It is a risky proposition to take issue with any advice offered by Warren Buffett.
Recently Marc Gunther, a notable philanthropy and sustainability reporter, wrote an article entitled Warren Buffett Has Some Excellent Advice For Foundations That They Probably Won’t Take. In the article, Mr. Gunther quotes part of the renowned investor’s annual letter: “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
Moving past the understandable issue Mr. Buffett has with high-priced investment managers, the endorsement for investors to stick with low-cost index funds is a more nuanced point, particularly as it relates to mission-driven foundations.
I do agree that investors who are purely seeking the best risk-adjusted rate of return net of fees should seriously consider low-cost index options. When it comes to foundations, however, one must first consider the reason foundations exist. That reason is to affect some form of positive social or environmental good, and not to achieve best-in-class investment returns.
Clearly, for a foundation to continue making a positive impact toward its stated mission in perpetuity, investment gains are a necessary component to support operations and grantmaking. When considering investment options for a foundation’s endowment, fees should absolutely be a factor, and index funds are a low-cost option. But index funds largely replicate the broader markets and hold hundreds of securities. As a result, mission alignment is nearly impossible through these passive strategies.
Reason 1: Mission Alignment Is Nearly Impossible Through Passive Strategies
For instance, if a foundation’s mission is to promote better access to finance and alleviate poverty in urban areas, then owning broad market index funds will potentially expose a foundation to predatory payday lenders. Similarly, if a foundation’s mission is to combat climate change, broad market index funds will likely expose a foundation to high greenhouse gas emitting oil and gas companies. This can present a serious dilemma for foundations. When a foundation’s cause is supported by its grantmaking, but contradicted by holdings in its endowment, important questions need to be asked. As Ellen Dorsey, executive director of the Wallace Global Fund and advocate of the Divest-Invest movement says, “If your investments are driving the problem that you’re asking your grantees to solve, that’s a problem.” 
What about Environmental, Social and Governance (ESG) screened index funds, ETFs or customized indices? Don’t they solve this problem?
Yes, to a degree.
Reason 2: Negative Screening Only Mitigates One Type of Risk
ESG screened index funds and ETFs come with their own set of issues. For instance, the methodologies utilized by index providers vary drastically requiring a keen understanding of the provider’s approach and definition of ESG. An index provider may simply include the highest rated ESG performers across sectors or utilize ESG as a minor input into an otherwise opaque process. Each of these examples may still lead to ownership of objectionable securities. If customized indices are preferred to avoid these issues, the mission alignment challenge is solved, but specific investment risks may result. Limiting an investment universe in the context of a passive index strategy inherently creates portfolio imbalances and potentially large tracking error.
So what’s the right solution?
Solution: Find a Dedicated Investment Manager Who Understands Mission Aligned Investing
As an impact investment manager working with foundations seeking mission aligned portfolios, we believe actively managed strategies create the opportunity to go beyond avoiding certain companies, and proactively find good financial investments that intentionally contribute to a foundation’s mission. When considering mission alignment, it is important to note that incorporating ESG considerations does not imply concessionary corporate returns. In a review of over 2,200 academic studies focusing on the relationship between environmental, social, and governance (ESG) criteria and corporate financial performance (CFP), nearly 90% of the 2,200 studies analyzed show no adverse connection between ESG and CFP, and, more important, many studies showed positive findings. 
Similarly, mission aligned investment portfolios do not imply concessionary investment performance. Much like the MacArthur Foundation and the W.K. Kellogg Foundation mentioned in Mr. Gunther’s article, the KL Felicitas Foundation has also published its returns. The returns of this fully mission aligned investment portfolio reveal outperformance compared to traditional portfolio weighted benchmarks over a full market cycle.
Ultimately, many investors should heed Mr. Buffett’s advice, but a foundation seeking to amplify its grantmaking through its endowment without sacrificing returns, should not so quickly dismiss the value of a dedicated active impact manager.
Jeff Cohen leads Sonen Capital’s business development efforts, supporting the development of impact investment solutions which combine competitive risk-adjusted returns with positive measurable social and environmental impact. Prior to joining Sonen, Jeff served as a Director of Investment Opportunities at Venovate Marketplace, where he worked with foundations and institutions on private placement investments. In addition, Jeff reviewed and conducted investment due diligence on alternative investments. Jeff holds an MBA from The McDonough School of Business at Georgetown University and BA from The Ross School of Business at The University of Michigan. Jeff has also received the Chartered Alternative Investment Analyst (CAIA) designation.