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Archives

Monthly Archives: May 2010

Impact Investing

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Impact Investing

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Capitalism is tackling the world’s biggest social and environmental problems-and giving investors a new way to do well by doing good.

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By Ron Cordes
May 1, 2010
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Pretend it’s 2007 again, and you must choose between two investment opportunities. One is a pool of U.S.-based mortgage-backed securities packaged by a huge Wall Street firm. The other is a fund with stakes in small, obscure, mostly privately held lending institutions around the world. These so-called microbanks make unsecured loans to people who earn less than $2 a day and lack anything resembling collateral.
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I can guess which one most of you would have picked. And while we all know what happened to mortgage-backed securities since then, the microbank investment has returned a consistent 6% annually over the past three years. What’s more, the loans those obscure little banks made (loans as small as $50 in some cases) have enabled entrepreneurs living in some of the world’s least developed countries to start or expand small businesses and begin to pull themselves and their families out of pervasive poverty.
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I know this because I invest in those microbanks, as do a growing number of pension funds, foundations and high-net-worth individuals. I am also an active participant in an emerging investment category called impact investing. Although it’s barely on most investors’ radar screens today-and despite the fact that some microbanks have been in the news recently for doing more harm than good in these developing countries-I still firmly believe that in the coming decade impact investing could fundamentally reshape how your clients “do well by doing good,” how the planet’s biggest problems get solved and how you bring value to wealthy investors.
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MAKING AN IMPACT

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Impact investing combines the often-opposed forces of capitalism and social justice to achieve two main goals:

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* Solve the major social problems of our time, including global poverty, infant mortality, a lack of clean water, homelessness, substandard education and global warming; and

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* Generate reasonable financial returns for the companies, organizations and investors addressing those issues.

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Impact investors pursue these twin goals by making debt or equity investments in social enterprises-companies and groups that use market-based solutions, such as sustainable business models and profit motives, to address social and environmental issues. Social enterprises are nothing new, of course. Thousands of these small, privately held firms have sprouted up around the world. The most famous is Grameen Bank, a microlender whose founder Muhammad Yunus was awarded the Nobel Peace Prize in 2006.

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Here’s what is new: As more of these firms have achieved their initial social goals, they’re looking to expand their operations and do more good for more people in more countries. Much like traditional small companies, they’re looking to the capital markets to help fuel their growth. This could significantly affect traditional charity and philanthropy as well as socially conscious investors (and the advisors who serve them).
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A BETTER WAY

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Impact investing is a response to some of the shortcomings in existing methods for enacting positive social change. Take government aid. For decades, it has largely failed to create meaningful and lasting social good due to an often ineffective use of resources and endemic government corruption in many of the world’s poorest nations.

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And traditional charity, while important, doesn’t have the scale to address the world’s biggest social issues by itself. The scope of problems like the lack of clean drinking water (which affects 960 million people) and proper sanitation (2.5 billion people) is enormous, especially for organizations that must rely solely on donations and the goodwill of others to make a difference.

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Within the investment arena, traditional socially responsible investment options, such as SRI funds, tend to focus on identifying and avoiding big companies with perceived negative business practices or products. More recently, ESG funds have sought to identify and invest in large companies demonstrating strong environmental, social or corporate governance characteristics. Both funds serve important missions. But they aren’t designed to provide targeted support to the types of privately held firms developing innovative solutions to the world’s social problems.

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By contrast, the new breed of social enterprises circumvents the limitations of government aid and traditional philanthropy by allocating financial and intellectual capital directly to entrepreneurs motivated to solve their own problems. This model is rapidly gaining acceptance in the marketplace as more of the developed world sees the world’s poor as deserving of our investment, not just our charity.

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Affluent baby boomers are a key driver of change here. Boomers are regaining their sense of social activism now that they’re older and have more time and financial resources. As they start to define their success beyond their bottom line, they’re looking for new ways to use their resources to create sustainable good. In addition, mid-career professionals in their thirties, forties and fifties are getting off the corporate treadmill and using their experience to support socially driven for-profit businesses.

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Social enterprise is also becoming popular among Gen Yers. As with the boomers before them, these students are highly socially conscious. Unlike their elders, they’re looking to integrate their drive to create change into an entrepreneurial career track right now.

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GETTING STARTED

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This momentum means you should start raising the issue of impact investing with your clients now-both to spark interest and position yourself as a pioneer. Your powerful message: You are driven to help your clients connect their investment capital with the social values and concerns that are important to them as human beings and to infuse their portfolios with a deeper sense of meaning and purpose.

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Chances are, impact investing will resonate most among affluent investors with $2 million or more in investable assets. These investors have less concern about outliving their savings-they’re at a level of affluence that enables them to explore the type of impact their wealth can have on the world around them. And most impact investments today are structured as private debt or equity funds, which are available only to accredited high-net-worth investors.

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Within that group, target your initial conversations to clients who have indicated an interest in leaving a legacy that demonstrates their passions and values-clients for whom a meaningful connection resonates. When these clients hear they can achieve social good while retaining the assets in their portfolios and use impact investing to leverage their traditional philanthropy, they will recognize an exciting new conversation.

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Your initial conversations should answer three questions:

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* What broad-based issues are of greatest concern-poverty, education, healthcare, housing, the environment or some combination?

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* Is there any particular geographic focus (country or region)? Is there a preference for domestic issues versus problems in foreign markets?

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* How much of the portfolio should be allocated to impact investments? Given the embryonic nature of the industry and the lack of products, begin with a modest allocation-2% to 4% of the portfolio-and build from there as the industry grows.

