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The Portfolio Model of Foreign Assistance

How U.S. Policymakers Can Maximize the Value of Aid

A young boy rests by empty USAID vegetable oil tins in the Dagahaley refugee camp which makes up part of the giant Dadaab refugee settlement on July 19, 2011 in Dadaab, Kenya. The refugee camp at Dadaab, located close to the Kenyan border with Somalia, was originally designed in the early 1990s to accommodate 90,000 people but the UN estimates over 4 times as many reside there. The ongoing civil war in Somalia and the worst drought to affect the Horn of Africa in six decades has resulted in an estimated 12 million people whose lives are threatened. (Getty)

by Alicia Phillips Mandaville

In the first half of this year, U.S. President Donald Trump’s administration began to call for reform of the various agencies, offices, and programs that provide U.S. foreign assistance. In response, the foreign policy community produced several structural bureaucratic proposals. Organizations such as the Center for Strategic and International Studies, the Center for Global Development, and the Modernizing Foreign Assistance Network, as well as coalitions like InterAction and the Advisory Committee on Voluntary Foreign Aid all made various recommendations, ranging from the immediate incremental step of a multilateral foreign assistance review to a fundamental redesign that would integrate all smaller agencies into a single US global development structure.

If the United States wants to maximize the value of its foreign aid, it needs a fresh paradigm that supports the purpose of foreign assistance, acknowledges the aspects of international aid that it can alter through structural change, and acknowledges that there are global or market forces that remain beyond Washington’s control.

The best way to approach the issue is to recognize that foreign assistance is an investment that sustains the United States’ global leadership in the long run. Whether responding to international crises, encouraging positive economic and social change, or supporting growth in countries that share U.S. values and security concerns, money spent today is a down payment toward a future in which the United States remains a superpower because the benefits of its leadership are visible around the world. The future-oriented nature of foreign assistance makes it complicated to manage, but also suggests an organizing principle: in short, Washington should take an approach to its foreign aid programs similar to the way investors manage their portfolios.  

Both U.S. foreign assistance and personal investment portfolios share the common aim to produce a specific long-term effect of great magnitude, the requirement of a small but regular inflow of resources, and the understanding that they are only successful when the portfolio is appropriately diversified. The logic of portfolio diversity is straightforward. To maximize the return on an overall investment, managers put money into various kinds of assets, each of which has a different combination of potential and risk. By spreading the money across these different assets, investors protect their overall portfolio from negative returns—if one part of the market takes a hit, the return on assets invested elsewhere can compensate.

Foreign assistance should operate the same way. Maintaining U.S. leadership requires a combination of activities in different countries, working toward different goals, and relying on different types of tools, budgets, and agencies. And just as an individual investor’s financial goals change over time, the activities that best support U.S. global leadership also shift. Taking a portfolio management approach would allow officials to consider adjusting their approach when necessary without undermining their overall capacity to invest in progress.

With the help of the Peace Corps and a grant from USAID, townspeople lay pipework to bring water from a mountain spring some miles away, Korem, Ethiopia, 1968. Prior to the project, water had to be rolled in metal barrels from a river four miles away. (Getty)

THE THREE POLICY CATEGORIES

Despite the tremendous breadth of civilian foreign assistance programs and organizations, it is nevertheless possible to categorize them into one of three types of foreign-assistance “investment funds”: an index fund, a managed fund, or a fund for venture capital.

An investment index fund is tied to and follows the market, making it a useful organizing principle for the U.S. foreign assistance that directly supports economic growth. These programs clearly include direct investment tools like the Millennium Challenge Corporation, which focuses large growth-oriented investments in public goods in countries that qualify by meeting specific policy criteria; investment facilitation tools like the Overseas Private Investment Corporation (OPIC), which enables the U.S. private sector to make investments in the developing world that would otherwise be considered too risky; and market-opening tools like the U.S. Trade and Development Agency (USTDA), which facilitates US exports by supporting priority processes or infrastructure in emerging economies. 

These investments are only successful to the extent that they work in the same direction as the market. For example, major investments in energy, telecommunications, or transportation infrastructure generate the highest returns when they occur in places that have enough economic activity for that infrastructure to be heavily used by people and businesses. To be successful, these programs need the flexibility to make market-oriented decisions based on factors such as rate of return, risk over time, and unmet demand for public goods and services.

Thinking of these elements of the U.S. foreign assistance portfolio as an index fund also makes sense because they are the type that works best when set up and left to run over time. The entire point of an index fund is to establish which parameters will be tracked, and then let it run. U.S. foreign assistance investments in economic growth should demonstrate the same trust in the market’s return over five, ten, and twenty-year windows as index funds do. This is the unsexy but reliable part of the foreign assistance portfolio that helps secure the United States’ long-term interests.

A managed fund differs from an index fund in that it relies on human judgment to regularly readjust assets toward an overall goal. This approach offers a better model for US foreign assistance programs designed to address immediate needs or to alleviate poverty in the medium term, such as the McGovern-Dole Food for Education program, or the work of USAID’s Office of Foreign Disaster Assistance. This is a much broader range of work, encompassing humanitarian responses to conflict and disaster; global heath programming to address issues such as pandemics, maternal health, and non-communicable diseases; education programs; and efforts devoted to nutrition and food security. Unlike the aid programs focused on economic growth, these types of investments often need to run counter to the direction of the marketin order to reach those in need.For example, childhood vaccinations and prenatal checkups for mothers living on a dollar a day are extraordinarily cost-effective ways to reduce human suffering and build healthier populations, and ensuring access to basic food and shelter for families fleeing war or persecution saves lives and stabilizes conflict zones. Such programs, however, are often most needed in places where markets are dysfunctional and there is no obvious potential for economic growth.

