Program officers and investment officers at nonprofits have traditionally operated in silos. As a result, cio’s tend to seek returns without considering social good. But the question beckons: should the bulk a nonprofit’s assets be tied back to the entity’s reason for existence? Community investing vehicles offer one way for nonprofits to bridge this disconnect between their investment strategy and mission. FEMM discussed this question with Mark Kaplan, partner at CEI Ventures, Mark Pinsky, president and ceo of the Opportunity Finance Network, Luther Ragin, v.p.-investments at the F.B. Heron Foundation, Kerwin Tesdell, president of the Community Development Venture Capital Alliance and Mark Finser, president and ceo of the Rudolf Steiner Foundation, an organization that uses financial vehicles to fulfill its charitable purposes. RSF has no endowment and its assets come from loans and gifts.
FEMM: The typical hesitation from investment officers when it comes to making social investments is the belief that investing for social good involves an inherent trade-off in market return. How much of that belief is based in quantitative evidence?
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Luther Ragin |
Luther Ragin: Many nonprofits still think it is a foregone conclusion that there is an opportunity cost. Since 1996, we’ve invested 24% of our total endowment in social and community investments and our experience proves that presumption wrong. Investors can identify opportunities in community development that are commensurate with traditional asset class objectives and risk parameters. In 2004, our overall performance ranked in the second quartile of our peer group of investors according to Russell/Mellon, and that is with a 24% dedication to social and community investing. We’re not sacrificing anything, but aligning our investment portfolio with our mission.
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Mark Finser |
Mark Finser: I talk to skeptical nonprofit investment officers all the time. My advice to them is to think of this as an investment continuum instead of falling back on the trade-off misconception. And investors need to realize that community investing doesn’t just mean low income housing but the facilities in a particular community and related toxicity issues, and job creation among other things. It is a whole system approach.
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Mark Pinsky |
Mark Pinsky: One traditional roadblock we’ve run into is that investors look at community investing through fixed income, and yet because it is not solely return-focused investors attach to it an equity level of risk without equity return potential. As a result, they don’t know how to fit it into their existing asset allocation. Our research counters the notion that no matter what type of community investing one does, there is going to be a higher level of risk. As an industry, we’ve done $17 billion in loan investments over the past 35 years and we’ve lost a total of a few million. This industry’s net charge-offs and delinquencies are on par with the banking industry. It is simply not true to say there is greater risk.
FEMM: What community development investment vehicles make the most sense for nonprofits?
Ragin: It depends entirely on your needs and risk appetite--there are investments in every asset class that will align mission with market return, from the safest short-term cash funds to alternative investments. For our cash investments, we use federally insured deposits in entities such as low-income credit unions, and those returns are competitive with current money market fund returns--between 3% and 4%. In fixed income, we have a bond account which explicitly follows our mission mandate, investing entirely in investment grade issues or above, and it has returned 5.85% since June 2001, versus the Lehman Brothers Aggregate Bond Index return of 5.53%.
Finser: Our unsecured loan fund has made $80 million in mission-related loans over the past 20 years and during that time investors lost $4,000. That fund is also asset-backed, which many investors prefer. And for nonprofits that know they are going to be making grants at the end of the year, the short-term loan fund is a great place to park cash.
Pinsky: We’re working on a fair mortgage investment vehicle that will be able to absorb large investments and generate market rate returns in the sub-prime loan universe. This will serve any community-related mission of combating predatory mortgage lenders and it is a major initiative for us because it will be a pooled investment fund--until now we have only offered individual loan transactions. We expect a $50 million pilot this year and a $1 billion loan portfolio over the next three to five years. We’re also working on a manufactured housing loan fund which should be interesting to nonprofits because it will focus on prime loans secured by actual property, as opposed to the working capital financing that many investors associate with community development.
FEMM: What are the opportunities for community investment in the equity universe?
