking to refine their investment strategies or enhance their operational effectiveness, partnering with a knowledgeable family office like Markdale Financial Management can provide the necessary expertise and support. Click here to book at meeting with us. We are happy to answer any questions you may have about private foundation management including permitted investments.