Exempt Market Investments Doing Well by Doing Good
By: Rod Burylo
One of the more interesting features of many exempt market investments is that they represent an opportunity for the investor to participate in a primary distribution. The investor purchases the investment from the issuing entity, rather than from another investor, and the capital is used by the entity to further some business activity. This feature also suggests that these exempt market investments may have a particularly strong appeal to investors with a particular disposition: those looking to make an impact.
Impact investing refers to assessing the merits of a particular investment not only for its potential to generate a financial return, but to influence some other state of affairs deemed to be important to the investor. These states of affairs are often related to some environmental or social condition. The expressions environmental investing, socially responsible investing, or simply ethical investing, have become common descriptions of such activity.
There are typically three distinct approaches used by impact investors in pursuit of their agenda. With the avoidance approach, the investor seeks to avoid the purchase of an investment, or sell the investment if already owned, if it is associated with some condition or state of affairs the investor deems to be inappropriate or undesirable (this is often referred to as a screen). Second, with the positive approach, the investor purchases an investment, or continues to hold the investment, if it is associated with some condition or state of affairs deemed by the investor to be desirable or worthy of support. Finally, with the activist approach, the impact investor buys or holds an investment in the hopes that by being ‘an investor’ they may influence management or promote changes of conditions from less desirable to more desirable.
The impact investor may also believe that, by avoiding or supporting a state of affairs, or influencing change, they may ultimately also impact the potential ROI or reduce risks related to the investments. However, this belief is not an essential element of these approaches.
Whether or not these approaches have any meaningful impact on the state of affairs deemed important to the investor is certainly open to debate. While measuring a financial return on an investment should be an objective exercise, measuring a social or environmental ‘return’ may be relatively subjective. Moreover, in many instances, it may be impossible to verify a causal relationship between the specific investing activity and any other static or changing state of affairs, and therefore, impossible to measure the success of a particular ethical investment.
Follow the Money
The crux of this issue is the distance between the investment activity and the state of affairs of interest to the investor: the greater the distance, the less influence exerted, and so, the less meaningful the exercise. For example, many enthusiastic impact investors pursue their agendas in the secondary market through purchases of publically traded stocks and bonds, or through mutual funds of such instruments (most notable are those funds branded and marketed as ‘ethical’). In the secondary market, however, investors are purchasing instruments from other investors. When we follow the money on such transactions, the distance between the investment activity and the state of affairs of interest to the investor may be cavernous; the money flows from investor to investor with perhaps very little influence on the entity that initially issued the instrument. In this environment, the actions of the so-called impact investors may be merely symbolic.
In contrast, a primary market distribution features a flow of capital from investor to business organization. That capital serves to support very specific business activities, and related social or environmental states of affairs that may be deemed important by the investor; as well, withholding or removing capital from such business activities effectively withdraws that support. The distance between investor, investment activity and the beneficiary business is reduced. As such, the exempt market sector includes investment offerings that may be of interest to impact investors.
Since the range of business activities supported by exempt market investments is considerable, the types of ethical considerations are numerous and varied. For example, one area of concern to impact investors is with respect to construction techniques, land use, and development. Such folk may be more inclined to support projects that address environmental topics meaningfully, or support inner-city projects associated with improving density. Real estate projects or REITs that consider topics such as affordable housing or immigration may attract impact investors either with an interest in current local social issues, or longer-term national economic and political issues. Business activities associated with the traditional energy sector, and with emerging alternative energy sources and technology, also either attract or repel impact investors.
Competition among the participants in the Canadian exempt market sector for scarce capital is fierce and Entrepreneurs may want to consider how their business activities may be of interest to impact investors. For some, there may be elements of these activities that are particularly attractive to some investors, beyond the opportunity for financial return, but these elements were never expressed prominently when pursuing or retaining capital. In other cases, the opportunity exists to alter aspects of business activities to be more appealing to these investors. For the dealing representatives in pursuit of new clients, knowledge and appreciation of impact investing may present the means for differentiation in their competitive environment.
While discussion about our sector, especially over recent years, seems to have featured an emphasis on some less than attractive issues, the opportunity remains to fashion and brand our segment of the capital markets in a very positive light. Rather than an association of EMD’s with WMD’s (weapons of mass destruction), the reality is that, perhaps more than any other sector, the exempt market can provide the means for doing well and doing good.