Articles / 12.14.2015
When Perfect Is The Enemy Of Good – mid-flight musings on moving goalposts, aspirations that become punishment, Blackrock’s highly-publicized entrance into impact investing, and running out of ammunition while shooting ones’ self in the foot.
Diatribe Warning: unlike most of my blogs which at least maintain the fiction of neutral, considered observation on the nature of impact investing, combined with a vague sense of advocacy for the discipline, this one is really nothing more than a bewildered screed based on random conversations with practitioners, investors and impact investing hangers-on. Importantly, it is NOT a solicitation for the fund that serves as a subject to the blog. Equally importantly, and in the interest of full disclosure and transparency, several of Caprock’s clients are invested in both the fund’s GP and the fund itself, as I am. More on this later…
Those who know me well (and even those who don’t, but claim to) have heard me invoke Voltaire’s dictum: Le mieux est l’ennemi du bien. Or, more prosaically in English: Perfect is the enemy of good.
In very few areas of finance does this dictum manifest itself so clearly as in impact. And in part, this is a good thing. High and rising standards are important. Just like the LEED building standards that have transformed commercial construction, it is important to evolve with the practice and with our knowledge of value creation in social and environmental enterprises. And, just like LEED (which, let us recall, began with the LEED Gold standard being so difficult to achieve with existing building materials and techniques that it was very nearly aspirational, and is now seen almost as a check-the-box exercise for almost any new construction project to the point that “beyond LEED Platinum” is a phrase I’ve seen bandied about by developers who hope to woo the most environmentally-conscious tenants. Clearly, LEED has been a huge success at developing an entirely new way of driving efficiencies in buildings and in developing a market for the products that support them.) impact needs to keep raising the bar.
But in equal part, the enemy of good is a real problem for impact. Why?
For a very simple reason: if we believe (as I most certainly do) that the challenges we face (and that have been enumerated more times than I would like to admit in these blog pages) require trillions – literally, trillions – of dollars of investment capital, impact cannot remain the plaything of a handful of enlightened, progressive, mostly wealthy families. It MUST go mainstream. Period. Because that’s where the capital is: pension plans, large foundations, the millions of accounts custodied by the bulge-bracket banks, etc.
For this to happen, however, products that offer impact, competitive returns and access for retail investors must be made available. And to get to that point we’ll have to experiment. We’ll need to embrace innovation, imperfection, and failure through what I’m calling “Goldilocks products”: investments that strive to meet the opaque and shifting standards of both dyed-in-the-wool impact investors and interested-but-skeptical conventional investors.
An important side note: while one could posit that this product already exists in the form of SRI and ESG screened mutual funds, I disagree that these funds will provide solutions. They represent a values alignment exercise rather than an impact investing strategy. At best, at scale, screening might be able to goad corporations into adopting practices that will eventually support the goals of impact investors… but that is only by adding proxy voting and shareholder advocacy to the fund’s operations. To date, this is not happening on an institutional scale.
So, how does this loop back to my initial comment/bewilderment about running out of ammo while shooting one’s self in the foot? Let’s take a look at TriLinc Global (and remember that this is NOT a solicitation for TriLinc… it is nothing more than an exploration of a phenomenon, of which TriLinc is a decent example):
TriLinc Global is a private mutual fund formed on the idea that retail-focused funds are a necessary part of the impact eco-system (see above comment on capital flows into the discipline). This goal – building and distributing these funds for the institutional/retail market – carries with it certain implications. A by-no-means exhaustive list:
- SEC registration. The TriLinc management team spent years and millions of their own dollars funding the registration process. A soul-destroying siege no matter how you look at it. And why? Because TriLinc wants to give access to investments that have been heretofore restricted only to accredited (wealthy) investors. In other words, TriLinc wants to provide access to impact for retail investors. Talk about democratizing impact. And in service to this goal, they are shouldering a non-trivial innovation and regulatory burden.
