All Things Impact.

private capital & the public good

All Things Impact 2016.9: patriotic philanthropy, peer to peer lending, ERISA, and abundance

Brian WalshComment

Hi friends,

Welcome to All Things Impact, a newsletter of interesting things I've seen from across the spectrum of impact: effective philanthropyimpact investing (in the private markets), responsible investing (in the public markets) and a wildcard topic. For previous posts and more, please visit All Things Impact.

Here are four links worth your time (plus job opportunities):

1. Effective Philanthropy: David Rubenstein, "patriotic philanthropy" and tax rates on carried interest
When I make money, there are at least 4 things that can happen: 
1) that money can be taxed to pay for government services
2) I can spend it on products and services
3) I can save/invest it for future use
4) I can donate it  

Many people prefer to have maximum control over the money they make, so prefer as low a tax rate as possible. If I made $100 and my tax rate were 35%, then I have $65 to use as I would like: consume, invest, or give. If, however, my tax rate were only 15%, I would have $85 to do as I like. I could even give away $10, be honored as a philanthropist, and still come out ahead of the guy paying $35 in taxes.

David Rubenstein's father sorted mail for the postal service in Baltimore. After several years in government, including working for Democratic President Carter, in 1987 Rubenstein formed the Carlyle Group, a private-equity firm. He is now worth an estimated $2.6 billion. He donates a considerable amount of money to charity and has been known for his "patriotic philanthropy", whereby he donates to things like repairing the Washington Monument after earthquake damage or supporting Jefferson's Monticello.  

Because of the "carried interest" exception in the US tax code, most of the money he earns from his private equity firm is taxed at the 15% rate, as opposed to the 35% tax rate most people pay on their labor. As Alec Macgillis explores in the New Yorker, Rubenstein has been an active lobbyist to maintain this favorable tax rate, while also being hailed as a prominent philanthropist (here is the Tina Fey-narrated video from October when Rubenstein was honored with the Carnegie Medal of Philanthropy):

"Private-equity partners argue that their tax treatment is justified under the tradition of encouraging risky business partnerships and is necessary for their industry to flourish. So far, the partners have won out: despite the rise of anti-Wall Street sentiment after the 2008 financial collapse, the loophole has withstood every effort at reform...

In 1889, Andrew Carnegie published “The Gospel of Wealth,” his Gilded Age manifesto. He believed that concentrated wealth was essential to capitalism, but that much of that wealth must be given away, in order to maintain a “reign of harmony” with the poor. The “duty of the man of Wealth,” he wrote, is to “set an example of modest, unostentatious living, shunning display or extravagance; to provide moderately for the legitimate wants of those dependent upon him; and after doing so to consider all surplus revenues which come to him simply as trust funds.” Those should be put toward whatever, “in his judgment, is best calculated to produce the most beneficial results for the community.”...

Major philanthropists today do not quote indiscriminately from Andrew Carnegie’s “Gospel.” In one passage, Carnegie writes that making a large charitable gift is “a much more potent force for the elevation of our race’’ than dividing the money into “trifling amounts” for distribution as donations or higher wages, which would likely be “wasted in the indulgence of appetite.” He says that “even the poorest can be made to see this.”

David Rubenstein’s patriotic philanthropy can be seen as a way of establishing the level of control over his wealth that Carnegie enjoyed. In Carnegie’s time, there was no federal income tax; charity was the primary means the rich had of giving back to society, and they could, of course, determine the size of their contributions. The super-wealthy now view taxes more or less the way Carnegie viewed higher wages, or alms spread among the needy: as more likely to be frittered away than if they bestowed the money themselves...

"Many of today’s Wall Street philanthropists win the public’s esteem by giving away money that, without the loophole they’ve fought to protect, would not all have been theirs to donate. “I don’t want to bash the philanthropy, because it does good,” Victor Fleischer told me. “But we’re creating what’s essentially a parallel system, where a small number of individuals control quasi-public spending, and that will reflect their values and not democratic values.” Of Rubenstein, he said, “It’s great that he’s helping out with the Washington Monument. But, if we had a government that was better funded, it could probably fix its own monuments.” 

2. Impact Investing: Peer to Peer lending platform SoFi is starting its own hedge fund
The always insightful Matt Levine at Bloomberg View reports on the "unusual" move by "peer to peer" lender SoFi to start its own hedge fund: 

"[It] turned out that a lot of the investors were not regular people -- not "peers" of the borrowers -- but hedge funds and banks. This makes sense. People have jobs! Why would they spend a lot of time evaluating which small-business or consumer loans are good risks? Instead they give their money to professional managers (as hedge-fund investments, or as bank deposits), and the professionals make those decisions. It also turned out that even the professionals don't necessarily want to spend their time choosing which loans to buy, so companies like SoFi package their loans into securitizations and sell different risk tranches to different investors. The encrusted layers of intermediation build back up. "SoFi is a modern finance company that's fueling the shift to a bankless world," says SoFi, but that world is looking increasingly like the bank world.

The latest news is that SoFi is starting its own hedge fund:

"The unusual move by SoFi, as the company is commonly known, is an attempt to get around waning investor interest that is threatening online lenders’ growth. The sector lacks the deposits needed to fund its loans like traditional banks, so it relies on being able to sell the loans to investors to free up capital to make new ones.

