By
Michael A. Blank, Managing Director Senior Advisor, Credit
Suisse Private Advisors, Miami, Florida, USA
Many investment vehicles designed to deploy private individuals’ wealth to meet specific moral or social objectives are now available. Microfinance and new private equity financing models, as well as socially-responsible funds, have opened the way for investors to include a social element in their investment strategies.
There is an ancient tension between the obvious merits of charitable donation to worthwhile causes, versus risks such as the creation of dependency and incentives that have unintended or undesirable effects. The fight against economic exclusion of the world’s poorest people is no longer the preserve of government and charitable aid. Today, their work is complemented by private sector initiatives that use business methods to combat poverty – and by pure profit-driven capital flows. As a private individual, what is the most effective way to use your own money for such causes? Donating to disaster relief? Giving cash to a fair trade campaign? Financing poor entrepreneurs, or the non-profit firms that sell them services? Buying shares in listed companies that score well on social issues like human rights? Or, investing in purely capitalist companies that base their operations in the world’s poorer countries?
USD3 trillion in socially responsible investments
The range of choices has started to expand rapidly in recent years. Looking back to the 1980s, investors often held just bonds, stocks and cash in their portfolios, and might have also made donations to charity. Since then, the possibilities have expanded considerably. Investors cannot only choose among alternative assets like hedge funds, commodities and private equity, but also a growing range of vehicles that go beyond charity, using business methods to tackle poverty, environmental, and other key social issues. The first area to grow rapidly was socially responsible investment (SRI) in listed equities. Well over USD3 trillion is now invested in this area1. SRIs combine investors' financial goals with their concerns about social, environmental and ethical issues. The terminology for SRIs has evolved and varies across funds. The first funds created in the late 1960s and early 1970s screened out investments in, for example, alcohol, gambling and armaments. Now, many funds consider new issues such as corporate governance, questionable business practices, pollution or human rights in their screening process. New funds are also emerging with screening based on positive activities that companies are involved in (for example, alternative energy, education, health care) or so-called ‘best-in-class’ screens that select companies with progressive social and environmental initiatives. Data gatherers provide metrics for the social, environmental and governance performance of companies and this type of information is one of the key inputs used by socially responsible listed equity funds.
Around USD4.4 billion in microfinance funds
A second key area is microfinance funds (MIFs). These have only become significant in the last few years and so are much smaller at around USD4.4 billion, but are growing rapidly. Microfinance provides a wide range of financial services to microenterprises and some researchers argue that the origin of microfinance started with village banking in Germany in 1864 where loans were provided successfully to rural farmers. Modern microfinancing dates to the mid-1970s, with Professor Muhammad Yunus founding the Grameen Bank Project in 1976. Currently, there is an estimated USD4.4 billion in MIFs. Microenterprises are small businesses in urban or rural areas that are often family owned and operated in the informal sector. Microcredit is the provision of small amounts of money to clients by banks or other institutions. Clients can be individuals, groups or communities. In group or solidarity lending, the members are collectively responsible for the repayment of the loan. Fostering a close relationship between loan officers and the clients is therefore crucial. Microfinance institutions are very solvent and the default rate for microcredit borrowers is very low. As more funding becomes available, however, this may encourage borrowers to take on riskier projects. Systematic risk is mitigated by the low correlation with political and economic conditions because the informal sector is less directly linked to the formal economy. Other services provided by MIFs include microinsurance, savings and transfer services targeted at low-income clients.
Tackling social and environmental problems
Further types of socially responsible investments just becoming available are ‘bottom of the pyramid’ private equity, and investments that allocate part of their income as charitable donations. Bottom of the pyramid (BOP) refers to the largest and poorest socio-economic group. The phrase was first used by US President Roosevelt. The more current definition of BOP refers to the four billion people living on less than two US dollars per day, as first defined in 1998 by Professors C.K. Prahalad and Stuart L. Hart. Prahalad. They suggest that the poorest economic group could be the engine of the next round of global trade and a source of innovation. Large firms also need to work in partnership with local governments and civil society organisations, and adapt their products to the BOP market. A report released by the International Finance Corporation (IFC) reveals that the four billion people living in relative poverty have purchasing power representing a USD5 trillion market. Private equity firms are also targeting the BOP market. Capital placed in such assets is not given away, as happens with outright charitable donations. Instead it is invested, and can be expected to deliver two types of return: a financial return, and a sense of well-being from the ‘social return’ that accrues to other members of the global community. As investors allocate their money across the spectrum spanning pure charity, socially responsible investments and pure financial investments, they are sending market signals. These signals influence the global debate among charities, governments, companies and communities about the best way to tackle social and environmental problems. As more money flows into socially responsible listed equities, it affects share prices. This encourages CEOs to focus on issues such as climate change, and helps explain why major oil companies are now among the biggest spenders on green energy technologies.
A future based on sustainability
In a recent speech at the World Economic Forum, Bill Gates outlined his approach to ‘creative capitalism,’ calling for companies to create businesses that focus on building products and services for the poor to not only make profits but also to improve the lives of those who do not fully benefit from market forces. Pure charity is well suited to certain projects, but not others. Some charitable activities can create dependency, cause perverse incentives, and compete with commercial activity. Most socially responsible investments avoid the problem of creating dependency, because they are market-based and have a commercial relationship with the recipients of the money. A microfinance borrower is expected to have a viable business, even if on a tiny scale. And, so far, the default rates experienced in diverse locations around the world have been very low. These may increase somewhat, as higher funding allows lenders to embrace riskier projects, and as we see more instances of systemic shocks like political unrest. However, a well-diversified fund should still be able to generate a good risk-return balance. Bottom of the pyramid and social enterprise private equity investments are inherently riskier than debt finance but, reflecting this, they aim to invest in companies that will generate total returns similar to mainstream private equity. And socially responsible funds based on listed equities operate in an entirely conventional market environment. Since commercially run enterprises aim to be profitable and financially sustainable, they provide resources on a medium to long-term basis. This contrasts with charities that, unless they are lucky enough to have a substantial endowment, have to keep finding new funds. While this can create dynamism for new projects and encourage the involvement of local communities, it also creates uncertainty, and means that significant resources must be devoted to fundraising.
Another dilemma faced by investors is that, as the range of socially responsible listed equity funds has grown, so the definition of what can be included has widened well beyond its origins. For example, some early examples of these funds excluded oil companies completely because of their environmental impact. Now, many such funds include oil companies that perform well on indicators such as their commitment to green technologies and their concern for local communities and environments. Clearly, this makes it important for investors to check that any given fund meets their personal criteria for social responsibility. The increasing availability of newer socially responsible investments outside the listed equity arena opens up new ways of meeting those personal objectives.
This article is not investment research and it is not intended to provide a sufficient basis on which to make an investment decision. Emerging market investments are most suited for investors with a high risk tolerance. The material on these pages represents the opinion of Credit Suisse Private Advisors and is not intended to predict or depict the performance of any asset class, investment sector or commodity. The information provided herein including excerpts, abstracts, and other summary material derived from third parties is believed to be reliable but no such warranty is made. Past performance is no guarantee of future results. These views are as of April 2008 and are subject to change based on subsequent developments.
END NOTE:
1.Social Investment Forum’s 2005 Report on Socially Responsible Investing Trends identified USD2.29 trillion in total assets under management in the USA. Eurosif's European SRI Study 2006 identified some EUR1.0 trillI?ion in Europe |
