Impact investing aims to make a difference and, sometimes, a profit.
This article first appeared in the April/May 2011 issue of Morningstar Advisor magazine. Get your free subscription today!
In the wake of recent natural disasters around the globe, investing with a social or environ- mental objective, in addition to a financial one, has been gaining traction as investors search for ways to apply market solutions to local problems around the globe.
Often called "impact investing," this strategy has the potential in the next five to 10 years to grow into a market of approximately $500 billion, or about 1% of total managed assets, according to a 2009 report by the Monitor Institute, a consulting firm. Microfinance, which
involves making small loans to entrepreneurs in developing markets, is the most mature of the impact-investment options, in part because of the proliferation of microfinance institutions. But the overall impact market-which includes investment options built around improving the environment, health, education, and community development-is still in its early stages.
"Impact investing is similar to the early hedge fund days when there were no rankings or comparisons of the offerings. That context doesn't exist yet," says Ron Cordes, co-chairman of Genworth Financial Management and a Calvert Foundation board member.
Simply finding the appropriate impact investment is a time-consuming task. At last count, nearly 1,900 microfinance institutions had reported data to the Microfinance Information Exchange, which provides information and analysis on microfinance providers. Plus, there is no centralized place to compare ROI and social impact across similar investment types. Despite these barriers, impact investing has appeal. Investors can feel like they are making a difference in the world, while gaining a new source of portfolio diversification and, at times, consistent returns.
Leaders of the Pack
Numerous private equity and debt funds, as well as funds of funds that focus on social enterprise projects, are available, but many are difficult to find, research, and buy. Attending industry events such as the Take Action! Impact Investing Conference Series in San Francisco and the Chicago Microfinance Conference can help investors gather information straight from providers.
The more-mainstream players target individual investors and make their options easily accessible. These firms include MicroPlace, Kiva, Calvert Community Investment Note, ImpactAssets Giving Fund, and the Certificate of Deposit Account Registry Service.
MicroPlace, a PayPal company, is a registered broker/dealer that invests in microfinance projects that aim to return principal plus interest to investors. Microplace's website makes debt offerings from six issuers available for purchase. These issuers fund microfinance projects, and each issuer provides a detailed prospectus. The funds are then invested in short-term, nonsecured notes. One project makes direct loans to farmers in Azerbaijan; another offers lines of credit to an association of cocoa bean farmers in the Dominican Republic. MicroPlace performs due diligence on the issuers, and none of its selected issuers has defaulted on a loan. Interest is paid quarterly at rates from 1% to 6%. Investors pay no fees, but issuers pay 1% of the investment dollars they raise through the website to MicroPlace for distributing each offering.
"When we launched in October 2007, the returns were modest compared to the market, but as the market declined and increased in volatility, our issuers maintained their schedules for interest and principal repayment, thus offering, in retrospect, above-average total returns versus the major market indices for the same period," says Paul Blyth, MicroPlace's CFO and head of business development.
Not all social investments are designed to offer market-rate returns. Nonprofit organizations such as Kiva use investment funds to offer charitable loans to specific projects or entrepreneurs. Kiva partners with microfinance institutions to find lending opportunities. Investors select a project to fund. Kiva then loans directly to individuals or groups associated with the project. Kiva organizes the projects into sectors, such as agriculture, construction, and retail, to help investors compare them side by side. At the end of the project, investors often get their principal back. They can lend to another project, donate the funds to Kiva, or withdraw their funds.
The Calvert Community Investment Note (which can also be invested in through MicroPlace) offers fixed-income notes ranging in maturity from one to 10 years and paying as much as 3% interest. The proceeds from the notes go to community-development organizations. The Calvert Foundation selects borrowers based on their record of enabling the poor to reach economic self-sufficiency. Each note is assigned a CUSIP and can be purchased through the investor's brokerage account. Brokerage fees may apply.
