4.2 Creating and Distributing Impact Products for Retail Investors
By Gloria Nelund, Chairman and Chief Executive Officer, and Joan Trant, Director, Marketing and Impact, TriLinc Global
- To achieve meaningful social, economic and environmental progress, participation in impact investing must be increased exponentially. However, current investment structures present challenges for attracting capital at scale.
- Engaging 75 million individual retail investors in the US is critical to the goal of creating a robust, permanent impact investment industry.
- Due to the nascent state of the impact investing sector, impact investment products are not “bought” – they must be “sold” – and therefore require specific product packaging, marketing and distribution to achieve market share.
Why Retail Investors?
Influence through compelling numbers
The US retail market counts 75 million individuals who collectively control in excess of $17 trillion investable assets. Current retail impact offerings have a philanthropic orientation and rely on a “buy” strategy that assumes investors already know that they want to invest in an impact product. Impact offerings structured like “traditional” products that are familiar to retail investors, which meet the investors’ return targets, risk tolerance and liquidity requirements and which are sold through financial adviser channels familiar to investors, can capitalize on a huge market opportunity. In turn, the retail sector’s participation in impact investing has the potential to sway public opinion and be the tipping point for the broad adoption of impact products.
Distribution at scale
To date, impact investments have generally been structured as private placement vehicles, which are available only to accredited investors or qualified purchasers. Private placements are exempt from the more stringent transparency and reporting requirements that govern publicly registered investment products, making it difficult for investors to assess and compare various impact offerings. As a result of the exemption, the Securities and Exchange Commission (SEC) limits the maximum number of investors in private placements to 99 for accredited-investors and 499 for qualified purchasers, thus substantially hampering the scalability of the individual funds.
Only 3.3 million individuals meet the SEC’s high net worth standards to be considered accredited investors, resulting in a very limited pool of potential impact investors. Furthermore, since the wealthy engage gatekeepers who manage their investments, bringing private placements to scale is a noteworthy challenge. In contrast, direct investment products offer access to new and innovative alternative investments and do not require accredited investor status.
Two key drivers contribute to the direct investment product category’s ability to scale rapidly. The first is the product structure, which aims to satisfy retail investors’ needs for a competitive income stream, a stable net asset value and a low minimum investment threshold. The second is the effectiveness of the disciplined wholesale distribution process through registered investment advisers (RIAs), independent broker-dealers and banks.
TriLinc Global Introduction
Founded in 2008, TriLinc Global is an impact fund manager with a mission to demonstrate the role that the traditional capital markets can play in helping to solve some of the world’s pressing economic, social and environmental challenges. We create institutional-quality impact funds that attract private capital at scale, aiming to set a high standard of transparency and accountability for delivering financial returns, and for tracking and reporting the impact of individual investments. TriLinc seeks to engage main-street investors, and some products may have retail-level suitability and minimum investment requirements according to state securities laws.
Executing a Retail Impact Investment Strategy
A successful strategy for democratizing participation in impact investing requires market-based design, packaging, management and reporting. TriLinc’s retail offering mirrors market practice of public fund registration and leverages the traditional financial adviser education and sales process, with the goal to exponentially increase capital flows from both non-impact and impact-focused investors, which in turn accelerates economic, social and environmental progress.
TriLinc employs a disciplined process to both screen companies for their ESG practices and to define, measure and monitor the specific impact opportunity of all individual portfolio companies. TriLinc uses industry-standard metrics to report these impacts to investors. The following steps describe TriLinc’s process in detail:
- Identify investment opportunities that can attract significant private capital and also address big societal issues
TriLinc conducts global development and sustainability research and engages in industry dialogue to identify themes that are market-oriented and scalable and have measurable impact.
- Conduct detailed market research to understand retail investors’ financial goals
To ascertain what investors need, what they buy and what gaps exist in their investment portfolios, TriLinc analyses retail investment behaviour, impact investment activities and trends, through data from government sources, private sector studies and third party market research. It coordinates with its product distribution partner to survey financial advisers and assess the competitive landscape. Research results indicate that retail investors value current yield, capital preservation and modest capital appreciation. In return for these benefits, they are willing to accept a moderate level of illiquidity.
