PURCHASING STOCK IN THE FUTURE OF HUMANKIND
Pension funds, charitable endowments, and sovereign wealth funds control over $25 trillion in assets worldwide. As investors, these groups share two key attributes: first, they have unusually long time horizons. Pension liabilities extend across decades, and endowments and sovereign wealth funds are often designed to operate in perpetuity. Second, the holdings of these investors span every region and sector. They are too big and too broadly diversified to hide from market volatility. When the world economy prospers, their assets grow. Conversely, when world markets falter, it undermines the ability of these investors to realize their long-term financial objectives.
Asset holders in these groups derive significant benefits from reductions in market volatility. A $1 investment that returns 8% annually will generate $46.90 over 50 years – $1 from the original capital, $4 from the 8% return, and $41.90 from compounded returns. However, long-term investment gains drop off sharply in a volatile market. The same $1 invested at an average 8% return in a market with a standard deviation of 20% will only produce $18.42 over 50 years. Due to the effect of volatility drag, the return from compounded growth is only $13.42, less than a third as much. Despite the fact that large asset holders clearly benefit from reduced volatility and related improvements in the investment climate, they rarely use their assets to influence these variables.
Large, long-term investors also profit as countries with nascent economies evolve into developed markets with strong institutions, the rule of law, and a middle class hungry for exports. For example, there is a significant negative correlation between a country’s perceived level of corruption and the size of its financial markets relative to GDP. Developing countries currently lose an estimated $1 trillion each year to corruption. However, sustained investment in good governance can mitigate these losses. During the decades following the Korean War, the United States dedicated roughly $30 billion in inflation-adjusted dollars to build up South Korea’s economy and capacity for governance. Today, American exports to South Korea top $40 billion each year, and the country’s financial market capitalization has increased from 0% to almost 100% of South Korea’s $1 trillion GDP.
In countries around the world, civil society organizations (CSOs) provide a layer of insulation against conflict, catastrophes, public health crises, and other shocks that contribute to market volatility. They also play a critical role in improving governance. However, many non-profit actors are severely undercapitalized. Even organizations that deliver a superb value for society often struggle to secure funding. The lack of capital in the sector is due in part to CSOs’ traditional reliance on two sources of support: contributions and fee-for-service payments. However, a quiet revolution in civil society finance is creating opportunities to address this market failure.
In recent years, innovative civil society organizations have started using financial instruments that were previously reserved for actors in the private sector. For example, the KIPP organization recently leveraged a $30 million partial bond guarantee from the Gates Foundation to raise $300 million from private capital markets in order to construct charter schools. Funds for the bond guarantee never left the accounts of the Gates Foundation, and KIPP will be able to pay back the $300 million over time from its increased revenues. Similar financial arrangements are enabling other organizations to save money on the bulk purchase of humanitarian supplies and other large capital expenditures. For-profit impact investments in projects such as clean power generation in poor countries or health infrastructure are playing an important role in creating an environment that is conducive to stable, long-term economic growth. Large asset holders stand to derive significant financial benefits if civil society organizations can leverage new resources to improve governance, reduce conflict, and tackle other root causes of market volatility. In July 2015, leaders from government, the private sector, civil society, and international organizations will convene at the Third International Conference on Financing for Development in Addis Ababa. A select group will commit to three objectives that make up the Progress Pledge:
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Investors will dedicate at least 1% of their assets or profits to social impact investment, development finance, or civil society support.
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These resources will be focused on countries that adopt basic standards of governance, accountability, and citizen engagement. CalPERS, the largest non-federal pension fund in the United States, has pioneered similar guidelines. A version of these rules would be developed to serve the needs of a broader array of investors. This effort will create a multibillion-dollar incentive for good governance and citizen engagement grounded in successful principles in use by the Millennium Challenge Corporation.
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Providing support for regulatory reforms developed by the G-8 Social Impact Investment Task Force and National Advisory Boards on Impact Investment. These changes will eliminate red tape around impact investment and incentivize asset holders to direct resources toward projects that provide broader benefits to society.
Over the next two years, signatories of the Progress Pledge will work to align the investment strategies of major asset holders with these goals. In addition to building out the analytical case for impact investment, signatories will also assess the potential returns from different impact investment strategies and metrics for gauging impact. The partnership will work to demonstrate that asset holders have both a vested interest and a fiduciary obligation to pursue impact investments that reduce market volatility, improve governance, and advance Sustainable Development Goals.
In 2016, signatories to the Progress Pledge will come together with political and cultural leaders at the site of the original Bretton Woods Conference in New Hampshire to convene Bretton Woods II. This meeting of key stakeholders will establish new architecture for measuring global financial responsibility, accountability, and impact based on the principles outlined in the Progress Pledge.