The ImpactAssets Giving Fund is a donor- advised fund administered by the Calvert Foundation. Donors create a portfolio of socially responsible investments tailored to their risk profile and causes of their choice. Investors then use the portfolio to fund grants to charities. The minimum initial contribution is $5,000, and all contributions are tax deductible. Also, private family foundations can be converted to a Giving Fund. There are administrative fees associated with this fund; fees vary depending on the amount invested.
The Certificate of Deposit Account Registry Service offers FDIC insurance on certificates of deposit above the standard $250,000 maximum. Investors place money with a CDARS-member
institution, which then funnels the deposit through member banks. The banks issue CDs in amounts less than $250,000 to qualify for the FDIC insurance. Investors can choose to channel their deposit to specific community- development institutions that support underserved communities. For example, CDARS is offering an initiative called the $1 Billion Gulf Coast Rebuilding Challenge, which allows investors to deposit their funds with a gulf- area community bank. Banks pay a fee to join the network, and some banks may offer lower interest rates to cover the costs.
Measuring Financial and Social Impact
There is no independent ratings provider for microfinance investments or issuers. Organizations such as the Microfinance Information Exchange provide data on microfinance investments, including gross loan portfolio, number of active borrowers, and project- specific risks. The Microfinance Information Exchange has a tool that compares one investment with all those in a region, country, or charter type, but it does not allow for direct comparisons between investments that focus on similar projects. What's more, it's difficult to measure the social impact of the investments, so it's challenging for microfinance institutions and issuers to relay that information to investors.
Cordes thinks that he has a solution to these problems. In April, he plans to launch the ImpactAssets Global 50-the first published "index" of the 50 largest impact-investment offerings. The index is meant to help advisors zero in on the projects and organizations that will have the highest financial impact. To that end, Cordes and his organization have been working with the Global Impact Investing Network to uncover information on the most successful impact-investment managers. The group is developing a system to measure social and environmental impact and the performance of impact investments (called the Impact Reporting and Investment Standards), which Cordes hopes to incorporate into the ImpactAssets Global 50 index.
Due Diligence Still Required
The lack of information makes reviewing impact investments more difficult than traditional investments, but advisors should apply the usual investing due diligence. It's important to look for a track record, management experience and integrity, and transparency. The investment should fit the risk tolerance and liquidity needs of the investor. Many private equity and debt funds and funds of funds are illiquid and require multiyear holding periods. Investors should understand any trade-offs between meeting market rates of return and making a more significant social impact and decide what balance they want to achieve.
Often, several parties take on different levels of risk in an impact investment. But that's not always the case. For example, Kiva reported a 98.6% repayment rate on roughly $197 million in loans as of March 8. Although Kiva and its microfinance institutions are in the middle of these transactions, Kiva's investors bear the losses if clients default.
MicroPlace conducts due diligence on issuers, not on the microfinance institutions, making sure that prospectuses clearly explain what investors can earn, when they can expect their money back, and the risks involved. MicroPlace also considers factors such as the issuers' track record in microfinance, financial health, portfolio-management policies, and compliance processes. Most risk related to the investments is assumed by the issuers, which include Calvert and Oikocredit USA. These issuers closely evaluate the microfinance projects and their ability to repay. This includes evaluating the borrowers to determine if the terms of the loan are sensible given the project in question or verifying the institution's ability to prevent fraud. The issuers keep loan-loss reserves in case a project doesn't pan out, and overall risk is typically minimized by a diversified portfolio of projects. Still, it is possible for several loans to default at once, which means the issuer wouldn't be able to return investors' principal.
Impact investing might attract new clients and act as a differentiator for your business. It provides a chance to talk to clients and prospects about something that is important to them outside of their portfolio returns.
Initiatives such as the ImpactAssets Global 50 index will go a long way to help narrow the field for advisors who want to find the best impact investments for their clients. In the meantime, due diligence will remain time- consuming until the market has matured and information is more readily available.
Karin Anderson is a mutual fund analyst with Morningstar. Alison Finn is a product development manager with Morningstar's advisor software group.