At NPQ, we have regularly tracked impact investing and community investing. These terms refer to ways to leverage private investment—a broad category that includes the investments made by wealthy investors, small investors, philanthropy, and managers of retirement funds—to achieve social benefit and build community wealth.
Now, no less an authority than the Federal Reserve Bank of New York has joined in, publishing an important report by Fran Seegull, John Cochrane, Claire Mattingly, and Miljana Vujosevic of the US Impact Investing Alliance on the state of community investment. Titled Impact in Place: Emerging Sources of Community Capital and Strategies to Direct it at Scale, community investing, the authors explain, “is broadly defined as investment capital that flows to underserved communities for economic development, affordable housing, and growing small business ecosystems” (page 11).
Overall, the report offers a clear-eyed view of both community investment’s promise and of the challenges to realizing it. The latter is critical, as any serious analysis of using private capital to achieve public good (“private capital, public good” is the alliance’s tag line) has to grapple with the many past failures of private capital, even when called “impact investing,” to achieve public good.
It’s no secret that wishful thinking pervades the impact investing world. Too many want to believe investors can both earn maximum economic returns and “do good” at the same time. This belief, although true in the narrow sense that it’s possible—and there are $17 trillion worth of examples—to design socially screened funds that have market rates of return that compete with those of non-screened funds, is not true in the more profound sense of using impact investment to shift relations of power in the economy. It is one thing to screen stocks and bonds and “select out” bad apples, but this does not change the central dynamic of seeking maximum return. (Indeed, for many impact investing funds, that’s the goal.) Shifting power in the economy fundamentally, however, requires that capital investors accept lower returns and that the beneficiaries of community investment, in turn, keep more. There is, in short, no free lunch.
Unfortunately, wishful thinking remains with us. On the report’s website, for instance, a video of Otto Kerr III, the New York Fed’s director of strategic partnerships and community impact investing, declares, “Many of America’s biggest corporations are in fact looking to make changes that are monumental.” As with the word “impact,” it all depends on how one defines the word “monumental.” But Kerr’s statement seems ill-timed at best in an economy that, despite the plethora of corporate racial justice statements, has seen a “monumental” shift of wealth and income to the top (and away from BIPOC communities) amid the COVID-19 pandemic.
One gets similar whiplash reading the report’s foreword by Darren Walker, president of the Ford Foundation, which funded the research behind the report. In his lead paragraph, Walker writes that, “If our out-of-balance capitalism was on the precipice before the pandemic, it is now in a state of calamity.” Yet in the next paragraph he adds, “As we transition to a new year and the next phase of the pandemic, leaders at all levels, and from every sector, must act swiftly to deliver investment capital to these overlooked populations in financial distress and build a more inclusive capitalism.”
Can an existing “state of calamity” be so easily resolved?
It’s a good thing that the report’s authors, even as they share Walker’s vision of “a more inclusive capitalism,” don’t shy away from the obvious difficulties. “The Alliance,” Seegull and her colleagues write, has “identified a number of structural barriers preventing more capital from flowing to underserved communities.” These barriers require doing far more than moving money.
In an interview with NPQ last December, Seegull underscored the need for more far-reaching change. “This year [2020] has shown us we are interdependent and there are big systemic risks that we have not observed the cost of.” Seegull added that she doesn’t think that “creating negative social and environmental impact and then asking the government and the nonprofit sector to clean it up” is “a sustainable system.”
Fundamentally, Seegull and her colleagues contend that core investment concepts must be reconsidered if community investment is to become more than a small market niche. For example, the core concept of “fiduciary duty” requires redefinition. Other barriers identified by the authors include measures that can broadly be labeled “investor education,” including the training of registered investment advisors who play a central role in investment placement.
Rethinking Fiduciary Duty
As a Cornell Law School website explains, “When someone has a fiduciary duty to someone else, the person with the duty must act in a way that will benefit someone else, usually financially.” Of course, fiduciary duty is a critical concept in investing. It is vital that when an individual is, for example, investing to support their own retirement (as with an individual retirement account, for example), the investment firm acts in the person’s best interests. But what if a client wants to invest with community impact in mind? Well, as the Impact Investing Alliance team indicate, then you have a problem.
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In their report, Seegull and her colleagues observe that, “Fiduciary duty considerations may limit the universe of investable opportunities for investors that work with a Chief Investment Officer (CIO), Outsourced CIO (OCIO), RIA [registered investment advisors], or wealth and donor advised fund (DAF) platforms. Specifically, these advisors and platforms are more likely to consider only market rate investments (or those perceived as such), effectively eliminating the option to pursue a more concessionary strategy, even if there is great demand for exposure from clients and for that type of capital on the ground.”
