Impact Investing in The Economist

The September 10 issue of The Economist has an article about impact investing.  It is a lot of the same stuff that I have discussed here before, though The Economist is approaching it more from an investing function than an impact function.  This piece seems to be much more clear that impact investing is primarily a private equity investment, as opposed to publicly traded stock screening of traditional SRI vehicles.

Two items in particular caught my eye.  The author tries to get at what makes an investment impactful. “ 'It is about having the right intentions, to improve the world as well as make money, and about taking seriously the process, especially measuring social performance,' says Jed Emerson, co-author of a new book on impact investing."  We've seen the social performance measurement idea, and noted the difficulties.  Now making an impact includes having the right motives and following the right process.  As I said before, "when businesses identify human needs and wants and find a way to fulfill them at a price that the market can afford and allow the company to make a profit, then value is created for all participants."  That is capitalism.  That benefits both buyer and seller.  That benefits both labor and capital.  All investing is impact investing.

The Economist also tries to manufacture a new asset class out of this idea.  One fund manager puts the notion to rest: “ 'Impact investing touches every asset class,' says Ron Cordes, who made a fortune in traditional finance before co-founding Impact Assets, an intermediary focused on building up the sector."  He allows that asset class is thrown around loosely these days, but I like that he resists the notion.  In fact, despite the actual structure of the investment, all impact investing amounts to private equity.  There is rarely any funding junior to the capital provided by institutions.

Allegheny Update

I recently received a letter requesting some corrections to the post on Allegheny Natural Resources I wrote last month.  I stated that Allegheny was the subject of an involuntary Chapter 7 filing; in fact, it was a Chapter 11 petition.  That case has proceeded to a settlement agreement between Allegheny and the original petitioners, and a hearing was scheduled.  However, another creditor has filed its own Involuntary Chapter 7 petition and an objection to the settlement.  The new creditor did not list the amount of claims in its petition.  As Allegheny had to secure financing to satisfy the creditors, the new petitioner's move appears wise.

In the meantime, it appears that Allegheny's well permits have been held up due to unresolved issues regarding the plugging of some abandoned wells.  So Allegheny still has not drilled any wells for the 2010 program, is not likely to get any production this year, and certainly will not issue any revenue checks to 2010 investors.

Lender Beware

I didn't realize it, but there is a bill to exempt small business loans that are crowd sourced from registration.  According to Investment News, loans which are less than $5 million in aggregate and less than $10,000 per investor will be exempt from any filing requirements whatsoever.  Apparently, this legislation is in response to the proliferation of peer-to-peer lending sites that are proliferating.

I have had a fascination with these site since they started appearing.  I have taken a look at a couple of sites and am generally intrigued.  The sites are dominated by individuals wanting to borrower money for personal reasons.  However, there are some businesses seeking funding and some seem interesting.

The fundamental drawback for intermediaries is that there is insufficient information available on the borrowers to conduct proper due diligence.  And the default performance of the loans bears out the skepticism.

I have reached the conclusion that these opportunities my be OK for my portfolio, but I could never fulfill my obligation for establishing a reasonable basis for recommending them to clients.  Based on the website structures that I have seen, I don;t think that any independent intermediary could.

See You In Las Vegas

I am at the REISA Annual Conference in Las Vegas.  I am on a panel called Oil & Gas Program & Sponsor Evaluation Practices.  Come say hello if you have a chance.

Research Supporting Socially Responsible Investing?

Dorothy Hinchcliff has another column about Socially Responsible companies on FA-mag.com, the Financial Advisor magazine website. She notes with approval some research that indicates that "socially responsible firms enjoy a lower cost of capital."  This is an important finding for firms pursuing SRI strategies.

The researchers, four academics from the University of South Carolina, University of Alberta, and University of Saskatchewan, used a discounted cash flow analysis applied to future cash flows, "the kind analysts would use," to arrive at the cost of capital measure.  In this manner, the researchers  estimate future cash flows for their subjects and found the discount rate that equates the forecasts with the current value of the equity.

The researchers used valid methodology in a robust manner to arrive at their conclusions.  They therefore claim that these "empirical" results are superior to actual observed returns.  That may be so from the standpoint of the corporate financial officer in charge of raising the capital to execute the company's strategic plan.  What is important to investors is the realized returns. 

