Market-Rate, Schmarket-Rate!

The New Risk-Return Paradigm
I am increasingly interested in why people get so caught up in the pursuit of market-rate financial returns. Not surprised, mind you…just intrigued. Why? Two reasons:

• People make decisions of little financial sense all the time: Individuals and institutions give away money to nonprofits — a financial transaction with 0% return and a loss of all principal (minus the tax deduction). They loan money to “friends and family” for questionable (ad)ventures, with unlikely repayment schedules and little to zero interest. This says to me that folks are actively doing some internal calculus on what else matters in addition to amassing maximum wealth, and drawing lines in the sand about how much is enough.
• Costs are externalized and therefore earnings are subsidized: What is market-rate anyway? When a big-box employer doesn’t pay a living wage and forces its employees to tap social services and government health plans to make ends meet, immediately increasing an investor’s tax bill, how is one to compute returns? Without true and full internalization of costs, market-rate benchmarks are often meaningless in an absolute sense.

“Market-Rate, Schmarket-Rate!” is therefore the story of an ongoing wrestling match between investors and investments living somewhere between philanthropy and market-rate, where conventional wisdom and Milton Friedman think nothing can survive. But is this true?

There is an emergent crush of “unconventional market-rate” investment activity going on…and it’s messy. But does it make less sense than philanthropy? Is it really harder to understand its returns than those of a firm that’s offloading much of its true costs beyond its financial statements? Those down in the trenches of tomorrow’s capitalism think not. But, it’s no wonder they are having so much trouble firing on all cylinders — these investments ask fundamentally challenging questions:

• How do we really define value and return?
• Can we cross the conventional lines that force either return maximization or philanthropy?
• How much financial return (and wealth) is enough?

Simply put, today’s investors face a challenge and an opportunity. By changing how we think about value within an investment frame, we can adopt the concept of “blended value,” to utilize all available resources to promote environmental, social, and financial equitability and sustainability. By changing how we define our appetite for returns, we can begin to rebalance wealth in the world with consideration for how much is enough.

Conventional investing, and the subsequent creation of economic value, has by and large been viewed as an activity separate from efforts to create social value and positive environmental impact. The convention is essentially to say, “Let’s maximize the risk adjusted financial return in a vacuum, and then give it away later.” But, then, we come back to the above discussion. Is that what we’re supposed to be doing? Or, even, is that what we really are doing?

Let 100 Flowers Bloom
Here are some real world examples from the field — ones that rewrite the conventional wisdom of risk and return and carve out a place between traditional philanthropy and investment. These examples barely scratch the surface of the wide spectrum of activity. They come from Calvert Foundation’s Community Investment Note portfolio, which is itself a global pooled fixed income product used by retail and institutional investors. These groups are generally taking financing at longer terms and relatively low yield. More information is available at the Community Investment Profiles database. These examples are for illustration purposes and are not meant as investment recommendations.

Education: Associacão Nacional de Cooperacão Agrícola (ANCA) is a nonprofit Brazilian cooperative that represents the settlements connected with the Movimento Sem Terra (Landless Workers Movement). ANCA provides publications for the training and education of leaders in various worker movements. Approximately 7,000 books are sold each month, and that number continues to grow. ANCA has taken soft debt from a range of investors to provide working capital and financing to its members.

Health: Voxiva is a for-profit voice and data solutions provider that has developed new ways to use technology to address some of global health’s most pressing challenges. From disease surveillance to adverse event reporting, Voxiva’s applications allow public health agencies from Peru to Iraq to collect critical data from, and communicate with, front-line health workers in real time, empowering them to respond immediately. Investors have placed “patient” equity into this social venture to grow the enterprise.

Housing: The Federation of Appalachian Housing Enterprises (FAHE) is an association of 30 nonprofit housing organizations producing affordable housing for low-income families across Appalachia, one of the most impoverished regions in the U.S. Cumulatively, FAHE groups have constructed or preserved almost 40,000 affordable homes. As a nonprofit, FAHE has used millions of dollars in soft debt from investors to finance its housing activity.

Media: The Media Development Loan Fund (MDLF) is a nonprofit dedicated to developing independent news outlets in emerging democracies into financially sustainable media companies. MDLF invests in a range of debt and equity placements to TV and radio broadcasters, newspapers, magazines, news agencies, and online media across Eastern Europe, the former Yugoslavia, the former Soviet Union, Asia, Africa, and Latin America. As such, MDLF is a revolving fund that takes soft debt from a range of investors.

These investments vary considerably, yet have one thing in common — they exemplify the rich landscape of activity that investors use to blend social, environmental, and economic returns, while re-imagining the risk/return paradigm. In so doing, they have created value both for the investor, the enterprise, and the world.

And, though the rate or risk may be out of line with what conventional markets have considered as valuable, does that make their impacts and returns less compelling? What if jobs are created and homes built, and funds come back whole, with even the most modest of returns, to be deployed over and over again?

The landscape can shift if we drive toward a new sense of value. Investment cannot be our only tool, but it is one of the more ubiquitous representations of underlying value and, as such, is a great opportunity to effect substantive change.

Timothy Freundlich is Director of Strategic Initiatives at Calvert Foundation, helping develop social capital markets with a concentration in alternative/independent media.This article borrows from certain concepts of The Investor’s Toolkit, by Tim Freundlich, Jed Emerson, and Shari Berenbach. It also builds upon a recent Brookings Institute paper by Tim Freundlich, and an article by the same name done for the prototype issue of Value Magazine.