Bottom Line: With a little extra effort, you can lend your money to organizations or people for housing, creating new businesses or education. You can pick your cause, your geography, and in some cases, even the borrower him/herself. You may get additional information about the social impact that your loan has, and you can still earn interest. Some of these loans have a higher risk of default, so understand what the issuers are doing to protect you from a loss. It won’t be the same as an FDIC-guaranteed investment.
Mission Related Investing for the Rest of Us series:
- Part 1: Motivation (Using your investments to earn a “social,” values-based, return as well as a financial one)
- Part 2: Background & Investing Theory (Where I’m coming from, and how I used to think about investing)
- Part 3: Banking and Cash Alternatives
- Part 4: Bond-like Alternatives
- Part 5: Stock-like Alternatives
Bond Mutual Funds
For most people, probably the easiest way to invest in bonds is through a bond mutual fund. I’d followed the path of least resistance, and ended up choosing the tax-free bond fund for California residents, offered by Fidelity (FCTFX). Not that much thought had gone into the choice, but I was steadily earning and reinvesting the dividends, growing at a tax-equivalent rate of 4.3%. The money was ultimately funding California municipal projects. Not bad, but perhaps opportunities to do better.
Andy Loving of Just Money Advisors prepared a list of socially responsible investments which included Community Capital Management’s Reinvestment Act Qualified Investment Fund (CRATX). In an article in Financial Advisor Magazine, he said “If you want something that’s earning a good return with safety and going good here in the U.S., you’d be hard-pressed to find something better…” It was something I could easily purchase in my existing Fidelity brokerage account, and I did. Here most of the money goes into GNMA and FNMA mortgages, although only ones that are Community Redevelopment Act (CRA) eligible. Interestingly, because of this higher level of due diligence, the fund actually had fewer of the “toxic assets” when the mortgage market melted down.
But even here, I question the impact that my investment has: if I’m just buying bonds of already existing mortgages, does that really get more people into houses? Perhaps, if that then means that GNMA has more money to lend. But there is a level of indirection, and there’s the question of whether home ownership is really the right step for moving people out of poverty. The F.B. Heron Foundation recently made some waves when it issued a new strategic plan including the statement: “We have also concluded that owning fixed assets is important to an individual’s longer-term prosperity only insofar as jobs and income are steady and reliable.” (Italics added) In other words, a house might be a good investment and avenue to long term wealth generation, but only if you have a job that lets you pay the mortgage.
Where else can you put money to get a favorable return while doing good? The Calvert Foundation offers Community Investment Notes, in $1,000 increments for periods of 1-5 years. The longer the time, the higher the rate, up to a maximum of 2% (current, 6/30/2012). The money is loaned (100% of it) to approved community groups that have different geographic and cause focuses (microcredit, jobs creation, home ownership, etc.). Calvert has reserves set aside to cover (some of) the risk, and their site states that no investor has lost money in the community notes. The notes can be purchased either directly from Calvert or through a broker (or Microplace, see below).
Oikocredit has Global Community Notes, similar in concept, which may be purchased directly through Oikocredit in increments of $250 (or Microplace for smaller amounts, see below). The bulk (79% at the time the prospectus was written) of these notes are invested in global microcredit funds. The notes pay 0-2% depending on the term.
For members of the United Church of Christ, the Cornerstone Fund is an investment that loans money out to church construction projects (which can have a hard time finding traditional funding, since banks generally don’t loan to places they wouldn’t be willing to foreclose on…) Interest rates are fairly attractive, starting off higher than the other community notes, though not rising as quickly into the longer maturities. These funds are not federally insured, and while they do have reserves against losses similar to those of Oikocredit or Calvert, the concentration risk is greater (e.g., a scandal in the UCC that caused a “run” on funds, or steep drop in church membership that impacted the borrowing churches’ ability to re-pay.)
Social Impact Bonds
After philanthropic organizations have invested the risk-capital to prove that an idea works, and even saves money in the long run, where does the capital come from to invest in that idea today? In general, foundations need to preserve their “risk” capital to try other fresh ideas, and don’t have enough to reach scale with these programs anyway. The government is already over-committed to existing programs. Social investors can step in to the gap with a Social Impact Bond, with the returns being based on achieved savings. This Forbes interview with Laura Callahan summarizes her longer report from McKinsey. Although Bridgespan partner Daniel Stid remains a skeptic, based on the challenges.