The new hedge fund, called SoFi Credit Opportunities Fund, has “a real chance to solve the balance-sheet problems facing the industry," said SoFi Chief Executive Mike Cagney in an interview."

The model to keep in mind is the basic one from the beginning: There are people with money looking to invest, and people without money looking to borrow. If online lending platforms face "waning investor interest," that means people with money are looking to invest less of it (with SoFi). SoFi's solution to that problem -- "the balance-sheet problem" -- is to repackage the way those people invest: If you can't sell your loans to hedge funds, build your own hedge fund, and then sell shares in that hedge fund to investors. You still rely on investor interest -- all financing relies on investor interest -- but you are at least presenting a different package to different pools of investor money...

SoFi's name is "Social Finance," not, like, "Captive Hedge Fund Securitization Finance." Lending Club is a "club." You can witness ontogeny recapitulating phylogeny. A social club for regular people to lend money to other regular people becomes a securitization platform with its own in-house hedge fund while you watch. The whole history of modern finance recurs, sped up, right before your eyes. It is kind of beautiful.

3. Responsible Investing: with ERISA clarification, fund managers promote sustainable investing to retirement plan administrators
Back in October 2015 the US Labor Department clarified the fiduciary duties of retirement plan administrators under the Employee Retirement Income Security Act (ERISA), saying they “do not need to treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social or other such factors.” As Alex Davidson reports in the Wall Street Journal, this has led sustainable investment fund managers to actively reach out to retirement plan administrators:

"Efforts to get sustainable investments into corporate retirement plans have accelerated in recent months, as funds try to capitalize on investor demand for products that have both a financial and social impact...

Fund providers have taken the initiative, rather than waiting for retirement-plan managers to seek out their offerings. “I don’t think the strategy of waiting for the market to come to you is the right one,” says Scott Kilgallen, managing director at investment manager Neuberger Berman, a firm that includes what it calls a socially responsive investment fund among its many fund offerings.

Mr. Kilgallen says many companies are still surprised to hear his argument that sustainable investments don’t necessarily sacrifice performance to achieve their social goals. The advisers who help plan sponsors formulate their retirement plans are a focus of fund providers’ marketing efforts...

Joe Sinha, director of sales and marketing at Parnassus Investments, which runs the largest socially responsible mutual fund, Parnassus Core Equity (PRBLX), says he and his team lobby for his firm’s offerings by meeting plan sponsors and sketching out scenarios that illustrate why sustainable investing is important. In one example he talks about two different companies with the same price/earnings ratio but different safety records. He then explains how a good safety record could affect future performance, including fewer lawsuits and more-successful recruiting efforts. Eventually, he says, plan sponsors come to understand the significance of social factors.

“I believe that there’s been a shift in thinking” among plan sponsors, he says. But many, he says, still haven’t shaken the notion that a pure sustainable-investment play could compromise returns."

4. Wild Card: Abundance
Joshua Brown writes at The Reformed Broker about abundance:

"There’s too much of everything and it’s not good for anyone. It’s hurting everyone. Paradoxically, abundance is now the enemy. This sets us apart from virtually every other society throughout history.

You can blame the Federal Reserve’s loose money policies if you’d like. There is over-investment in every industry. It’s killing confidence. Nothing is worth what it used to be. We haven’t adjusted to this reality yet.

Unlimited music, nine dollars a month.
Unlimited movies and TV shows, thirteen dollars a month.
Unlimited news and journalism, zero dollars a month.

Facebook is free. Twitter is free. Snapchat is free. Instagram is free. Youtube is free. Video game apps are free. Texting is free. Sexting is free. Skyping is free. Chatting is free. Why would you spend money on anything? Where do you think people spend their time now? Endless entertainment and content, for almost nothing.

What’s the business model? “We go public or get bought out by someone with the opposite problem – too much profit, not enough user growth.” The business model is an exit for the investors. “BlackRock will eat it. They’ll eat anything.” No one cares how many actual business models get wrecked in the process. How many useful jobs are lost in the process. The new fixed income or currency trader on Wall Street will never need health care, or take a vacation or grab a female co-worker’s ass. It’s a chip on a server. Much cheaper to employ, much easier to manage.
Automate everything, outsource the rest – it’s cheaper for the customers. “But now there are no customers left, no one has the money to be a customer anymore.”
Here’s the perfect business idea for this environment: Open a Hundred Dollar Bill Store™. You sell hundred dollar bills for ninety dollars each. You’ll lose ten dollars per transaction but you’ll do a trillion in revenues in year one. Maybe you show an ad to everyone who walks into the store and you break even. User growth with be on the order of 1000% per month. A billion users. You’ll be the biggest IPO of all time when Goldman’s underwriters get wind of that growth rate. Go public and let someone else worry about a competitor selling hundred dollar bills for eighty-five."

5. Job Opportunities
Here are some impact related job opportunities that have come across my desk. Please feel free to send relevant openings, which I am happy to pass along.

That’s it for this week. Help me spread the word about #Allthingsimpact to your friends and colleagues, who can sign up to receive this newsletter at All Things Impact. Please also send me any compelling links you discover in your own journeys across the web (even things like this gif of a prairie dog sneaking a kiss).

Until next time, thanks for reading!

Brian Walsh
Head of Impact at LiquidnetFull Bio.