Narrow is the road that Christian Super takes in the pursuit of returns. It negatively screens the ASX300, avoiding stocks that focus on alcohol or gambling, and going beyond the call of the average institutional investor’s duty by putting a lot of energy into investments that help make the world a better place.
Around 8 per cent goes into clean technology investments, microfinance or community investments in Australia.
Turning minusses into plusses
It started out as a fund that defined itself by what it did not invest in, but that became an overly negative message for the members.
“Members said they wanted to hear less about what we did not invest in and more about what we did invest in,” says Tim MacCready, the 31-year-old chief investment officer of Christian Super. “We got into clean tech first, started to sell that story to our members and got a lot of good feedback. Then we got into microfinance and got more good feedback.”
In this fashion, most of the fund’s annual report is devoted to reporting on the 8 per cent that makes a difference. The mainstream equities, property and infrastructure that make up the rest only gets a brief mention.
“We are a small fund in the big scheme of things and if we are not demonstrably different there is no reason for our members to stay with us. Three quarters say they are members because of the social and ethical investment,” says MacCready.
Diversification and uncorrelated returns
The path towards keeping the members happy has been an experimental one. Clean technology would seem a safer bet than microfinance, but it has been a disappointment. As MacReady explains, it turned out to be more exposed to equity market beta than expected and took a “hammering” during the global financial crisis.
It is a familiar complaint of institutional investors that far too many of their assets were correlated during the financial crisis of 2008, but the initial microfinance investments that Christian Super moved into that year have since proved to have no correlation with the relative health of American or European banks.
To be precise, it is invested in the equity or venture capital of companies that issue loans to people who are generally without an income, assets or those who are too poor to be of interest to mainstream banks. With their customers, such organisations work on a relationship model, which might appear too precarious for the mainstream investor, but the results – with the odd bump along the way – have justified the risks.
MacCready says that what is happening in Paraguay, India, and Kenya “at the grass roots” has little connection with the liquidity of big banks in the United States and Europe.
“A big part of what we are doing is seeking diversification and uncorrelated sources of return. We learnt from the GFC that when things go bad, everyone owns the same assets and is trying to get out at the same time.”
Limits and opportunities
It is the plan of Christian Super to increase its holdings in ethical investments from 8 per cent to 10 per cent of the fund. It will then sit back and assess whether there is scope to expand further, but there are limits to this strategy. When or if Christian Super turns from a $700-million fund to a multi-billion fund, there would not be enough opportunities available to make a difference.
At present it typically takes up 10 to 15 per cent of the allocation to microfinance specialists or to funds that specialise in this space.
“We often find ourselves as second or third biggest investor. If we had more money, we just could not put the capital to work and it would just be a meaningless allocation in the big pile of money we had. That does not mean we are not keen to grow further, and there is scope as these markets are developing.”
It is not just microfinance that presents capacity issues. The fund is making a series of direct investments to social causes, such as a $750,000 investment in social benefit bonds to help foster children return to their families by equipping parents with the knowledge, support and confidence to care for them. In Australia, the fund is happier to make direct investments as these are easier to monitor.
Since Christian Super’s first allocation to microfinance in 2008, the market has matured and expanded, bringing its own problems.
In particular, a microfinance organisation in Andhra Pradesh, a state in central India, faced a backlash from its customers after news filtered through about how rich it was making its founders. The organisation floated on the Indian stock exchange, giving its initial managers a return of 14 times their initial investment.
MacCready says: “The average default rate for a microfinance organisation is about 2 per cent, but suddenly we were looking at significantly higher default rates. The Indian government came in and regulated microfinance banks after this, capped the interest rate, which is good in terms of preventing exploitative loans, but it means small operators struggle with costs and dampened returns. So our microfinance investments in India stagnated for a couple of years.”
India, with 1 billion people, represents one of the biggest microfinance markets, but it is coming close to saturation. MacReady thinks that in a crowded market, the social impact of the investment becomes lost. “You have to make sure you do not lose the social mission. If you do that, you lose your customer base,” he says.
There is still scope in other markets and MacCready remains positive about expansion.
“We are a little bit nervous the market is getting overheated. Nevertheless, it is getting bigger so we can deploy more capital there,” he says.
High among the risks facing microfinance investors are political and regulation changes.
Christian Super has a microfinance holding in Paraguay, where only a year ago the president was empeached and removed from office in the space of a couple of days, a move that has been seen by neighbouring countries as a coup d’etat.
Another potential risk is in a recent private equity investment spread across Indonesia.
“There are governance issues with investing in emerging markets and Indonesia is at the less developed end of these. But it has huge potential, it has land, it has natural resources, it has people, it has an excellent distribution network into India and China, and it has a stable democratic government. When you look at it next to Malaysia, it seems cheap,” says MacReady.
Taking a unique path is hard work, but the extra effort is paying off in the growing confidence of the fund to make direct investments in its impact portfolio, rather than to go through fund managers. Some of this is driven by the growing expertise of its inhouse analysts who are used instead of external consultants when making clean technology or microfinance commitments.
The work carried out by the consultants is not all number driven as one was brought up in Africa, another worked in an orphanage in India, while McCready himself spent five years in Papua New Guinea growing up while his parents worked there as missionaries.
The fund is looking at how to help create secondary markets in its microfinance investments, which at the moment are highly illiquid. There is even talk of selling on their expertise.
“We have talked about that internally, but we do not think the demand is there. Experts are difficult to find in this area and we have trained them all up ourselves. We are confident we have a market expertise that may have some value in the future.”