- Determine the optimal legal entity and product structure
Entity and structure selection are vital to satisfy customer objectives and leverage the existing retail sales process. Specifically, the product must be accessible to non-accredited investors, permit investment in target instruments, such as private debt or equity, and provide appropriate valuation terms, e.g. monthly or quarterly. Equally important, the structure must provide a way to compensate the financial intermediaries who sell the product to the end-customer. This incentive “rewards” RIAs, broker-dealers, banks and financial advisers for diligencing the product, placing it on their product platform and educating and then selling the product to their clients. Like the product itself, the fee/commission schedule should follow industry practice for each distribution channel to promote sales.
- Reverse-engineer the investment strategy to meet retail investors’ objectives
To ensure sales success, the investment strategy must satisfy investors’ risk tolerance, return targets, liquidity requirements and other constraints. It must also absorb capital at scale and deliver intentional, transparent and reportable impact results.
- Create a publicly registered product
Compared to the private placement model, public registration drives accountability and transparency, given the SEC’s detailed reporting requirements. Registration enables scalability, because there are no maximum investor limits, and a familiar, market-proven product reduces the barriers to acceptance and accelerates adoption by both the sales channels and the investors.
- Partner with a specialized wholesale product distributor possessing deep industry relationships
Partnering with an experienced product distribution firm provides strategy, business development, marketing, sales, technology, operations and compliance support. The distributor works closely with financial intermediaries to support due diligence, establish selling agreements and train financial advisers, who engage with retail clients. TriLinc develops the messaging, assists with the creation of all marketing material, trains the trainers and participates in due diligence meetings, financial adviser meetings, client meetings, conferences and webinars.
- Complement top-down macroeconomic analysis and portfolio management with investment services from institutional-quality sub-advisers
TriLinc conducts ongoing macroeconomic analysis to identify investment trends, risks and opportunities. It then leverages the geographic, asset class and sector expertise of its investment sub-advisers, which must pass rigorous due diligence based on their institutional experience, investment processes, track record, local presence and assets under management.
Sub-advisers originate and evaluate opportunities that meet TriLinc’s strict investment and impact parameters. They perform financial analysis, site visits and tax/regulatory analysis. Alongside the underwriting process, the sub-advisers assist with evaluating investee companies’ ESG practices and with gathering impact data (baseline and annual), for TriLinc to assess, monitor and report impact results at both the company and portfolio levels.
The sub-advisers structure the transactions and, upon TriLinc funding, manage and monitor investments through regular contact, on-site inspections, financial reviews and sector tracking. TriLinc conducts stringent sub-adviser monitoring and aims to reduce risk through comprehensive portfolio diversification across multiple factors. Beyond daily contact over current and upcoming transactions, TriLinc conducts formal quarterly reviews via telephone and a minimum annual site visit with each sub-adviser and selected portfolio companies. The monitoring process assesses investment rigour, the management and performance of investments, and the verification and reporting of ESG standards and impact metrics.
- Demonstrate financial returns and positive impact through transparent reporting
TriLinc adheres to the rigorous financial reporting required for a publicly registered company, and it provides investors with quarterly investment and impact updates. TriLinc uses its portfolio management system, eFront, to track and report individual company credit and impact data. To facilitate consistent impact measurement across investments, TriLinc’s sub-advisers gather ESG and impact data employing impact reporting and investment standards (IRIS). TriLinc conducts additional due diligence on the company’s social and environmental activities, and it reviews related industry research, standards and best practices to complete a baseline assessment on each portfolio company, measuring the specific metrics tied to its impact objectives.
Annually thereafter, TriLinc conducts a full evaluation of each company’s progress based on sub-advisers’ reporting, with third party verification of the data and process. TriLinc produces an annual impact report showing consolidated data at the portfolio level and highlighting particular investments. The box below provides further details on its impact measurement approach.
A key component of TriLinc’s investment process is tracking, analysing and reporting the impact of investments through its proprietary system, the TriLinc Impact Measurement Engine (TIME).
