Impact Investing As It Hits

            If you asked me a couple years ago what I thought of “double-bottom line” investing, I might have half-jokingly guessed you meant only considering net income, a reference to the peculiar formatting of that item on it's namesake statement.  Yet since working at Kiva for the past few months, I’ve come to appreciate more the merit of taking ideology and other intangibles into consideration when investing as opposed to merely seeking the highest monetary return.

            At Kiva, we often use terms like “risk-tolerant capital” or “patient capital” in conversation to describe the liquidity that runs through our pipes.  It has been unique, coming from a traditional finance background, where cash rules everything around me, to see the inner workings of a finance firm that facilitates lending money at zero interest.  What inspires people to do this?  Having been part of the organization for some time, I see the return first-hand.  Conscientious citizens given the opportunity to put their money where their mouths are will seize it and give nearly 1.5 million borrowers not a hand out, but a hand up: a chance to build themselves out of poverty. 

            The vast majority of investors, however, do not have the luxury of allocating their money simply based on good feelings.  Happily, impact investing has become an entire field with methodologies and funds that emphasize values without having to compromise financial return.  By looking at how internal and external stakeholders are affected by a business’ operation, an investor can decide whether holding them in a portfolio would be consistent with his or her values.  The commonly used metrics are summarized by a research paradigm called ESG analysis: environmental, social, and governmental measures.  

            According to MSCI and Pax World (providers of research and funds, respectively) environmental measures include carbon emissions, carbon footprint, energy efficiency, water stress, raw material sourcing, toxic emissions and waste, electronic waste, as well as opportunities in clean tech, green building, and renewable energy.  Social measures include labor management, human capital development, opportunities in health and nutrition, chemical safety, privacy and data security, and access to healthcare, among others.  Governance measures include levels of corruption, anti-competitive practices, fraud, etc.  To make an investment decision, the interested party chooses metrics relevant to the company being evaluated and draws a conclusion based on the findings.

            This kind of evaluation is esceedingly difficult for the individual investor who does not have the capacity to do this research independently and would find a subscription to research services prohibitively expensive for his or her needs.  Thankfully a lot of mutual funds and ETFs have sprung up in the past few years that invest according to ESG principles, though finding one that consistently outperforms the S&P 500 benchmark remains a unicorn hunt.  I may have some rebalancing to do ahead of Q3 dividends.  If this internship has taught me anything, it’s that the highest payouts may not be taxable. 

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International Waterways

People!

My senior thesis for economics is finished and published on the website. A couple of you have asked to read it and now it's here.  The topic is international rivers, the Nile and Mekong in particular, but the concept is common-pool resources.  CPRs are a variety of resources whose usage is shared amongst several parties.  The subject becomes complicated because the repercussions of certain actions or usage do not fall on the perpetrators of the action in the first place.  Rivers are a classic example because users upstream, whether for agriculture, fishing, or otherwise, end up impacting the outcomes of users downstream.  Over the course of time, stakeholders have sought to find ways to reconcile differences using economics, politics, biology, ecology, etc. and that is the matter at hand here.  The document can be found in the Writing Samples page as well as in the link below.  I hope you enjoy reading it as much as I enjoyed writing it.

The Curious Task of Shared Goods: International Waterways and their Treatment as Archetypal Common-Pool Resources

Acknowledgements:
Kristi Ellis, Morningstar Academy
Dr. Michael Rizzo, University of Rochester
Dr. Stephen L.S. Smith, Gordon College

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Microfinance 3.0: On the Shoulders of Giants

            This is the last of a three part series. Part 1 can be found here and part 2 can be found here.   
            The first post in this series focused on the inception of microfinance and the second talked about the current state of microfinance.  This final one will talk about its limitations, and in light of those: where to go from here in the future. As one browses Kiva or some other equivalent site, he’ll come to the realization that there is a soft cap on the size of a given loan.  While the average loan is in the two or three thousand dollar range, the number of available loans tapers sharply after around five thousand dollar mark.  There are essentially two connected reasons that larger loans are unrealistic: the repayment period and the large number of lenders.  This is best explained by way of example.

Realize that to operate an individual typical loan, with an eight month repayment period to 135 lenders (based on an actual project), Kiva has to collect eight times and disburse that as 1,080 repayments altogether.  If the scale was brought up to a ten thousand dollar size, at $25 per average lender, this is 3,200 repayments ([10000/25] * 8).  Of course, the borrower would need more time to pay the money back, perhaps a decade, meaning 48,000 repayments ([10000/25] * [10*12]).  Kiva already processes an immense amount of payments continuously, so one would have to be uncharitable to believe that they could not scale up to meet this challenge, but it would at least be cumbersome.  This is not to mention that from the individual lender’s perspective, who wants to wait a decade to get their $25 paid back?  Half of the fun of funding microloans is watching the money lent out come back so that it can be sent out again.  It gives people the satisfaction of seeing their money participate in double, triple, and ad infinitum amounts of good as long as they opt to relend it.

