As The Economic Crisis Deepens, Socially Oriented Capital Emerges
As The Economic Crisis Deepens, Socially Oriented Capital Emerges
Thursday, March 5, 2009
By: Robin Hacke
Our nation is in uncharted waters as the economy proves resistant to a jump start, even after injections of hundreds of billions of dollars. Huge returns on investments that once seemed assured have, in fact, proved illusory. Whether through fraud, as in the case of the Madoff scandal, or through an unanticipated level of risk, the realities of the current bear market have led investors to plumb alternative vehicles for their increasingly scarce investment dollars.
One beneficiary of that search is a niche market: social investing (AKA “mission-driven” or “impact” investing). Social investing is defined in the January 2009 Monitor Institute report, Investing for Social and Environmental Impact as “actively placing capital in businesses and funds that generate social and/or environmental good and at least return nominal principal to the investor.” Impact investing has, unfortunately, long suffered from the assumption that doing good involves a huge sacrifice of return.
The current market, however, is proving this assumption to be false. Amid staggering losses in mainstream investments, mission-driven investments stand proud with a solid track record for having produced modest–but consistent–returns with only moderate risk. As a result, doing good is looking a lot more attractive. In the words of the aforementioned Monitor Institute report, “Despite the substantial disruptions in the general investment community that have left many people shell-shocked…impact investing innovation is proliferating.”
Not a New Idea, Just a New Application
Impact investing is not new. Program-related investments (PRIs) were pioneered by foundations like Ford in the 1960s. PRIs are defined by the U.S. tax code as investments made by foundations to support a charitable project or activity. They may be structured as loans, loan guarantees or lines of credit, and are expected to be repaid. Over the past 40 years, such foundations as Ford, Annie E. Casey and MacArthur have built substantial portfolios of PRIs.
PRIs offer foundations flexibility and leverage, augmenting a grant strategy and extending the reach of philanthropic programs. They enable recipient organizations to gain credibility and strength by providing the opportunity to build a track record. PRIs also help an organization to demonstrate that it is financially disciplined, well managed, and credit-worthy. In fact, PRIs often fill financing gaps that might otherwise impede projects, according to the John D. and Catherine T. MacArthur Foundation, which offers a variety of resources and information on PRIs. Foundations, in turn, benefit by generating a return on investment while expanding impact. The PRI Makers Network – an association of grantmakers that use program-related and other investments to accomplish their philanthropic goals – provides a wealth of information on this topic.
With such proven benefits, why don’t all foundations and wealthy individuals practice impact investing? The answer, in part, is that impact investing requires somewhat different skills than traditional grantmaking. Finding staff with the knowledge to source, underwrite, structure and monitor impact investments has been an impediment to growth for this the sector. Most high-net-worth individuals and many foundations don’t have the resources to dedicate a staff member to acquire the specialized skills required for impact investing.
Catalyzing Social Investments
Helping investors to overcome this and other barriers to implementing an impact investment strategy is why Living Cities, a collaboration 21 of the world’s largest foundations and financial institutions, has begun to create a series of social investment vehicles. With nearly 20 years of experience in bringing together the private, public, philanthropic and nonprofit sectors to channel capital to underinvested communities in America’s cities, Living Cities can be a helpful guide to the world of impact investing.
The first of the Living Cities’ social investing vehicles, the Catalyst Fund, is a $20 million debt fund raised in the midst of one of the most tumultuous eras in U.S. financial history. Investors include foundations with deep experience in PRIs as well as foundations newer to the field of social investing, including the Robert Wood Johnson and Kresge Foundations. Through the Catalyst Fund, which provides flexible, patient capital to community-based organizations around the country, the pioneers of PRIs share their experience with those inexperienced in social investing, opening this field up to new players who would otherwise lack the know-how or resources to ensure sound investments.
For investors who care about the future of America’s low-income urban neighborhoods, participating in the Living Cities Catalyst Fund also enables them to build a diversified portfolio of investments quickly, efficiently and cost-effectively; lower transaction costs through economies of scale; reduce risk; access broader pipeline of potential investments; avoid the need to underwrite and monitor individual investments; and maximize the impact of their investment dollars.
Expanding Social Investment Opportunities
Other avenues for social investors not wishing to go it alone include investments through a range of intermediary organizations, some of which have long track records of producing consistent returns, managed risk and tremendous social impact. For example, the Local Initiatives Support Collaborative and Enterprise Community Partners (Enterprise)–two national intermediaries active in community development financing–provide loans and grants that have financed the creation of hundreds of thousands of affordable homes.
LISC and Enterprise are only two examples of community development financial institutions (CDFIs). CDFIs provide capital to organizations that may otherwise be unable to secure a loan from traditional financial institutions. The Community Reinvestment Fund for example, has supported lending to small businesses ineligible for bank loans. Low Income Investment Fund serves as a bridge between private capital markets and low-income neighborhoods, focusing its efforts in the areas of child care, education and housing. Given the current state of the market, and the timidity that those financial institutions left on the playing field have with regards to lending, the demand for CDFI services has increased greatly.
Jeremy Nowak, the president and CEO of The Reinvestment Fund a leading CDFI with a number of innovative programs including a unique program to support access to fresh foods through the development of supermarkets in underinvested neighborhoods, notes that, “The effect of the recession and financial meltdown has been profound on our organization, the communities we serve, and our borrowers. On the financial side we are carefully managing our liquidity as some of our largest investors have pulled back from the market…At the same time we have more demand then ever, due to the contraction of conventional debt.”
Looking Ahead to an Increased Level of Interest
CDFIs, which recently received a substantial allocation of additional capital from the stimulus bill, are only part of a larger movement to invest for both social and financial returns. Social investing is slowly emerging as a force that will yield a variety of investment alternatives–from pooled funds to start-up “green” laundries; and from community banks to companies that provide health insurance for freelancers. The Social Investment Forum estimates that socially oriented capital now encompasses an estimated $2.71 trillion of the $25.1 trillion in the U.S. investment marketplace.
This number seems to be on track to increase over the next few years as organizations devoted to increasing the impact of and interest in social investing continue to emerge. In addition to the aforementioned PRI Members Network which boasts more than 90 member foundations, the More for Mission Investing Campaign announced in 2007 by the Annie E. Casey Foundation, and Meyer Memorial Trust challenges foundations–private, community and corporate–to increase the percentage of funds they dedicate to mission-driven investments. Small foundations are provided specific help in this area by the Association of Small Foundations which has published four primer guides on the ins and outs of social investing.
And yet, despite the increase in resources around social investing, this sector is still very much at risk of remaining a niche market. It is for this reason that vehicles that remove the barriers for everyday investors and foundations with limited resources are an essential step toward ensuring the strength and the future of impact investing.