What Can Private Foundations Invest In?
There are many different rules that govern how private foundations can invest their funds. 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 every private foundation must give at least 3.5% 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 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.
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 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. In Ontario, courts have defined specific standards for how prudent investors should behave to support laws like the Trustee Act.
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. So private foundations can 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.
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.
Family Office Supports
Your family office can provide support to your private foundation by keeping books and records, drafting policies and procedures, identifying qualified donees, and provide other administrative support services depending on the goals of your private foundation.