Checking the Principles for Responsible Investment in 2014

I attended a confab of local investment pros at the Commonwealth Club in December 2014, appropriately enough just before Christmas.  The Principles for Responsible Investment (PRI) initiative released its progress report for 2014 back in October, so naturally it takes money managers almost two months to figure out what it means.  It made for the perfect segue into how asset managers implement ESG criteria.

Experts from Bernstein Global Wealth Management, BlackRock, Nelson Capital, and TriLinc Global held forth on how they manage money.  I have no business relationship with any of those firms, although I have invested in BlackRock's iShares securities in past years.  I also have no relationship with the sponsors MSCI, Parnassus Investments, and Industry Capital.  I tried very hard to launch a career as a portfolio manager with large investment firms, and every firm I encountered said my military background was a disqualifier.  I must therefore be very skeptical of what professional money managers have to say about how they apply theory in reality.

The panelists admitted that the $45 trillion figure quoted in the event's title was just a guess.  Well, there goes their credibility right down the tubes.  Analysis comes from data, and leading practitioners who can't cite reliable statistics from PRI or elsewhere should stay off the platform until they can get their stories straight.

The "responsible investing" rubric covers ESG criteria and impact investing.  It started with negative screens that eliminated objectionable stocks from actively managed portfolios.  Money managers tried to address the concerns of some institutional clients' investment policy statements that prohibited owning stocks exposed to alcohol, gambling, and other controversial sectors.  The evolving thesis is that reducing a company's ethical and environmental risks will raise its valuation.  It is a compelling thesis addressing the supply side of providing attractive investment products.  I need to see matching demand data proving Millennials and others want to buy responsible investments.

I have known about the Sustainability Accounting Standards Board (SASB) since 2013.  It has not yet overtaken FASB in prestige.  Advocates could probably use a hearing in front of the SEC to make that happen.  Public companies will hesitate to adopt SASB standards without a regulatory push.  CFOs already have a full plate with Sarbox compliance and IASB rules for their multinational operations.

I suspect that the extra effort going into responsible investing causes a larger tracking error when portfolio managers measure their alpha against a benchmark.  Tweaking the benchmark is not a satisfactory solution.  Independent studies of the tracking error acceptable in risk budgets will inform responsible investing decisions.

A large body of evidence substantiates the weakness of divestiture as a response to unpalatable investments.  Someone else always comes along to buy what others throw away.  The current trend among overly sensitive portfolio managers to divest from carbon-heavy energy companies is a perfect case.  Oil and gas stocks still make money, and plenty of people will buy them even if fourth-generation Rockefellers turn up their noses.

Stock exchange listing requirements can play a leadership role in responsible investing.  Solid ESG regulations can deter companies from exploiting regulatory arbitrage by listing on a less restrictive exchange.  Exchanges in multiple countries will have to adopt ESG guidelines simultaneously.

Responsible investing has a future.  Alfidi Capital does not yet have an ESG policy.  That may change in 2015.  

Launching the Bay Area Impact Investing Initiative

I attended last week's official launch of the Bay Area Impact Investing Initiative.  I met the movers and shakers behind this project prior to this year's SOCAP conference and my blog article about their ideas sums up their approach.  This isn't just some charity effort to channel giving.  BAIII wants to show fiduciaries how to obtain market-rate ROI from ESG investments.

Lauren Agnew from Seal Cove Financial broke out brief descriptions of real estate, private equity, and infrastructure as separate asset classes.  I think there are plenty of impact investing opportunities within each category.  I've blogged before about how land trusts can configure real estate parcels for long-term investment, so isn't much of a stretch to attach impact investing criteria to them.  Private equity has an obvious role to play in microfinance as angel investors flock to crowdfunding portals.  I see no obstacles to rating infrastructure projects according to environmental impact criteria to make their funding more marketable.  The Global Impact Investing Network created its Impact Reporting and Investment Standards (IRIS) for those of you who need impact evaluation metrics.  The IRIS registry looks like a good connecting tool for institutions looking to either attract or deploy capital.

The panel got going and I discovered that Pacific Community Ventures' PCV InSight research practice has published quite a bit of thought leadership on this subject.  The panelists mentioned that advisors' lack of education on impact investing and the scarcity of available products have been roadblocks to the widespread adoption of impact investing despite obvious demand.  I've read recently that independent advisors are concerned about competition from discount brokers as clients seek more control over their money.  I also think that AI engines like Personal Capital will put a lot of RIAs out of business.  If small-practice advisors are a dying breed, it behooves impact investing practitioners to either configure their products for automatic inclusion in the AIs' engines or focus on marketing products through the big SIFI investment banks.  The panelists mentioned that several wirehouses  are all at various stages of launching their own impact investing initiatives.  Morgan Stanley brands it "Investing with Impact."  UBS has an Impact Investing Private Equity fund.  Goldman Sachs offers a fund and bonds for social impact.  I've had some experience dealing with all of those firms in one way or another and I can't exactly give them ringing endorsements for doing the right things.  They all received bailouts during the 2008 crisis.  I cannot assure my readers that they will not need bailouts again in a renewed crisis.

The panel mentioned that US pension fund trustees are reluctant to second-guess their plans' investment policy statements on value investing, but place-based investing is very consistent with their fiduciary duties.  I did not know that the vast majority of California's private equity investing is confined to a small number of ZIP codes.  I had to look up the source for that concentration in PCV's 2007 report on CalPERS' California Initiative.  If you need more reportage, check out McKinsey's research on social impact bonds.  One panelist mentioned that the Affordable Care Act will offer massive impact investment opportunities as the mandates for community health care clinics creates demand.  I wonder whether sovereign wealth funds do impact investing.

