Doing Well by Doing Good

With a little knowledge and effort, investors of many kinds can work with financial advisors to learn how to match their investments with their values and build a meaningful portfolio with solid returns.

Trying to do well by doing good with your investments can seem overwhelming and confusing, but it doesn’t have to be.

There is increasing interest in this kind of investing. In 2010, Hope Consulting did a major study of the appetite of individual investors for “impact investments.” There were a number of revealing findings. First, investors’ primary concerns about making an impact investment were protecting downside risk while addressing a cause they care about. They didn’t care if they didn’t make as much money on the investment as they might in a market-rate investment, but they didn’t want to lose any money.

In a 2012 survey of investors by Merrill Lynch, almost 60 percent of the youngest responders listed “social responsibility” as one of the most important factors by which they selected investments, far more than their older counterparts.

Perhaps the greatest opportunity identified in the Hope study was that those who have already made an impact investment are willing to invest 15 to 20 percent more in the future than they have to date. Similarly, in a follow-up study on financial advisors, Gateways to Impact, advisors who had previously invested client assets in sustainable investments were markedly more interested than other advisors in recommending less-traditional products aimed at creating specific social and environmental impacts.

Beginning Where You End

To begin to get a handle on how to navigate the challenges of impact investing, it is helpful to think about the end goal. Ultimately, as an investor, you have identified a desire to change the world for the better. The first step is to analyze if the investment will provide the desired social returns. The second step is to evaluate the investment as you would any other investment. Being an impact investment doesn’t change an investment’s inherent structure. Equity is still equity. Debt is still debt. Wise impact investors and advisors still evaluate the risk and opportunities as they would for any investment.

Impact investing, however, does require a shift in mindset because it requires a decoupling of the standard risk:return ratio. Rather, in impact investing, risk is coupled with impact. The financial returns will vary greatly depending on the change that the investor is hoping to make in the world.

First Steps

When considering becoming an impact investor, it makes sense to start small. Begin by making a simple debt-type investment in a local community investment in your home state or region, such as a CDFI, with a small percentage of your short- to medium-term fixed income/cash allocation. For example, if you live in Vermont, start with the Vermont Community Loan Fund. Community investments have a 30-plus-year track record; some community investments are even insured. The local connection is very important because both the advisor and the client can see, touch, and hear from the players directly doing the work.

Starting small with a community investment enables the advisor and the investor to learn together while getting comfortable with a new investment product. As the advisor and the investor learn from the community investment, most clients then want to add additional impact-driven investments with a broader scope. There are many out there with varying degrees of financial risk. As the advisor and client gain experience with community investments, they will be able to move on to other opportunities.

Aligning a Portfolio

Impact investors generally come to us because they want to actively align their money with their values. For example, a client who recently came into our office for a periodic review of his investments identified the following concerns and goals:

  1. Frustrated by the recession’s impact on his community, he wanted to do more to invest in supporting the local economy.
  2. Distraught at learning that his son’s best friend was living in the family car, he wanted to find ways to invest in affordable housing.
  3. Witnessing the decline of the local family farm, he asked for opportunities to invest in small farms and food systems to help ensure the safety of the food his family eats.
  4. Understanding that we are all on this planet together, he requested that we find a microfinance investment that would help people in other countries.

As an advisor, it is exciting to work with clients who look at their portfolios holistically, where impact and financial return are weighted at the very least equally. Yet, in terms of execution, it can be daunting to devise an impact investment plan.

This client provides a perfect example of the progression that an advisor and client can take together in the impact investment space. Because he wants to build the economic health of the community and support affordable housing, he invested in the Vermont Community Loan Fund for three years at 1.5 percent. To support family farms and job creation, he invested in the Vermont Sustainable Jobs Fund with an objective to achieve an internal rate of return of 4 to 5 percent. He also invested directly in The Northeast Kingdom Tasting Center, a new real estate investment that has been set up to fund food businesses in Vermont’s Northeast Kingdom, one of the poorest regions of the state and around the country. Internationally, he is currently looking at ENvest, which is a microfinance equity pool with an annual target distribution of 6 percent.

Each investment addresses a different social concern of the client. The investments themselves were chosen and evaluated on a risk:impact ratio. On the impact scale they are all strong. The returns, although important, were the secondary consideration. Remember these investments retain the inherent structure of regular investments and should be diversified like any other investments in your portfolio.

The Challenge

As an investor working with financial advisors, it is important to remember that many money managers are grappling with a host of challenges that will make them slow to accept impact investments.

There are very few impact investments that are “publicly traded” like shares of a stock like IBM. Investors often can’t even see these investments on their brokerage statements. These investments usually offer a softer financial return for perceived (and at times real) financial risk according to investment standards of today. Even when clients can tolerate that risk, the compliance teams in bigger firms won’t approve these investments because they can’t be put in a standard box that can be readily understood and communicated throughout the firm. As a result, most firms are not comfortable with these investments and will not accept them. If they do, the cost is often prohibitive for the client.