Five Lessons Learned
TriLinc’s early experience with fund design, management, distribution and reporting has imparted many lessons regarding how an investment manager might establish a replicable process for launching and managing impact funds at scale. Key insights follow.
Impact products are “sold,” not “bought,” requiring a methodical process of adviser education
Creating a robust selling group of RIAs, broker-dealers and banks is a time- and labour-intensive process. Impact-oriented RIAs can be instrumental in providing initial capital, but scaling requires that traditional, non-impact players join the selling group. As detailed in Gateways to Impact,14 financial advisers (FAs) must be educated about any new idea, so they become confident enough to discuss it with clients. For the vast majority of 223,400 USFAs,15 impact investing is a new concept. The education and sales process involves major upfront costs in due diligence materials and meetings, marketing materials, road shows, webinars, sales training and sales management systems. However, education is a critical industry-building activity as FAs in turn educate hundreds of thousands of clients.
To engage financial advisers, it is necessary to counter the perception that all impact investments are concessionary, and to educate FAs on the opportunity to retain and grow assets based on macro trends, such as the generational wealth transfer combined with the growing preference by women and millennials for investments that improve society. However, some mainstream advisers sell an impact product, not for impact, but because it targets a market-rate return and complements their clients’ current investment mix. In this way, it is possible to attract both impact and non-impact capital to increase flows to the sector.
Matching the unpredictable inflows from retail sources and the investment of capital requires both rigour and flexibility
Unlike the private placement funding model of committed capital, retail inflows are harder to forecast. This may create over- or under-matching to the sub-advisers’ deal pipeline. While capital amounts earmarked for transactions are orientative until approved, sub-advisers’ reputations and future deal flow depend on the ready availability of funding. On the other hand, if sub-advisers cannot place capital quickly enough, the investment manager runs the risk that uninvested cash may lower portfolio returns. To mitigate mismatches, it is critical to coordinate closely with sub-advisers on their investment pipelines and identify additional sources of deals, such as other impact fund managers and public-private partnerships, that can be channelled to the sub-advisers for consideration.
Incorporation of a broad spectrum of impact objectives ensures sufficient investment opportunities at scale
TriLinc believes that capital deployed across the risk spectrum constitutes impact investment provided it is committed to intentionally achieving social or environmental benefits, and tracking and reporting on impact progress. TriLinc’s process requires the companies it invests in to have an intention to create impact along with clearly identified impact objectives that can be measured and reported. This approach encompasses not only social enterprises serving low-income markets, but also companies targeting broader markets but with specific impact goals for socio-economic and environmental benefits. The expanded scope of potential portfolio companies generates a wider range of impact investment opportunities that can meet retail investors’ risk-return profile, absorb exponential capital flows and generate significant economic, social and/or environmental impact.
Time and financial costs of public fund registration are significant
Public registration of a direct investment product entails filing with the SEC, the Financial Industry Regulatory Authority (FINRA) and the regulatory bodies in each of the states and territories where sales will take place. The significant investment of time, legal, tax and audit counsel, registration fees and organizational expenses require substantial resources.
The direct investment product model has the potential to drive impact innovation adoption
The rapid adoption of a new investment idea, delivered through the direct investment product structure and traditional sales channels, presents an exciting opportunity for impact fund managers. As a case in point, the first fund manager in the non-traded business development companies market initially struggled to raise capital. However, within 36 months of fund effectiveness, the manager raised $2.5 billion. Such success highlights retail investors’ ability to mobilize significant capital for direct investment products, which can be adapted to incorporate impact strategies and accelerate capital flows to the sector.
To achieve meaningful, long-term social and environmental progress, impact managers must “expand the pie” of dedicated capital by engaging main-street investors. Impact funds which mirror the already familiar structure of publicly registered, non-traded funds while offering competitive returns, measurable, reportable impact opportunities and institutional-quality management have the potential to mimic the stellar growth of their non-impact counterparts. If they are successful, the impact sector will be well on its way to mainstream status.