Ragin: Right now we are beta-testing a positive screening investment tool that we created with Innovest Strategic Value Advisors and which is being managed as a fund by State Street Global Advisors. It’s going to be a combination of the S&P 500 and S&P 400 best in class companies that are engaged with underserved communities. We’ve also been invested in nine private equity funds since 2000--six of them in real estate--and the real estate funds are returning low to high teens to the limited partnership. The three community funds we’ve invested in, which support business in low income communities, have returns in the low to mid 20s. These funds are good for any investor interested in a value-added, opportunistic real estate play. Furthermore, we’re working on an urban real estate fund of funds that we will offer to small and mid-sized nonprofits who might only have $5 to $10 million to invest and want a diversified portfolio. We’ll soon be doing a fund of funds manager RFP.
Kerwin Tesdell: Community development venture capital offers a way for investors to avoid the crowded and high risk Silicon Valley approach to alternative investing. These investment professionals all experienced the dot.com bust. Our returns should be less correlated with traditional venture capital, spread across many regions and types of businesses, and focused on companies with established products. These funds should have much less volatile return swings. I think more and more nonprofits are realizing that you can only do so much with 5% grant-making a year. You don’t want to be foolish and lose money, but when close to 100% of your assets do not further your mission, something is wrong.
Mark Kaplan: On the pension fund side we are seeing more and more state funds investing in their local regions through venture capital and we expect foundations and endowments to follow this trend. Organizations are increasingly seeking local investment opportunities and community development venture capital fits perfectly with that trend. And it is not just the combination of competitive returns and social good through which nonprofits may benefit. They should consider that socially-minded entrepreneurial investors in their local areas may become important givers to nonprofits who demonstrate a dedication to local investing. Take someone like Tom Chappell of Tom’s of Maine after the sale of his company to Colgate-Palmolive Co. When those types of cash-out events happen, nonprofits that have demonstrated their commitment to the community may be in a better position to receive large gifts.
FEMM: Investment professionals always want to see track records. When we talk about venture capital, do track records exist for the community development arena?
Kaplan: The track records are beginning to develop but these are typically 10-year funds so we’re not there yet as an industry. But that doesn’t mean that investors can’t evaluate investments in this space. There are good companies that have already been uncovered in these funds and profitable exits made that investors can scrutinize. There are portfolios with holdings at various stages of investment that will show patterns of growth. To some extent, the traditional fear that any social investing will result in a return trade-off cannot be erased until we demonstrate long-term track records.
Tesdell: We’ve got approximately $1 billion across 60 funds now, some very small, and we’re still too nascent as an industry for track records, but investors can look at portfolios at various stages of growth. As far as being less correlated with other venture capital funds, that is theoretical at this point, but it should prove to be the case as 10-year returns start coming in over the next few years. We also don’t have a $300 million fund yet, so those nonprofit investors who never want to make up too much of any one fund, no more than 10% for example, will become targets for us as we grow.
Ragin: We use a private equity manager that was selected based on classic investment criteria combined with social good, and now Cambridge Associates has a “buy” on the manager for its entire client base, so opportunities do exist in the community development venture capital space for all investors.
FEMM: Is there any risk to nonprofits if they continue to ignore this investment approach?
Finser: There is the potential that nonprofit investors that do not align investment portfolios with mission will come under government scrutiny. As the federal government’s deficit widens, it is possible that Congress will take a much closer look at nonprofits’ investments and if they are not deemed “mission-related,” treat them as unrelated business income. This is just a worst-case scenario, but why not be proactive here and head off Congress by aligning your investments with your values? There is an irony in the current state of the industry, too: if we make a working capital loan to a for-profit entity it is scrutinized by the Internal Revenue Service, but if we passively invest in Exxon/Mobil, no justification is required.
Pinsky: Once upon a time, the program side of nonprofit investors was the largest source of assets for the community development industry. That’s no longer the case. Banks have taken their place because we are bringing them the next generation of clients. In the short term, this means that if nonprofit investors don’t pursue the growing number of pooled investment opportunities in the community development space, they will lose more ground to more aggressive financial institutions. Long term, it could mean that the public image of nonprofit investors as a vital force in community development will diminish.