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Markkula Center for Applied Ethics

Nonprofits Should use ESG to Guide Investing

Joan Harrington

Joan Harrington is the director of social sector ethics (@SocSectorEthics) at the Markkula Center for Applied Ethics. Views are her own.

Investors have long had the opportunity to consider investing in companies that practiced corporate social responsibility and the overlapping concept of ESG: a company’s commitment to environmental, social, and governance issues. Recently, however, companies have become significantly more committed to ESG practices and measurements due largely to increased interest by the public and by governments in the United States and Europe.

Targeting investment in companies that take responsible positions on environmental and social issues, as well as good governance, is not yet widely embraced by nonprofit organizations. While nonprofits may be careful to avoid investing in areas that are directly in conflict with their missions, this view has generally not broadened to ESG investing.

Does it matter?

In 2017, nonprofits held $1.7 trillion in endowment funds, with about $1 trillion held by private foundations and almost $700,000 billion by other nonprofits, such as universities, hospitals, large arts organizations, churches, and donor advised funds. $1.7 trillion is roughly the size of the gross domestic product of Canada.

Endowment funds are invested to help provide sustainable operating support for the organization. Most nonprofits also have funds held in reserve to provide for short term needs. For larger organizations, these funds can be significant; St. Jude Children’s Research Hospital’s reserve fund in 2021 was $5.2 billion. The board of directors decide how endowment funds and reserves are invested.

With this much money to be invested, nonprofits can have a significant positive impact on the environment, social issues, and governance through thoughtful investing. Companies adhering to ESG principles have specific initiatives in these areas with measurable performance requirements. These initiatives depend on the nature of the business as well as applicable regulations. Environmental initiatives might include climate change policies, waste management and recycling, or reducing the environmental impact of employees commuting to work or traveling for business. The social standards could focus on human rights; diversity, equity, and inclusion; and treatment of workers. A focus on governance might consist of effective whistleblower programs, transparency, and business ethics.

The concern that investments in companies that focus on ESG criteria are less profitable is generally not valid. In fact, these companies are viewed as promoting “sustainable earnings and facilitate long term success.” ESG investing is a well-accepted method for an investor to ensure they will have a positive impact on ESG issues while still getting a return on their investment. It may take additional time and screening but careful selection of a portfolio of investments allows the board of directors to fulfill their fiduciary duties regarding management of funds and investments.

Do nonprofits have a special responsibility to use ESG criteria?

Nonprofits that are 501(c) (3) organizations are tax exempt and can provide a tax deduction for those who contribute to them.   These organizations receive this benefit because the IRS has determined that under the law, the work of these organizations benefits the public. Through these tax rules, the public helps to support these organizations. As the Supreme Court noted in a case about tax exemption and Bob Jones University, “When the Government grants exemptions or allows deductions all taxpayers are affected; the very fact of the exemption or deduction for the donor means that other taxpayers can be said to be indirect and vicarious “donors.”

This raises an ethical issue for nonprofits and their boards of directors. With the special treatment of the tax rules and the public’s stake in nonprofits, shouldn’t nonprofits work to ensure that their investments do not contribute to environmental or social harm?  Shouldn’t they invest to reduce such harms and support good governance?  

The path forward

ESG investing is a way for nonprofits to expand their good work. “In the long term, incorporating ESG criteria into a portfolio means that all of the organization’s money, not just the earnings earmarked for charities doing great things, can accomplish good in the world.”

Some universities may be leading the way. The Association for Advancement of Sustainability in Education has developed a voluntary, self-reporting rating system in which colleges and universities can receive a rating based on their activities related to sustainability including “human and ecological health, social justice, secure livelihoods, and a better world for generations.” The rating program, STARS, uses performance indicators to assess the success of those colleges and universities that apply. STARS reports that 1,000 universities and colleges around the world are using the system to measure their sustainability.

Many investment firms provide advice and ESG funds for investing. For-profit companies are increasingly committed to ESG principles. It is time for nonprofits to join the movement.

 

Feb 8, 2022

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