Ms. Hinchcliff does her cause a disservice in citing this research.  The cost of capital to a company is the expected return to an investor.  The goal of investment professionals is to increase the expected return on a risk-adjusted basis.  This research actually reinforces the notion among many advisors that an investment in SRI strategies is an acceptance of lower returns.

The Case Against Commodities

That is the title of the article from The Wall Street Journal.  Not a damning case, but one that touches on all of the major weaknesses and risk factors of investing in commodities in all of their manifestations.  There is the substitution effect, such as when kerosene replaced whale oil in lamps.  There is the technology effect of applying hydraulic fracturing (and horizontal drilling) to shale formations to vastly increase the productivity of natural gas wells.  There is also more speculative capital in the market, attracted through very retail friendly vehicles such as ETFs and structured notes.

Finally, there is contango to overcome in the futures market where most of that ETF capital is deployed.   Contango is the normal stateof pricing in which a longer dated contract is more expensive than a shorter contract.  Thus, with the expiration of each contract, an investor has to pay more to re-establish the position than the proceeds from closing the contract.

Two striking passages hit home.  Dylan Grice of Societe Generale is credited with the observation that "(s)pot prices for raw materials have been basically flat, after adjusting for inflation, since 1871, vastly underperforming stocks and bonds...."  And this from author William Bernstein: "You're picking up nickels in front of a steamroller.  The risk of getting crushed is enormous."

The typical diversified portfolio has some exposure to commodities through the stocks of commodity producers.  Think ExxonMobil and Archer Daniels Midland. The type of commodities investing discussed in the WSJ article is speculative exposure to price changes.  A more conservative approach to increasing exposure would be to invest in a sector fund focusing on commodities producers such as Fidelity Global Commodity Stock Fund (FFGCX).

FINRA On Non-Traded REITs

The online version of Financial Advisor magazine, www.fa-mag.com, had an article yesterday about an Investor Alert issued by FINRA concerning non-traded REITs.  The Alert concerns those particular risks that an investor faces with non-traded REITs that he wouldn't necessarily experience investing in traded REITs.  FINRA mentions the obvious lack of liquidity and high fees.  These are issues that have been scrutinized in the due diligence process for some time now.

It also mentions the issue of dividend coverage and valuation; again two issues of close attention in the due diligence process.  The regulator gives a quick formula for determining whether dividends are being covered, then directs investors to the SEC website for source material.  While I would argue the choice of sources and the equation,. if an investor can find his way around an annual report well enough to find the numbers, he will be well served by doing the calculation.  On the other hand, the caution concerning valuations is rather vague and provides no suggestions on how an investor can protect himself.

Arguably, the offering materials of a REIT that is in the capital formation stage should address all of these issues.  Unfortunately, the materials have become weighted down with so much disclosure that finding the discussion of these issues is difficult at best.

This is where the sophisticated advisor distinguishes himself.  By being familiar with the term of the offering and the details relating to these hot button issues, the high value advisor can assist the client in evaluating the offering in light of the  issues and can put the importance of the items in the proper perspective.

Three Classifications For Foreign Markets

The July/August 2011 issue of the Journal of Indexes includes an article making a case for the establishment of a third classification of foreign markets: Frontier.  Dow Jones is reorganizing its foreign equity indexes to reflect the three categories.  Markets, and the equities traded on them, are to be groups according to what Dow Jones terms market-centric attributes and investor-centric experiences.  The factors considered either introduce additional costs of trading (settlement cycle, foreign capital flow restrictions) or incremental risk (differential treatment of domestic and foreign investors, public availability of trading data).  The figure below indicates how markets stack up in the new classification system versus versus total market capitalization.

 

Table courtesy of Journal of Indexes

What I did not expect was the extent of the overlap of developed and emerging markets.  A couple of names also stand out for being better developed than expected: Hong Kong and Singapore among the developed and Russia among the emerging.

Normally, I would consider this a marketing gimmick on Dow Jones part, trying to create differentiation where there is no difference.  However, given the factors considered, I think that a credible case has been made that investing in the Frontier markets presents different risk exposures than investing in Either
Developed or Emerging markets.  Indeed the final figure ion the article indicates that the Frontier markets had a lower correlation with the other two classifications than Developed and Emerging had with each other.

Look for products to be developed using the new classification, most notably ETFs.  Once we get a critical mass of capital applied to the new classifications, we can perform the experiment of comparative value of three- versus two-class foreign equity investing.