Impact investing provides more than impact. Diversification and counter-cyclical investments can create standalone value for investors, especially as risk assets get pricier.
To some, impact investing is a concessionary exercise where you sacrifice returns and financial rigor to "do good." However, those more in tune with the goal of impact investing know it does not have to be about trading a financial loss for a social gain. Impact investing can drive smart investment choices that both bring in strong financial returns and have a societal impact.
It’s not an either or. It’s a win-win.
Similarly, when it comes to providing stability when the economy begins to turn down, impact investing can be an effective strategy to build resiliency both in your investment portfolio and in local communities around the country.
Take, for example, community investing at scale. By investing in a national network of Community Development Financial Institutions (CDFIs), which have been trusted by major U.S. banks for over 20 years, investors can simultaneously infuse capital into marginalized communities across the country and provide financial backing to traditionally underrepresented borrowers while shoring up their individual investment portfolios in preparation for future recessions.
CDFIs, The Unsung Heroes of Community Finance
CDFIs date back to the 1990s, however, they remain one of America’s best-kept secrets. What exactly are these unsung heroes of community finance?
CDFIs are federally certified private financial entities that are 100 percent dedicated to providing responsible, affordable lending to historically underserved borrowers, including low-income households and business owners, women, minorities, unbanked borrowers, first-time homebuyers, nonprofit and tribal organizations, and borrowers living in low-income and low-wealth communities across the United States. The mission of CDFIs is to provide these marginalized and underserved borrowers and communities with access to capital so that they can join the economic mainstream and succeed.
Additionally, CDFIs are counter-cyclical lenders intended to step in at times of financial distress, economic downturns, and natural disasters, and because they offer exposure to different parts of the economy than other investments, they have the potential to be a stabilizing addition to your investment portfolio.
Banks Look at CDFI Playbook to Prepare for Coming Recession
The question isn’t about if a recession is on the way, it’s about when.
All of the warning signs of an impending recession are there, and according to the Wall Street Journal, most surveyed economists predict that it will arrive within the next two years. Some think it could begin as early as late 2019.
As banks simultaneously strategize and scramble to prepare themselves for the coming downturn, CDFIs, which have a history of absorbing shocks and doing well during economic dips, continue to receive debt and equity investments from large financial institutions.
Consider the example of the Great Recession. From 2008 to 2015, more than 500 banks failed, and many that didn’t outright collapse either accepted forced mergers or agreed to submit to federal oversight. During the Great Recession, the Federal Reserve Bank of Dallas estimates that every household in the United States lost the equivalent of $50,000 to $120,000 — that’s $6 trillion to $14 trillion nationwide. During this time, unemployment rates in low-income and marginalized communities was higher than it’s been since the Great Depression, and most financial lenders pulled out of these areas, worsening inequality and racial segregation.
However, CDFIs went against the grain and invested in these communities during the downturn. Surprisingly, as bank lending contracted following the Great Recession, CDFI loan origination outpaced pre-recession levels.
How did CDFI come out on par or ahead of big banks during the Great Recession?
According to the Federal Reserve Bank of San Francisco, CDFIs’ blend of flexible, patient capital alongside rigorous risk management and a commitment to community-driven projects and enterprises was enough to keep them on solid ground while many financial institutions felt the shocks more deeply. Instead of foreclosing on properties or taking legal action against borrowers, CDFIs counterintuitively agreed to loan extensions and softened terms, allowing for borrowers to ride out the recession and, ultimately, to survive.
Just like other financial institutions, CDFIs suffered losses, but they were lower than their for-profit peers, and between 2008 to 2015, every one of the 500 CDFI loan funds certified by the U.S. Treasury survived and, for the most part, emerged stronger than before.
That’s why many banks and for-profit lenders are now looking at ways to partner with CDFIs and to channel CDFIs’ inherent patience, flexibility, commitment to communities, and local expertise to improve their own rate of success during the forthcoming economic downturn.
The Opportunity for Individual Impact Investors
Today, there are over 1,000 CDFIs across the country, and investing in CDFIs is becoming increasingly accessible to individual impact investors. Even though CDFIs as a whole remain a tiny sector compared to mainstream financial institutions, choosing to invest in CDFIs can be, solid strategy to incorporate some economic shock absorbers into your portfolio, increasing diversification, resiliency, and stability.
As demand for CDFIs increases, investors will find there are two main ways to access them either directly or through intermediaries. Direct investment is a great option where the CDFI deploys capital it receives directly from individual investors and institutions. Unfortunately, given most of the 1,000 CDFIs are not set up to take direct investor capital, especially if the investments are not large or come from multiple individuals. Intermediaries play an important role to connect high-performing CDFIs with values-aligned investors while easing the administrative challenge of deploying capital. Intermediaries such as CNote, the firm I co-founded, provide nationwide access to highly-quality CDFIs. Additionally, Calvert, who includes CDFIs along with other loans as part of their debt investment vehicle, provides another easy to access this asset class without having to be an expert in community finance.
Similar to how CDFIs are viewed as long-term financial partners within the communities they serve, having a partner who understands how to best invest and safeguard your impact investment dollars in a resilient, community-serving network of CDFIs is a forward-thinking strategy that might help you — as well as women- and minority-led small businesses, first-time homebuyers, borrowers living in low-income communities, and many more — come out on top of the next recession.
As investors look for ways to generate returns and diversify their portfolio, it is important they don’t look past Main-Street America and CDFIs, a proven class of lenders that generate solid financial returns along with providing transformative economic opportunities to under-served communities across America.
-Catherine Berman, CEO & Co-Founder, CNote
Catherine Berman is the CEO and Co-founder of CNote, an impact investment platform delivering competitive returns by investing in women, minorities and low-income communities across America. Prior to CNote, Catherine served as Managing Director at Charles Schwab and Senior Vice President at Venture Capital firm, Astia. At the vanguard of impact investing, Catherine has spoken at events hosted by Stanford, Oxford, Google, The Economist, SoCap, Coinbase, and others to challenge conventional thinking about money and meaning.