Did you know that .coop is a top-level domain (like .com or .edu)? There are some 29,000 co-ops in the US with $654 Billion in revenue, and 2 million jobs (stats from Amy Cortese’s book which features a chapter on Cooperatives). Some business cooperatives raise capital from members, offering a return in the form of dividends. In this limited case (only from members, typically within one state) securities do not need to be registered as they would more broadly. The examples she gives of the largest co-ops are from Europe, while the ones that you might invest in are generally much smaller, local affairs such as groceries, farms, or pubs.
Searching out investment opportunities can be a challenge, but if you want to support co-ops, there is a Community Development Financial Institution (see Part 3) that invests in co-ops. The Cooperative Fund of New England offers you the chance to name your own return between 0-2%, provided you’re investing at least $1,000 for at least 1 year. Although the securities are not federally insured, the Fund says that several of the co-op investors have agreed to take the first losses as a way to protect other (retail) investors.
Most of finance has been about aggregating individuals to diversify risk. If one fails to repay, it’s a small loss that, shared among many investors, isn’t too painful. One interesting trend in social investing, is to bring back the individual. Websites like Microplace, Kiva, and Prosper feature the profiles of individuals, and an investor chooses one (or more) to invest in. Of course, the investor can choose to diversify herself by investing a small amount in several individuals. Choosing at the individual level lets the investor make a strong personal connection (especially rewarding in an “impact”-focused rather than financially-focused investment). Although similar in concept, with each site listing borrowers along with their intended usage of loan proceeds, the three sites fill distinct niches:
- Kiva does not pay interest. This removes the need to be treated as a security. You loan money to one of the borrowers profiled (through one of Kiva’s partner microfinance institutions–Kiva does not manage the loans themselves.) When (if) the loan is paid back, you have the option of getting your money back or loaning it to someone else in the system. You are not donating the money to the borrowers (many of whom are inspiring micro-entrepreneurs in very needy parts of the world), but you are loaning it to them. They are obligated to pay you back, and a very high majority do. (98.97% of dollars are repaid, as of 6/30/2012)
- Microplace does pay interest (typically in the 2-3% range). With each borrower profile is the amount of interest he or she is offering (really, the MFI is offering on his or her behalf). Here again, you have the opportunity to either pull your money out or roll it over with another borrower when the first loan is repaid. Also, both Calvert and Oikocredit offer versions of their Community Investment Notes for sale through Microplace. With PayPal handling all of the transactions digitally, they are able to offer lower minimum buy-ins of just $20, instead of the $1,000 and $250 minimums required for direct purchase through Calvert or Oikocredit.
- Prosper is less concerned with the social impact aspect, and is just a marketplace for peer-to-peer lending. The borrowers put up their own descriptions, along with some credit history information that Prosper turns into a risk rating. Interest rates can be very high (30%+) for risky borrowers. You can find listings to help start or grow businesses here, but there are also loan consolidation, wedding loans, home improvement loans, etc. Substantial risks of default, but high potential return compensating for the risks.
Bonds, A primer
A bond is an investment where you have loaned money (to a company or government) and you are entitled to a stream of interest payments for a certain duration, after which your loan is returned. This right to receive income and return of principal may be sold, so there is also the notion that the bond has a price, which may be fluctuating over time as demand for the secure payment goes up (typically in an environment where the other investment alternatives look too risky) or down (when investments in stocks look to bring good returns). There is some risk that the company or government that took the loan can’t make the contractual payments, and defaults instead. If investors believe that there is default risk, they will demand a higher interest payment when the bond is issued, or trade it at a discount to face value after it is issued. Certain government bonds are tax free at national or state level or both.
Overall, bonds tend to be more stable than stocks, with a predictable income stream, so are recommended for investors with a lower risk tolerance. Bonds blended with stocks provide added stability for a portfolio, at a slight reduction in expected return.