What the 1 Percent (of Capital Markets) Could Do for Impact Investing
How can we unlock new sources of capital from retail investment to ensure impact investment opportunities aren’t just for the wealthy?
While major investment banks have alluded to the promise of impact investing, (think J.P. Morgan in its 2010 report with The Rockefeller Foundation, which included an analysis of 1,100 impact investments that were identified as asset class), at this point in time, impact investing is still not an important activity for any of these major players. Even if it were deemed a priority, the vast majority of the $80 trillion in global capital markets is locked up in investment structures unlikely to be unlocked for impact investment anytime soon.
So what is a realistic goal in the near-term to free up some of this capital and how do we unlock it? Anthony Bugg-Levine and Jed Emerson in their new book Impact Investing: Transforming How We Make Money While Making a Difference discuss how opening just one percent of these assets for impact investing would create “a capital pool four times larger than all current annual official donor flows and almost three times greater than the total of U.S. annual charitable giving.”
In order to do this, Bugg-Levine and Emerson discuss the importance of “widening the doorway” in order to create a greater pool of private capital for impact that moves beyond a handful of innovative deals. They explain that the sector needs to create replicable deal structures, funds, and platforms that achieve scale and offer liquidity to investors.
But “widening the doorway” holds importance beyond achieving this 1 percent asset goal for impact investing; the concept needs to be applied in a way that promotes the democratization of capital flows. As Bugg-Levine and Emerson explain, the sector has so far existed almost exclusively in the realms of “the ridiculously rich and the ludicrously large.” Family offices, private clients, and pension funds are the ones with the large capital to put to work, perhaps more than the impact sector can even handle for a very long time.
So what about retail? While opening up the doorway to retail clients may not hold as much sway in terms of volume of investment capital, taking impact investing retail is important for more than sheer capital reasons.
As Bugg-Levine and Emerson say, “it is about creating a more integrated relationship between our assets and our values,” and it’s about transforming what society values and how we organize our resources to achieve these values. If impact investing remains confined to the upper echelons of society, then opportunities for transformation at other levels are limited. What we need are less boutique, innovative deals, and more products that can be accessed by a wider range of people. And with the recent Occupy Wall Street protests making it clear that our society is in desperate need to rebuild trust in our economy, it’s very important that we as a sector do our part to aim for inclusivity.
Most of us are familiar with the Calvert Foundation, which has been the leader in the retail sector in the United States, especially with its Community Investment Note. This program, to date, has leveraged over US $200M for community development initiatives, like low-income housing, and has less than a 1 percent loan default rate.
Looking beyond the U.S., TriLinc Global is an example of a private investment manager with a retail product focused on channeling investment into SMEs in emerging economies. I thought the launch of their retail fund in 2012 was a good tangible example of products that will reach a wider swath of people and moving beyond just the “ridiculously rich and ludicrously large.”
TriLinc Global’s Retail Investment Fund
At the 2011 Net Impact Conference at the end of last month, I had the opportunity to speak with Gloria Nelund (pictured left), the founder and CEO of TriLinc Global. In 2012, with Gloria at the helm, TriLinc is launching a $1.25 billion Global Impact Fund for “mainstreet” retail investors.
In late 2007/early 2008, when Gloria wanted to do something more fulfilling in the finance sector after a 30-year career on Wall Street, she decided to do some market research on existing impact funds. Nelund explained, “I wanted to focus my attention on bringing scalable capital to SMEs in stable, emerging markets because of their potential to catalyze economic growth and reduce poverty.”
Through this process, she found the No. 1 issue for SMEs in emerging economies was a lack of access to private capital (her research showed that less than 17 percent of SMEs had access to capital at that time). Also, most impact investment funds were under $100 million, and there was a need for scale. So as she went about her research, she did a deliberate review of which class of investors she considered most plausible to unlock. In her career as a Wall Street industry veteran, Gloria has experience servicing, packaging and delivering products into all three channels:
- Retail investors. Nelund knew that retail investors do buy into new investment products and represent a significant pool of untapped capital – if one knows how to access them.
- Institutional investors. This cadre of investors is usually the last to enter any new market.
- High net worth individuals. These investors have lots of capital, but they are difficult to access because most have gatekeepers to whom they delegate authority.
So Gloria decided retail was the avenue she wanted to take. The first step, working with legal counsel, was to determine an appropriate registered fund structure and understand the resulting investment restrictions. Simultaneously, she selected a third-party distribution partner institution with a track record raising $1+ billion funds in this channel and worked with them to understand the product characteristics that would be necessary for a successful raise. From there, she reverse-engineered the investment strategy to achieve the fund objectives that would be required: current yield, modest capital appreciation, market returns and measurable, positive social impact (including job creation).
Knowing she could achieve scale on the capital raising side, the next key was to be able to scale the investment side. Using a proven strategy from her investment days, she decided to hire a Chief Investment Officer with global, macro investment expertise and then select and hire sub-advisors to make the local investments. To meet retail investor objectives and comply with investment restrictions, TriLinc decided to focus mostly on debt investments. Another benefit of a debt strategy is that it keeps wealth in the country. With many private equity deals, once there is an exit, the money leaves the country, ultimately working against the economic growth strategy.
What about impact?
TriLinc is mostly focused on economic development and poverty alleviation through job growth, raising the average wage of unskilled workers, and increasing the local tax base. Their impact measurements primarily focus on these metrics. In terms of tracking other environmental and social metrics, Gloria is waiting to see what resonates most with investors as the sector evolves. As a reference, Gloria pointed me to the 2010 Hope Consulting study, Money for Good, which shows strong retail investor demand for impact products that can prove their impact and deliver market-rate financial returns.
When I asked Gloria to explain her reasoning on how TriLinc tracks social and environmental returns, she shared her thoughts on the differentiation between impact-focused and financially-focused products. She believes the sector would be better off if it acknowledged the existence of two camps. Although she is committed to impact investing, TriLinc is upfront about pitching their tent in the finance camp, and expecting market-rate returns.
But Gloria doesn’t think there will always be two camps. She is optimistic about longer term behavioral change in the impact sector and believes that as new financial products are created, a bigger shift will occur in the industry, toward more patient capital. Gloria predicts that in 10-15 years, as the industry develops, we’ll see more investors who are willing to accept a more modest financial return, while expecting clear and significant environmental and social returns on their investments.