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Next, identify specific investments and discuss their appropriateness based on the client’s goals, assets and risk tolerance. As noted above, options include private equity and debt funds (and funds-of-funds), which can carry minimums of $50,000 or more and can be highly illiquid, requiring holding periods of several years before investors can realize any gains.

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It’s also important to be realistic about the current state of impact investing. It’s still early in the game. Lack of an organized infrastructure and intermediation capabilities makes it difficult to find social enterprise projects. In addition, there’s no universal criteria for how to measure the social or environmental results of these investments, making apples-to-apples comparisons of various investments challenging.
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ADVISOR OPPORTUNITY

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Despite the complexity, advisors who begin these conversations soon will have a distinct competitive advantage. This advantage has three parts. First, there’s an opportunity to appeal to affluent boomer clients yearning to live lives of significance as they age and reconnect with the desire to create social good they felt when they were younger. They’ve achieved financial success and are now starting to think about their “life footprint”-the lessons, values and legacies they want to pass along to their heirs and to society. Introducing impact investing lets you talk to these clients about their core interests and values-a topic their other advisors likely aren’t addressing.

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Second, from an overall prospecting and referral standpoint, impact investing is new and interesting to many ideal client segments. It’s a fresh conversation to have with investors who are tired of hearing the same old stuff.

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But the biggest impact is in client retention and multigenerational opportunities among affluent families. Currently, less than 10% of the next generation retains their parents’ advisors. Advisors can use impact investing as a multigenerational glue to engage not just their wealthy older clients, but also those clients’ children and grandchildren as families work together to define their social impact beliefs and strategies. Use the social enterprise movement to talk to younger generations about issues they care about deeply-more deeply than beating the S&P 500.

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Early adopters are already embracing impact investing (see “Veteran Advice,” above), and the infrastructure is being put into place. While it’s not for everyone, impact investing could resonate with baby boomers, affluent clients and multigenerational families-and be crucial to the growth of your practice in the decades to come.

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Ron Cordes is co-chairman of Genworth Financial Wealth Management and president of the Cordes Foundation.

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Investing into Microfinance Investment Funds

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Investing into Microfinance Investment Funds

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This paper aims to measure the performance of microfinance investment vehicles (MIVs) in terms of risk and returns to investors. The study included 11 MIVs (in the form of mutual funds) and their sub-funds that publish data monthly. The authors describe the funds as “commercial MIVs that focus mainly on financial objectives while their social and development contribution is a sort of value added that sets these funds apart of traditional mutual funds.” The funds primarily invest in debt instruments with maturities of no more than five years and have more than half of their investments in the microfinance sector.
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The period for the study is January 2006 to March 2009, which notably includes a major portion of the global financial downturn. The mean monthly return on assets (based on net asset values per share) for the MIVs was modest but positive throughout the study period. The average monthly return for the MIVs was 0.36 percent. This compares favorably to the Morgan Stanley Capital International (MSCI) World Index, which measures the performance of developed country equity markets (-0.99 percent), and the MSCI Emerging Markets Diversified Financials Index, which measures equity performance in emerging markets (-0.40 percent). It also compares favorably to the JP Morgan Emerging Bond Index (EMBI+, 0.27 percent) and the four-week US Treasury Bill, an asset that is considered to be virtually riskfree (0.26 percent). The MIVs, however, did not perform as well as the Markit iBoxx USD Overall Index, which consists of corporate bond issues and bonds issued by the US government and government-sponsored agencies (0.41 percent).
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Though MIVs in this study saw increased annual returns each year from 2006 to 2008, the authors point out that these MIVs could suffer from the downturn further into 2009 and 2010. The MIVs also compared favorably to the above-mentioned benchmarks in terms of risk. In terms of total risk, measured by standard deviation in monthly returns, the MIVs had a lower mean (0.32 percent) than all other indices except for the “risk-free” Treasury Bills
(0.15 percent). There was increased volatility for the benchmarks in monthly returns starting in 2008 due to the financial downturn, but this is not seen in the MIVs data, though the earlier warning about possible repercussions after March 2009 again applies.
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Additionally, the authors find that there is no positive correlation between mean MIV returns and either equity market index, indicating that MIV investments may serve well in portfolio diversification. The same cannot necessarily be said for the correlation with fixed-income indices, as there were not enough statistically significant results to make a conclusion in this regard.
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Lastly, the authors compare MIV performance to the same indices using a risk-adjusted monthly return measurement. Including only statistically significant results, MIVs outperformed the other indices by 14 to 16 basis points. However, during times of positive global market sentiment (pre-financial downturn), MIVs lagged behind the MSCI World Index (other indices were not included in this regression).
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By Karel Janda and Barbora Svárovská, published by the Institute of Economic Studies, Faculty of Social Sciences Charles University in Prague, 2009, 35 pages, available at: http://www.microfinancegateway.org/gm/document-1.9.41460/Investing%20into%20Microfinance%20Investment%20Funds.pdf
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Richard Rosenberg on the Compartamos Controversy

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Richard Rosenberg, consultant to CGAP, speaks about the spectacular success and controversy around the IPO of Compartamos, one of the leading MFIs in Latin America. He concisely addresses the core issues of their transformation from a NGO to a for-profit and the impact of the IPO.  Upon a thorough review of the facts and reflection, the Compartamos case reveals the potency of the for-profit model  in delivering the most value to all stakeholders, individually and as a whole.

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Part 1

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Part 2

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Part 3

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