Rightly understood, what is being described is a blatant violation of fiduciary duty. In this case, investors (clients) have made their desires known, but their so-called fiduciaries are blocking rather than enacting their preferences. Be that as it may, it is hard to entirely blame institutional investment firms, which may legitimately fear lawsuits from clients who say at one time that they want community impact, but then opt to sue later if they earn sub-market rates of return. (Never mind that this may be an expected outcome of said investments).
Here it’s worth recognizing that approximately 80 percent of all stock in the US is managed by institutional investment firms. In other words, these conditions apply to most investment capital. Clearly, there’s a need for new norms (likely backed by regulatory change) here. The way this gets phrased in investment language is, as the US Impact Investing Alliance wrote in a recent related report, “Regulators should provide clarity to investors—including retirement plans and charitable endowments—around their duties as fiduciaries and their ability to consider the long-term materiality of impact factors.”
Changing the Culture of Investment Advising
Changing regulations would help, but even if the definition of fiduciary duty were altered to facilitate the consideration of community impact as “material” (of value), that might have relatively little effect, unless the culture of investment itself shifts. The report authors offer some suggestions regarding how that shift might occur. Two of the most important are the following:
1) Integrate community investment into modern portfolio theory: For the uninitiated (and simplifying a lot), portfolio theory is widely applied to maximize a person’s risk-adjusted rate of return through diversifying holdings by industry and in different forms (stocks, bonds, cash, etc.). “Community investment” does not fit into this schema, and therefore often gets ignored (or, at best, included as social investment screens, such as not investing in tobacco companies). As the report authors put it, “Integrating community investments into traditional portfolios can be challenging.” (30).
And yet, challenging though it may be, rethinking portfolio theory is essential. As Robert Eccles wrote earlier this year in Forbes, “Diversification works well, but only to mitigate idiosyncratic risk. The problem is that non-diversifiable or systematic risk, often caused by systemic risks to the environmental, social, and financial systems in the real world, actually matter much more to returns than do risks associated with any individual firm or security.” And, one might add, these systemic risks matter far more to both the quality of life of people and the planet.
2) Educate investment advisors about the range of community investment models: The way Seegull and her colleagues put this problem is to state that there is “poorly defined market segmentation.” Indeed. This theme should be familiar to NPQ readers. Often press accounts like to mistakenly assume there is a singular nonprofit business model—although there are vast variations that depend on revenue type(s), type of services provided, and many other factors. Well, community investing has a similar problem.
As the Impact Investing Alliance team observes: “Strategies can vary across sectors (e.g., housing, small business, etc.), return profile (from market rate to concessionary), and geography (from rural to urban). From an investor perspective, it is also important to understand the type of capital needed (e.g., debt vs. equity), the risk profile of these investments, and potential constraints as they relate to duration, liquidity, and headline risk.” (30)
Here, as the report authors note, is a critical role that registered investment advisors can play, but that will only happen if community investment becomes part of their training. As Angela Barbash, a registered investment advisor herself, explained in NPQ earlier this year, “Surprisingly though, investing outside of Wall Street is not required education for licensed professionals.” Even the (optional) Chartered SRI Counselor (CSRIC) training, meant for socially responsible investment (impact investing) professionals, “only covers CDFIs, not direct community impact investments.”
Beyond the Challenges: The Promise of Community Investing
So far, the focus here has intentionally been on the challenges. But that is not to deny that positive steps are being taken. In the report, the authors include a number of case studies, including the Black Economic Development Fund, which NPQ covered last month, and the Boston Ujima Fund, one of a growing range of grassroots community engaged investment efforts that are spreading nationally.
Other forms of emerging community investment covered in the report include the rapid expansion of equity crowdfunding and the growing access of larger CDFIs to low-cost bond financing. Also notable is that in the December 2020 coronavirus relief bill passed by Congress, CDFIs received an unprecedented $12 billion in federal support. “Overall, the $12 billion represents a large influx of capital that will likely have significant ramifications for the community investing field,” the report authors point out.
Is all of this enough? In their conclusion, the report authors concede that “systemic inequality is deeply rooted in society.” In an interview with NPQ last year, Seegull identified COVID, racial equity, economic recovery, and climate change as the kinds of “big issues we think the impact investing can play a part in.” But she was careful to add that this was different than suggesting community investment was the “be all, end all.” Figuring out what role community investment can play as part of what the authors acknowledge must be a “multi-pronged approach to confronting collective challenges” remains a critical, and not fully answered, question.
