The Power of the Muni-Bond Market for Impact Investing
A Q&A with Adasina Social Capital and Activest on muni bonds as the intersection of finance and policy.
Investors may not think of the municipal-bond market when it comes to building an impact portfolio around racial justice, but it’s one area where their dollars can have a direct connection with public policy.
We spoke about this intersection of social impact investing and public finance with Rachel Robasciotti, founder of Adasina Social Capital, Ryan Bowers, co-founder of Activest, and Chelsea McDaniel, a senior fellow at Activest. Adasina and Activest work together on the Adasina Fiscal Justice Municipal Strategy.
Q: Rachel, Ryan, Chelsea, thanks for joining us. Let’s start at the beginning. Why municipal bonds?
Ryan: The municipal market is supposed to be not only low risk but also public purpose. But we're seeing things in the market that are neither good for a city's fiscal health or its residents.
Rachel: People start off by assuming that investing in municipal bonds is an unqualified good and what we're saying is, "No, it isn't."
You can have cities that are actively, financially exploiting the Black residents. And then, on the other side of the table--something that we haven't dug into as deeply yet--is that there's evidence of racial discrimination in the municipal-bond market. There are cities that are doing a great job, but there's evidence of them being penalized in the municipal-bond market--charged higher interest rates simply because they're Black communities.
And so the strategy that we put together flows capital to those communities that are doing things right. It strategically invests where we have partnerships and where we know that our bondholder engagement can have a tremendous impact on that community.
Q: Many investors might not see the link between racial justice and municipal finances. Ryan, how did Activest come to find its mission?
Ryan: Right after Michael Brown was shot and killed by the police in Ferguson in 2014, a number of our foundation clients asked us to figure out how to get some dollars quickly on the ground.
What came out was essentially that the city of Ferguson was raising an outsize portion of its revenues from excessive fines and forfeitures fines and fees on the Black community. Everything from fees for broken taillights to jaywalking and motor vehicle violations. People call it "taxation by citation."
In Ferguson, 20% of their revenue was coming from Black residents in this way. The national average is closer to 2%. This is a problem across St. Louis County.
Q: How did this spill over into the bond market after the consent degree between the Justice Department and Ferguson?
Ryan: After the consent decree (between the Justice Department and Ferguson), Moody’s downgraded Ferguson’s bonds from investment-grade to junk, and the pricing on their bonds went from one to one on the dollar down to around 50 cents on the dollar.
So, we saw that and had an "Aha!" moment because we knew that the rating agencies don't have a racial justice lens. And we know that there are other Fergusons out there, not just across St. Louis County but across the country.
Whether it's excessive tax abatements that take revenue from school districts to police misconduct expenses of billions of dollars, as bondholders we took the angle saying: It is actually the fiduciary duty of investors to know when there is a mispricing of social risk in the bond market.
Q: You mentioned tax abatements. How do they fit into this?
Ryan: When Jacob Blake was shot in Kenosha, the city council and the police supported the city buying body cams for the police department. But they didn't end up [making the purchase] because they said they didn't have enough money to do it. But then we found out Kenosha had actually given away 29% of their revenue in 2016 toward corporate tax abatements.
This is significant because research shows these dollars given away to corporations are the most expensive, redundant, and ineffective ways to do development. Wisconsin has the most tax abatements given away in the country of all the states. So, Kenosha was the most abated city in the most abated state.
You can see how decisions around expenditures impact the ability to use revenues in a way that could have created some police accountability and reduce that kind of social unrest.
Q: The Activest website talks about the bondholder engagement campaign you took part in around Chicago. What was the story there?
Ryan: In Chicago, they were getting about 9% or 10% of revenues from fines. And there's research that shows Chicago has bankrupted thousands of residents a year because of debts owed for unpaid fines. They found that over 100% of the revenue brought into the City of Chicago goes back out the door in the cost of obtaining these fines, court operating costs, and collections agencies. And it's eroding the tax base, which is actually one of the things that impacts your city credit profile.
It’s bad financial practice, and it’s bad from a justice and equity perspective. We ended up writing to bondholders, which includes the usual suspects like Vanguard and big insurers and banks, saying there is an unmitigated risk that your investors might be exposed to.
Q: It also sounds like part of the problem is that some of these cities become addicted to this revenue stream.
Ryan: Yes. New Jersey is one of those places your drivers license can be suspended for unpaid criminal justice debt or even motor vehicle violations. New Jersey, like many states, is realizing that this is onerous and hampers economic security for residents. They did a study of their fines and found these fines actually are the revenues that back so many state bonds. So they had to push it out 15 years.
Q: In terms of the investment strategy, how does it come together? Does this mean you’re excluding certain issuers?
Chelsea McDaniels: We have an engagement strategy, not an exclusion strategy. Black and brown communities don’t usually have the luxury of excluding problematic issuers, communities, and deals--and neither do we.
Q: The Activest website details a strategy around bonds issued to help address the water crisis in Flint, Michigan. While Activest had concerns about inequities in the details of the revenue plan, it also explains the rationale for owning the Flint water bonds, those of a hospital in the area, and specific areas of engagement to directly help residents of the city.
Rachel: The way we built this, it’s really a 75/25 kind of strategy where 75% of the portfolio is flowing capital to those really well run, fiscally just communities, and in doing so, we help to resolve some of that mispricing. And then 25% of the strategy are municipalities that may have some fiscal justice issues but there's deep relationships on the ground. What they need is somebody with a seat at the table. In other words, something where you know the city treasurer wants to listen when you call.
Chelsea: Hampton, Virginia, is a good example.
Hampton is a Black-affirming community, takes a generative approach to public safety and economic development, and presents an exciting opportunity to invest in a traditionally underresourced community. They have a different approach to policing and even when you look at their budget, it's much, much smarter.
While we primarily invest in general-obligation municipal bonds in Black communities, we may also invest in school bonds, such as those issued by Historically Black Colleges & Universities bonds.
Q: There’s research that shows HBCUs pay higher bond costs than comparable schools that are predominantly white.
Chelsea: It’s getting more liquidity in that direction and helping to correct some of that mispricing.
Q: Ryan, Rachel, Chelsea--thanks for taking the time.
Ryan: This is the intersection between social justice and finance, and this is really why we got into this work.