Getting Organized – Classifying the Social Sector
Updated: Apr 12, 2022
This essay is the first in a four-part series titled "Social Investing v. Financial Investing” discussing the differences between financial investing tools vs. what’s available for social investors and charitable funders.
In the early 2000s, in a former life, I suggested creating a classification system for non-profits based on the NAICS and SIC systems for publicly traded companies. The benefits of such a system would be wide-ranging, but I was thinking about it primarily as an investing tool and for maturing the social investment field. Now, because the capital needs and stakes of the social sector have never been higher, it’s time to revisit this issue.
There are more non-profits than ever struggling to meet an ever-expanding roster of needs, with all of them chasing resources that are not growing as rapidly. More transparency about effectiveness and impact – whatever the social issue – will help to galvanize resources in that direction.
When companies need to tap into much bigger pools of income, they agree to “go public.” They agree to document types of economic activity they conduct and disclose it to the general public. Investors are much more likely to invest in companies that are more transparent because it reduces their risk. Historically, the capital markets were miniscule for private companies that did not document or disclose as rigorously. The risks were so much higher that the private company was not as well-run, and default, fraud, or poor performance were more likely.
This is the current state of the social sector. Big organizations with huge marketing budgets and well-established brands do very well. Organizations that address the most pressing issues of the time attract funds. The current system rewards effective marketing, but whether or not it rewards effective management is another issue.
As a result, most people think of the social sector in charitable terms. They give money because they like the mission, but they have no idea what kind of social value that the organization truly provides. Their money is 100% at-risk, and they are comfortable with that. Greater transparency and comparability should lead to more social investment, as it rewards and validates charitable giving more effectively.
When a financial investor makes an investment decision, they have an investment time horizon (e.g., retirement, college), they have a preferred strategy (growth v. value v. income, etc.), and particular stock screens that they use to filter out the best stocks or investment vehicles that meet these objectives. A vital operation supporting this work is comparison, specifically the following three types of comparison.
First, financial investors seek to compare the value of one investment vehicle v. another, and at a more granular level, how stocks in one industry (such as technology) compare to stocks in another (like financial services). 90% of the growth of an individual stock can typically be calculated by the trajectory of its industry. For social investors, one could envision a “mutual fund” for health, education, etc. that would contain a basket of organizations in that particular sector pursuing a number of different strategies.
Second, they seek to compare one stock with another in the same industry. Investing in Apple is very different from investing in Dell. Similarly, when it comes to education, some people might want to invest in teachers, others in after-school enrichment, and still others in a particular field like STEM or literacy.
Third, financial investors compare the past performance of the stock with its projected future performance. They want to know what the growth and income trajectories were from 2020 to 2021 to today, and then their forecast for the next 1, 5, 10, or 20 years. This allows for the creation of the Price to Earnings Ratio – how long it will take the company to earn back their investment at the current rate of operations and the Price to Earnings Ratio relative to Growth (PEG Ratio), which allows them to anticipate how much future growth might accelerate their payback period. For social investors, this might be defined as performance over time.
To summarize, both financial and social investors would like to be able to compare (1) apples to oranges, (2) apples to apples, and (3) the apple over time. A classification system would be a giant step forward.
You can see how this could be incredibly helpful if you’re thinking about giving in response to disaster. Suppose you have humanitarian objectives – is the Red Cross, Salvation Army, or some other NVOAD member the best performer? Which organization has the best strategy to deal with refugees and displaced people? Where are the biggest deficits and needs? What sets the community up to recover fastest?
One of the biggest challenges is figuring out what criteria to use to evaluate these social actors (that’s a subject for a future article), but grouping them logically would be an enormous step forward in learning how to compare them.
I would propose as a starting point, a two-digit classification system such as the following:
10 Arts, Culture, Heritage
20 Disaster Management
40 Education and Labor
60 Health and Human Development
70 Humanitarian Assistance
80 Housing and Community Development
In the financial investment realm, the Financial Accounting Standards Board (FASB) exists to determine Generally Accepted Accounting Principles (GAAP) to help decide how certain thorny economic actions should be treated. If only there were a Social Sector Standards Board (SSSB) to determine Generally Accepted Social Objectives (GASO), then the top tier classification system could be worked through that body. As it is, the sooner the process begins to equip social investors with better tools, the sooner they can become a reality.
This is the first in a series of articles on “Social Investing v. Financial Investing”:
Getting Organized – Classifying the Social Sector
Clearing Up Confusion about Social Value v Economic Value
The Lack of Social Investing Infrastructure
Developing Social Value criteria