For far too long, there haven’t been many good options for Americans who want to do well by doing good with their investment dollars.
An entire industry has emerged to counsel investors on stocks to avoid, based on certain criteria: companies that don’t have diverse workforces, or those with objectionable business models, like private prisons or for-profit colleges. But for many investors, that’s weak sauce: indirect at best, suspect at worse, and, in the end, unlikely to make much meaningful difference.
The solution may lie in an innovative new strategy that directly matches investor money to places that need capital, via the municipal bond market.
The strategy, known as fiscal justice investing, springs from an uncomfortable reality in the municipal market. While “munis” often are known for being staid and conservative, they’re also extraordinarily idiosyncratic. Within a $3.9 trillion marketplace, there are 50,000 issuers — states, cities, towns, water districts, transportation authorities, school systems, hospitals, and so on — from all over the country, representing a range of local economies, credit risk profiles, fiscal challenges, demographics, and more.
‘Trump almost seems to celebrate chaos in cities. That would make me apprehensive. It’s too bad because this is exactly when cities need it the most.’
Bonds from those thousands of entities trade in a financial marketplace with all the inherent biases of any human institution. That means many municipalities and institutions known to have higher populations of people of color pay higher rates to borrow than primarily white issuers do.
Fiscal justice investing aims to turn that bias on its head. It was developed by Activest, a research and analytics organization made up of former public finance and municipal bond market participants. “We like to try to analyze for the equity and the morality of a municipal budget,” said Activest co-founder Napoleon Wallace, who previously worked in state government and as a bond analyst for a major bank, among other things. “Places that treat their residents better have better fiscal outcomes. Conversely, places that treat their residents worse have worse outcomes. It’s like integrating an (environmental, social, and governance) view into the municipal market.”
That means Activest doesn’t just identify municipalities with higher populations of people of color, but focuses on those that it considers fiscally sound, in ways that support its community. Wallace ticks off a list of characteristics such a locality may have: affordable housing, a well-funded educational system, healthy interactions and relationships between public safety officials and residents, and so on.
Just as important is what, in Activest’s view, such communities should avoid: a reliance on “extractive” revenues like fines and fees levied on residents, racial segregation in education and housing, selling off public income streams, like Chicago’s infamous parking meter gamble, for a short-term cash infusion, and more.
It’s not just a feel-good badge of honor when cities check the right boxes, Wallace believes, but an indicator of a good investment for bondholders. “The fiscal justice framework goes deeper than a traditional bond rating does,” he said in an interview.
“Investors can avoid uncompensated risk and obtain higher returns because they are basically taking advantage of other peoples’ bias,” Wallace said. “That means that on occasion, there will be bonds trading at a discount, with a higher yield.” Bond prices move in the opposite direction of yields, meaning that bonds trading at a discount imply a higher risk of default. Similarly, investors expect to get a higher interest rate for bonds deemed riskier.
To bring the strategy to investors, Activest teamed up with a San Francisco-based wealth management firm called Adasina Social Capital. Adasina’s co-founder, Rachel Robasciotti, spoke with MarketWatch earlier in the summer about her firm’s innovative screening process for stocks, and her desire to help investors make even more meaningful connections between their good intentions and their dollars.
‘Places that treat their residents better have better fiscal outcomes. Conversely, places that treat their residents worse have worse outcomes.’
“It is the single most exciting opportunity for racial justice investing I’ve seen in my entire career, Robasciotti said in an interview. “This is pumping capital directly into communities where it’s most needed.”
Bringing capital to where it’s needed may sound innocuous, even admirable, but it makes some municipal market observers wary.
“You don’t want to be accused of predatory lending,” said Matt Fabian, a partner with Municipal Market Analytics. “In places like Puerto Rico, the muni market is called vultures and jackals because we loaned money. It’s a difficult challenge for our market. That dynamic is not clear-cut. But, to the extent that people think muni bond investing can do good, who’s against that? I’m all for it.”
As a complement to the primary focus of the strategy, roughly one-quarter of the bond portfolio will be devoted to communities that are, in Wallace’s words, “ripe for change…communities underperforming their potential because of bad environmental, social, or governance policies. If they do improve, we believe their bonds will outperform as well.” Activest and Adasina share a view that engaging more directly with communities, in the long tradition of activist bondholders, is the antidote to the “predatory lender” misstep.
Adasina will manage a portfolio of bonds from several dozen communities, identified by Activest, and available to any investor, with a minimum $1 million initial investment stake. Robasciotti says there’s been great interest and enthusiasm for the idea among her clients, institutional and retail alike.
The partners aren’t willing to share the names of cities included in the portfolio, for now, but Wallace says that it was Ferguson, Missouri, being slapped with a multi-notch credit rating downgrade in the wake of massive civil unrest, that offered an “a-ha” moment for him and other Activest co-founders.
“Somewhere along the way someone should have said to Ferguson, while they were still a double-A credit, we know people are leaving, the right way to support your budget is not to expand reliance on fines and fees that you extract from your residents,” Wallace said. “As a bondholder, we have an interest in you modifying that strategy to support your long-term fiscal outcomes.”
For Daniel Bergstresser, an associate professor of finance in the Brandeis International Business School and the co-author of a 2013 paper that documented the racial bias in the municipal market that Activest is trying to address (another paper, also from 2013, identified such bias against historically black colleges and universities), the compelling investing thesis may not be enough to overcome headwinds.
“I’d be uncomfortable today trading on this strategy because I think that a lot of the issuers you’re talking about are Democratic-led, minority-run cities in Republican states,” Bergstresser said. “I think across the board, not just with Trump, the Republican enthusiasm for helping out cities is lower. Trump almost seems to celebrate chaos in cities. That would make me apprehensive. It’s too bad because this is exactly when cities need it the most.”
But Wallace wants Activest to represent a movement as much as an investing strategy. “We see local government as the building blocks of our society and our democracy. When those entities are biased against some of their residents, it betrays the values of our democracy. We want to bring a fiscal justice voice and a racial-social-equity voice to the municipal bond market and ensure there’s financial and fiscal accountability for communities that are underserving their residents. That would be an amazing achievement and something that hasn’t been done in the municipal market at all.”