Also, it is in the interest of the advisor to be seen by their clients as the expert and these types of investments may be new to them. Though most clients don’t expect their advisors to be experts in this space, this may make advisors uncomfortable. Don’t let their discomfort stop you from inquiring and educating them on the opportunity. The client pushing for the investment is the best method to overcome that discomfort. Encouragement and helping a client know that they have the right to make these investments are the best tools for practitioners in the field as they work to remove the perceived barriers over time.

One of the most successful impact investment instruments to reach a broad range of individual investors to date is the Calvert Community Investment Note (CI Note). Now 10 years old, it took three years of effort and lots of philanthropic support to bring to market.

The CI Note became the first fully liquid tradable note that valued and addressed social and environmental impact on an equal footing with financial quality. In general, social and environmental impact had been considered “externalities,” superfluous to the investment decision equation. The CI Note and all the efforts of social investors are slowly creating a whole new language and structures, like B Corporations (see page 22), L3Cs (“low-profit limited liability companies”), and more, that enable investors to consider society and the environment in addition to profit in their decision-making processes.

Although the mindsets of investors and advisors are changing, it’s still a long, hard road to get investment options like the CI Note to market. The transaction costs are a big obstacle. Every step of the investment process takes cents off the dollar. As you might expect, with a softer financial return, all the “middlemen” can eat up the financial viability of the transaction quickly.

Role of Philanthropy

Philanthropic institutions are often impact investors as well, but they have a multifaceted relationship to the field.

It is well known that it took decades of philanthropic support before the microfinance industry became commercially viable. Impact investors have looked at that success and said, “I have to figure out what the next microfinance is and how I can get in on the ground floor.” The scary issue for the impact investing field is that philanthropists are saying the same thing. Seeing the returns available on things they have supported, some are becoming reluctant to provide philanthropic capital for the next big thing, hoping that they can jump right to providing investment capital so that they can realize a financial as well as a social return.

But that could be a problem. In April 2012, the Monitor Institute released From Blueprint to Scale, which argued that to realize the “impact” in impact investing, the sector will require more, not less, philanthropy, and that philanthropic support will need to be delivered in new ways. They argue that this type of “enterprise philanthropy” has been the hidden catalyst behind a number of successful social enterprise models, including M-PESA, the mobile payments platform developed by Vodafone with significant grant support from the UK’s Department for International Development. Another example they cite is the clean-burning cook stoves sector, which has benefited from the sustained funding and advocacy efforts of the Shell Foundation.

There is a “pioneer gap” where young socially responsible businesses and potential impact investments need philanthropy to develop their model, validate and refine it through trial and error, and prepare to bring it to market. The nuance that sets these businesses apart from solely for-profit models that might not warrant grant support has to do with the markets these businesses are in, how the products and services are targeted to those most in need, and the way the businesses are conducted in terms of social and environmental impact.

Even so, providing grant support so that that someone can eventually make money off of what they are supporting makes many philanthropists uncomfortable. But it is effective. Whether you are a philanthropist or working with a philanthropic entity, finding comfort developing a multi-tiered relationship — both grants and investments — with those making the change you seek is the key to unlocking real change.

Growing the Sector

There are a number of organizations that are currently helping investors and advisors navigate this space. For example:

  • ImpactAssets publishes The ImpactAssets 50 (IA 50), a database of experienced private debt and equity impact investment fund managers. ImpactAssets also offers a unique donor-advised fund, with a host of impact investment options.
  • Imprint Capital, an impact investment firm, creates and manages customized impact investment programs and portfolios.
  • Bamboo Finance, a private equity group, specializes in financing entrepreneurship globally. They have funds supporting microfinance, social enterprises, and global energy.
  • MicroPlace is a brokerage platform where you can invest as little as $20.

These represent important steps forward for impact investing, but until we find a way to make the transactions more seamless there will always be reluctance to pursue these kinds of investments. We need to make transactions easier for financial advisors who are the gatekeepers to most of the individual and institutional wealth.

While not a magic wand, a new trading platform being developed may help. This platform, Impact Trader (www.impacttrader.com), eases paper-based transaction and custodial burdens for clients and advisors. If successful, it will do four things: increase awareness and suitability of impact investments, make it easier to access such offerings, turn what had been custom investments into more standardized products, and provide custodianship of those investments once purchased. If this platform succeeds, it will take a labor-intensive, paper-based product and make it into one that is more similar to an IBM trade.

In some ways, it is still new, hard, and confusing to do well by doing good. However, the seeds have been sown to make the process easier and more comfortable for investors, advisors, nonprofits, and social enterprises. The keys for advisors and investors are to stay true to basic investing principles, start small with a local investment that they can see and evaluate for themselves, and measure the investment by the change they are hoping to see in the world as well as the financial return. For those seeking capital from investors and philanthropists, the keys are to make the transaction as easy and transparent as possible and be mindful of both the self-interest and mission of the investor.

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