So we see the limitation of microfinance for borrowers who wish to start a business that requires more capital than a few thousand dollars could provide but is not so large that an entrepreneur could get funding from a private equity fund or other traditional means, perhaps in the range of 10-50 thousand dollars such as starting a dairy processing facility or a large water filtration service. 

Because of their extensive networks with partner microfinance organizations on the ground in developing countries, while being situated in the richest country of the world, Kiva and other US-based organizations are uniquely and ideally situated to conquer this limitation if they have the volition to solve it.  Yet to this day, one does not see them acting on the somewhat obvious solution.

The question is: are there investors to whom the larger scale of 50,000 dollars would not be problematic?  The follow-up question is: is there a context wherein a payback period of several decades would be a feature rather than a bug?  Glad you asked, because the answer is yes!  This might even be worth developing an entire post for in the future because this one has already covered a lot of ground.

Kiva builds bridges between people who have money and those who need it.  That has always been the mandate.  Yet by myopically focusing on the individual lender platform, they have failed to hunt in a greener pasture: the US capital market. The clear solution, therefore, is that medium-sized loans be financed through the issuance of bonds to institutional investors.  Bond markets are massive, robust, and there is no shortage of lenders who would jump at buying this kind of security, even though it is riskier than a traditional corporate bond (the securitization of subprime mortgages during the housing bubble proved that).  Investors who buy bonds do it for many reasons, but one of the primary appeals of bonds is that it gives steady income from repayments for an extended period of time.  Another is that it provides protection against interest rate risk since repayments are contractual.  So to put it succinctly, scale is unlimited and the bug, as we say, becomes a feature. 

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Microfinance 2.0: By the People, For the People

            This is the second of a three part series. Part 1 can be found here and part 3 can be found here. 

            Last week we talked about the savings groups that allow individuals living in poverty to be able to get periodic access to more liquidity than they would otherwise be able to get.  At some point, a Bangladeshi economics professor named Mohammad Yunus realized that the amount of money required to make some simple life improvements was as little as a few dollars.  These could be the same things as the savings groups facilitated but also might be things on a larger scale.  In Bangladesh, the “larger scale” could indeed be the equivalent to just a few US dollars.  In other words, an insignificant sum in the developed world might be a huge sum of money in the Third World.  This reality became an important feature as Mr. Yunus innovated the microfinance machine: a platform for allowing philanthropically minded individuals who could spare a few dollars to pool their resources and fund loans to the poorest of the poor.  These loans, which range from $25 to a few thousand dollars, are used in some capacity to help a person who does not have access to a commercial bank’s credit to make some investment that would help them work out of poverty. 

This “investment” is usually related to their line of work such as seeds, tools, and livestock for farmers, input factors like raw materials for manufacturers, and goods to be sold at a grocery store or restaurant.  Having thus borrowed a sum of money, the person taking the loan directs the resources in an appropriate value-adding way and pays back the loan.  He is able to keep the profits to fund further expansion, sending children to school, or improving life in some way.  It is not uncommon for individuals and groups to take increasingly larger and larger loans as they build up a good reputation for repayment and expand to bigger and bigger projects.  While outliers exist, the soft cap on microfinance loans tends to be approximately what can be repaid in a couple years and in practice has been a few thousand dollars.

There are several organizations that facilitate the creation and repayment of loans, but their particularities are beyond the scope of this piece.  The prominent ones are Grameen Bank, the first microfinance organization, and Kiva, a San Fransisco based non-profit that streamlines the lending experience for anyone who has a desire to be their own “banker to the poor” (as Yunus phrases it).  While almost all finance institutions build pipelines between those with money and those who can utilize it, Kiva has been unique in microfinance circles as it sources funding from small-scale investors rather than institutions like banks, pension funds, governments, or high net worth individuals.  Kiva does not only empower the poor in developing nations, it gives anyone with $25 dollars the opportunity to help change someone’s world.

Interjecting with a personal note, I’ve had an overwhelmingly positive experience lending through Kiva.  The interface is informative, beautiful, easy to use, and that’s not even mentioning their mission. 