- Significant capital absorbing capacity. A conversation with the person responsible for product approval at the largest brokerage firm in the world revealed an interesting fact: unless a fund seeks to raise at least $500mm, the firm won’t put it on their platform. Why? Because their risk management policies dictate that firm clients can’t hold more than 10%, in aggregate, of the total capital in the fund. And the economic realities of their business model means that they won’t launch a product on the platform unless their brokers can place at least $50mm in client capital. Simple math. So… how many impact funds can you name that have a target AUM of more than $500mm? And how many of those also target retail investors? That’s right. Not very many.
- An institutional flavor, from the top down. In other words, it has to look, feel and maybe even smell like something that these big institutions recognize. Three badass, smart as hell, challenging and excellent young impact venture capitalists targeting a fund of $50mm just won’t make it onto these platforms. Ever. A fund that is built for retail distribution right from launch? Including paying sales commissions? Maybe.
- Efficient, institutional-caliber capital raising functions. In other words, it appears to be more of a “sales” business than an “investment “ business. Why? Because the cold, practical reality is that impact investing is still a poorly understood and unfamiliar discipline. To raise the kind of capital that impact requires will also require sales. Education. Marketing. And lots of it. “If you build it, they will come” won’t cut it.
So, here’s where it gets interesting. What I have heard from a number of impact investors are some unexpected (and in my mind hypocritical) objections. In no particular order:
- These funds feel too much like an institutional product.
- These funds are sponsored by financial services/sales organizations, introducing an intermediation layer. Many, if not most, impact investors believe that more layers between the investor and the investee means less impact. We disagree. In the case of TriLinc or Calvert or MicroVest or CIM or Huntington Capital or RSF or any of the other lending institutions, they serve a very real and very valuable service: connecting investors with those who need capital.
- These funds are all trying to be “too big”. Which is mildly offensive to some deep-rooted impact investors. But if the SME trade finance funding gap, for example (which is TriLinc’s current focus) is estimated by the IFC to be somewhere around $800bb), the funds MUST be big to make a difference. Yes, you can raise a small venture fund targeting sustainable, organic, responsible consumer products. But there is no point in raising a $50mm trade finance fund. It would be nothing more than a rounding error on the market.
- These funds reflect an SEC-imposed regulatory environment. In other words, they just don’t feel as if they come from The Tribe. Who knows, maybe this association just reminds us of the recent financial crisis?
In other words, the very factors that are required to raise the amount of capital necessary to actually make a difference are the same factors that are limiting the success of these funds within the impact investing community. Add in the fact that most mainstream investors are still fuzzy on what impact even is, and firms like TriLinc are sitting in the bizarre position of being too “impact-y” for mainstream investors and too “impact lite” for committed impact investors. Bizarre, indeed. And frustrating.
I am never going to be one who says that the end justifies the means. I’m insufficiently Machiavellian for that. But, underneath the idealistic and optimistic attitude that drives my continued passion for evolving the capital markets towards impact, I am also pragmatic. And having spent 14 years in the belly of the beast at Smith Barney, I know how these institutions work. Thesis-validating performance, client demand, realities of climate change, etc. will not alter the economic reality of their businesses nor the essential character of their organizations.
Put more directly, the impact investing discipline NEEDS Goldilocks products like the fund offered by TriLinc. We aren’t going to go from zero to impact in one giant, cathartic, step.
Yes, wealthy families will always be able to do what they want with their capital. They always have, and they always will. But small investors are captives of the regulatory environment (just look at the equity crowdfunding policy gymnastics for proof) and the policies of their custodians. This is reality. What we therefore need are funds that provide bridging strategies for the institutions, so that they can begin to offer impact funds to their clients that don’t give their legal and diligence teams collective aneurisms.
So. My question to the impact community is this: why aren’t we all supporting funds like TriLinc’s if for no reason beyond creating an opportunity to validate the thesis that retail investors are, actually, interested in impact? And, if given the opportunity, they’ll direct capital accordingly?