One of the last public comments during this launch event revealed something I should have suspected.  A panelist revealed that many thought leaders and activists in impact investing are unable to select impact investments in their own portfolios . . . because their families control their assets!  Well, that says it all.  Is this whole movement driven by trust fund babies who can afford not to work?  This is merely anecdotal but it jives with my impression of the trust fund kids I've met in this town who never seem to have real jobs.  I suppose somebody has to have time on their hands to make this happen.  Kudos to these folks for doing something productive and not wasting time.  If they ever get tired of working the crowds at investment conferences I'd be happy to take their places.

I look forward to more exciting developments from BAIII.  The movement reminds me of CalPERS' leadership in activist investing back in the 1990s.  Cal-PERS forced underperforming companies to shape up their operations based on traditional metrics.  That movement lost steam when institutions turned away from shareholder activism to alternative investments.  Too many pension plans lost their way when they started copying the Yale University endowment's model and had to watch their portfolios blow up in 2008.  Impact investing is one way to ensure institutional investors keep their eye on important things rather than fads.  

Insights from SRA Impact Investment Dialogue, October 2012

Impact investing is the hot new thing in capitalism.  I attended Security Research Associates' Impact Investing Dialogue, an expert panel they launched with their annual Fall Growth Stock Conference in late October.  I'll run down the main points the panel raised below, with my extraordinary insights in italics.

Impact investors are still too risk-averse to fund pre-revenue startups.  Well, for crying out loud, they need to get over those first-date jitters.  Either go big or go home.

Deal flow is still relationship-based, so VCs and money managers cultivate entrepreneurs for years.  Not for long IMHO.  Crowdfunding will wipe out some of the early-entry barriers to fundraising for social enterprises.

Impact investing seeks opportunities serving low-to-middle income consumers.  Grameen Bank broke the mold.  

Philanthropy can be integrated into asset class choices.  I dunno, there has to be an ROI for it to matter.  The ROI might be measured in charitable deductions' contributions to a lower tax burden but any new policy ideas out of Washington will have a say in that.

Fair trade products are an import/export opportunity.  True, but too much of the fair trade community is exposed to single source supply risk.  Read my 2011 article on fair trade cocoa to see the importance of building multiple suppliers into a fair trade business model.

Injecting business approaches into philanthropy will encounter tax law hurdles and cultural differences, but benefits are possible.  Culture is the biggest one.  I recently had a very bad experience trying to incubate new enterprises within an established, nationally-known non-profit.  The people I had to deal with had zero understanding of how to cultivate a high-risk startup.  They had been entry-level non-profit drones or government employees their entire lives and had never been exposed to risk-taking entrepreneurial personalities.  

The Opposable Minds concept is like our opposable thumbs' evolutionary advantage.  It means grasping two fundamentally opposing concepts (like business and philanthropy) to create a superior integrated solution.  I haven't heard of this idea.  It sounds legit but I need to read more about it.  I have long believed the management consulting sector reinvents itself every few years by pushing new concepts on an unsuspecting public.  I also suspect business leaders lap up these new concepts because they were too busy playing office politics on their way up the ladder to actually learn how to add value.  

Impact investing happens in between pure ROI and pure philanthropic giving.  Agreed, but then you need some hybrid measure of its value to convince money managers to keep doing it.  A family office that does impact investing will need to measure how it lowers the portfolio's tax burden.  A venture capital fund doing it will need to see some technology spinouts that they can commercialize.

Poor societies need more than access to capital; they need basic infrastructure.  The most important thing they need is the rule of law!  Impact investors can use the Heritage Foundation's Index of Economic Freedom to determine the likelihood of their investment going to some thug.

Impact investing is a highly fragmented, inefficient market that needs structure.  Consolidation has already begun.  Social Capital Markets (SOCAP) is a clearinghouse for this sector and I expect it to take a leading role in publishing whatever guidelines investors need.  

Angel investors can find entrepreneurs who build enterprises that add social value.  It's more like the other way around.  Determined entrepreneurs go looking for angel clubs to give pitches.  I still think it's funny whenever some wealthy person claims they found a new idea all by themselves after a dedicated first-generation striver banged on their door repeatedly to get their attention.

Microfinance can convert a non-profit structure into a for-profit structure that will add value.  I didn't know that.  Non-profit leaders need to seek good legal advice before they try converting their legal charter into something else.

The "informal economy" served by microenterprises is an uncorrelated sector.  True enough, so the challenge for the finance community is to use metrics that convert System D activity indicators into a broad index.  That also gives law enforcement agencies and securities regulators a means to track the underground economy, so some actors will be reluctant to self-identify.  This is an area that cries out for an innovative financial solution, right up my alley. 

Founders can look for credit enhancement instruments that make an equity offering attractive to institutional investors.  I wrote about a few crowdfunding platforms that are developing pretty robust models.  I believe those platforms that accommodate things like warrants, LEAPS, and contingent value rights will have a huge edge in attracting participants.  

I appreciated the fact that two of the panelists were attractive women.  Thank you Sonen Capital and Elevar Equity for showing off your finest assets.  I always like to see quality in finance. I'll definitely keep watching the impact investing sector, and not just for the eye candy.