This grouping of programs represents a managed fund because each of these programs contributes to the overall goal of human well-being. But the United States will always want to periodically rebalance the relative volume of each type of work. The HIV-AIDS epidemic led to the creation of the US President’s Emergency Plan for AIDS Relief (PEPFAR), a global food commodity crisis motivated Feed the Future in 2010, and today’s refugee crisis, with 65 million displaced people, drives demand for relief work. Each of these initiatives represents a moment of rebalancing within this fund.

Finally, the United States has historically maintained a series of foreign assistance mechanisms intended to respond immediately to political or diplomatic concerns. Taken together, these can be best conceptualized as a venture capital (VC) fund, as such funds are known for their willingness to spread capital across numerous opportunities that hold high risks and offer big returns. In the realm of foreign assistance, this would include tools such as political transition funds, direct budget support, ambassadors’ in-country budgets, and security assistance.

This category includes a set of US investments made in hope that the message associated with the financial commitment will deliver extremely positive political returns. Here, policymakers are less concerned with reaching sustainable development outcomes than with signaling their support for a particular U.S. priority. For example, the chances that an ambassador’s scholarship fund for girls will create fundamental social change is low, but such funds nevertheless make clear to host governments that the United States supports equal access to education regardless of gender. Sustained security assistance may also fall into this category.

For this type of assistance to be effective, officials must accept that it often fails. Rigorous evaluation of the impact of these types of expenditures is likely to prove that they fall short more often than they succeed. However, political returns, which are hard to measure, may be high for some of these investments. As a result, this type of assistance represents short-term, risk-tolerant mechanisms that the United States can use to respond to evolving circumstances. 

THE PORTFOLIO MODEL IN PRACTICE

Taking a portfolio-like approach to U.S. foreign assistance could immediately shape the structure and management of the country’s aid programs and resources. The U.S. foreign aid sector is awash with questions about reform. The officials running the country’s development programs can readily identify the need for greater efficiency, but they fear that some of the current calls for reform by an administration with limited foreign policy expertise fail to recognize the need for different types of assistance. Meanwhile, diplomats and budget managers worry that their development colleagues are naively pushing to divorce foreign assistance from the United States’ diplomatic and national security strategies. 

The fears of both sides have roots in reality: development practitioners tend to overvalue the growth-fund and managed-fund aspects of foreign aid, whereas diplomats and strategists tend to be overly confident in the effectiveness of high-risk, highly politicized VC-like aid. But both sides’ concerns are also overblown. Neither wants its preferred aid approach to become the totality of the U.S. global investment: they just want to ensure it remains available for times when it is most useful. 

Thinking of U.S. foreign assistance as a portfolio to be balanced and managed helps demonstrate that each of these approaches is a different tool, each used for a distinct purpose. It can help make clear the need for diversity without prompting fears that if one side acknowledges the value of the other’s preferred tool, that acknowledgement will lead to the elimination of every other tool. 

An emergency medical technician rides a USAID donated motorcycle through Manzanillo, Monte Cristi Province, Dominican Republic, on Tuesday, May 10, 2016. Founded in 2009 by former paramedic Jason Friesen, Trek Medics International, a New York nonprofit, employs only a handful of people to manage operations. Responders volunteer in exchange for a first-aid training certificate, a pressed uniform, and, for 1 in 5, free mobile phone service. (Getty)

Practically, it also suggests that bureaucratic proposals must start by examining the goals and incentives of each type of U.S. assistance. Some organizational proposals may be aimed at cutting costs that would roll market-following approaches into a bureaucracy managed by counter-market program directors. This, of course, would be a catastrophe for long-term growth. Similarly, judging impact-focused human development programs by the same standards as highly politicized deliverables undervalues positive returns to tailored, structured programs. For example, programs designed to effectively match vocationally trained youth with employment opportunities may help maintain social stability, but are not likely to alter a country’s voting pattern at the UN. In essence, a portfolio approach recognizes that totalizing approaches with a single, politically managed, monolithic aid agency is not likely to maximize the impact of U.S. foreign assistance. 

THE AID POLICY OF THE FUTURE?

U.S. officials would be wise to adopt a few of the tactics used by financial portfolio managers. First, portfolio managers know that the market can move abruptly and in unforeseen ways. This complicates questions of timing when it comes to implementing changes in investment strategy. Investors do not want to move all their assets out of one fund the day before its value jumps 20 percent, or into a new asset right before its value falls dramatically. To compensate for this, portfolio managers use an approach called dollar-cost averaging to shift funds from one tool to another gradually over time. This allows them to reduce their exposure to unanticipated reversals. The lesson for foreign assistance planners is clear: don’t change everything at once. Staggering gradual but purposeful change is the right approach.
Second, investors know that risk is necessary to generate returns. Investment managers have developed ways of risk balancing, or adding assets with diverse but complementary risks, to seek higher returns without endangering the entire portfolio. This means that it is possible to take on a risky asset while still increasing the general predictability of the portfolio. In a similar way, there is a need for diversity among foreign aid resources and tools. Although administrations of all kinds tend to prefer their own new foreign aid initiatives, U.S. officials should still work to balance risks by maintaining a variety of programs. 

Last but not least, just as investors consider a fund’s possible returns when determining whether its expense ratio is sustainable, the United States must look at the value that its development and diplomacy programs provide before setting arbitrary targets for cuts or new, reduced operating costs. By recognizing more explicitly that the U.S. foreign assistance portfolio is essentially a collection of investments in the United States’ future, U.S. officials could better manage the country’s foreign assistance portfolio and deliver strong long-term returns to the national interest.

This article was originally published on ForeignAffairs.com.

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