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Microfinance 1.0: Bootstrapping from the Bottom

            As we are all aware, hundreds of millions of people are living in poverty all over the world.  While many societies have been able to build their way to modernity since the Industrial Revolution, there have been many others that have not.  Sometimes this is due to lack of natural resources.  Other times it is due to ongoing regional conflict, and still other times cultural or religious norms inhibit growth.  The state of the world’s poorest is a tragedy of the human condition but much progress has been done to alleviate it in our lifetimes.  Globally, poverty is at an all-time low and its rate, according to the World Bank, has dropped from 43.1% in 1900 to 20.6% in 2010.  This is a testament to the “rising tide lifts all boats” adage, but it also often due to the sheer ingenuity of the poor themselves.

            Such evidence of the poor building themselves out of poverty can be seen in the innovation of informal savings groups.  This is the idea that a community of individuals get together periodically (daily, weekly, monthly, etc) and pool savings to distribute to a member of the group.  The recipient of that meeting’s proceeds gets to take advantage of a big inflow of money to make a relatively large purchase or some kind: tools, seeds, and the like.  Ultimately each member pays as much into the system as they receive but the arrangement works well because it allows each individual to have that access to a large cash flow all at once rather than having to try to save for n number of periods.  Other features include enforceability because members of the groups can visibly check to see that the other participants are contributing as their arrangement requires.  Anyone who shirks the responsibilities is visibly noted.  It might seem like one could forego the group and just save the same amount that they pay every period until the needed amount for some given purchase has been saved.  That does happen most of the time, but the reason that people sometimes chose to forego pure savings and opt for this system instead is the reality that frequent small cash outflows and a large inflow periodically is more palatable than trying to keep cash on hand, for security or any other given reason.

What we witness in this primitive capital market is a simple and yet unquestionably effective way of facilitating access to money.  The particulars of each group, pay-in rates, payout periods, and other factors vary from group to group.  But the general concept stands at the base level.  You can read a more thorough explanation of savings groups here (starting on page 7) if you’d like.  Though it is a limited solution, it is particularly beautiful because it can be implemented with no more than willing participants and the infrastructure of a record keeping pen and paper.  For want of a pen and paper, good memory can suffice. 

This is the first of a three part series. Part 2 can be found here and part 3 can be found here. 

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What the Price Says: Facebook brings WhatsApp into the fold

            Right in the wake of a failed Snapchat takeover bid, the M&A folks at Facebook are the toast of the business world and the founders of WhatsApp, Jan Koum and Brian Acton, are the debutantes of Silicon Valley.  I’m sure you’ve read the headlines: Facebook buys WhatsApp for 19 billion dollars.  That’s four billion in cash, 12 billion worth of Facebook stock, and three billion in restricted stock to be paid over the course of four years.  And that’s billion with a “B”. If you glazed over seeing three big numbers, let me put that in real terms.  19 billion dollars, as TechCrunch contextualizes, is: four times the market capitalization of BlackBerry, one third the market cap of Ford and Hewlett-Packard, and 25 times the size of Facebook’s last in-the-public-eye acquisition, Instagram.  I’ll add anecdotally that the London Olympics of 2012 cost 15 billion dollars, as did NASA’s Mars rover program.  I could go on… 

            Let’s not forget that at their last round of fundraising, the company was valued at 1.5 billion dollars.  So the question on my mind, your mind, and everyone else’s mind is: what possible reason could Facebook have to spend such an immense amount of money on a texting app?  With a claimed 400 million active monthly users, that’s $47.50 per account.  For comparison, it takes a decade to get that much nominal ad revenue from a Facebook user.  It would be even longer if we were discounting to the present value.  At the current subscription price of a dollar per year, whatever the discount rate is, Zuckerberg will be lucky to see the break-even point before retirement.

            While all those numbers are true, and our friends at 1601 Willow Road deserve all the funny looks they’re getting from pretty much everyone else, two sentiments seem to float to the surface that explain this occurrence.  The first is, as one can imagine, a desire to expand into different markets.  Most of WhatsApp’s users are in emerging markets like Mexico, Brazil, and India (countries with lower adoption rates of Facebook itself).  These days, the sun never sets on the Zuckerberg empire.  The second sentiment, and this might explain the magnitude of the deal, is a fear of obsolesence.  From niche news sites like TechCrunch to mainstream sources like ABC and The Guardian, the consensus seems to be the same: the people Facebook is meant for, the “cool kids”, are browsing elsewhere.  Time will tell whether the acquisition was worth the cost, and with over a billion users already, Facebook has quite some time before it goes away.  Yet it must be in the back of Mr. Zuckerberg’s mind that a decade ago, one Harvard student single-handedly took down the incumbent social network: MySpace.  

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