Toni Johnson: This is Toni Johnson for Heron.org Soundbites. I'm here today with Dana Bezerra, vice president of Capital Markets to discuss Heron's work on the net contribution framework. Hi, Dana.
Dana Bezerra: Hi Toni, so exciting.
First of all I want to congratulate Heron for getting to 100 percent impact aligned in the endowment. One of the things I think that was confounding the space was where to put money for impact. Heron decided five years ago to do it across all asset classes, but that at the time was very novel. Now everybody wants to do it. I think what would be helpful for our listeners is what did you guys learn, and what are the pitfalls?
It's a great question, and it's one we get asked a lot. One of the interesting things, I think, is once you're in the work and you're trying to actually move positions from, call them conventional or unexamined positions to impact, some of our best learnings were often when we stubbed our toe, and we did that a fair amount.
For example, in the public equity space, Heron for nearly 20 years had been an asset building funder. When we went through a presidential transition at Heron and the economic downturn, we emerged focused on employment and job creation and reliable livelihoods for people. When we started looking at the public equity portfolio, we started looking through the lens of jobs, and in particular at things like the revenue intensity per number of jobs and trying to find enterprises that were job intense.
One of the things we learned fairly quickly was you have to be careful what you ask of data, and what you ask data to tell you. In an example you know well, we were looking at job intensity and came across a position that seemed to be particularly rich in employment, and got very excited, and thought, "That's it. We want more of those. We want more things that look like that." When you sort of look under the hood at what the enterprise is… (this is a story you can tell better than I)… We discovered it was Correction Corporations of America, a private prison company.
It was a hard lesson to think about. Getting the very thing we thought we sought, a lot of employment, actually was coming from a company that's not very consistent at all with the change we wish to see in the world or the impacts we wish to have on low income people. Through that experience I think one of the things we learned was, it's much harder than we thought to get the outcomes we seek if we're focused narrowly on single thing. We learned several times over that by focusing on the single thing we actually- if you broaden your aperture, if you will, just a little bit larger, the trade-offs you have to accept in order to get what seems like the very thing to create change really become quite unsustainable. For us, we learned to back off a little bit what we thought was the center of the bullseye in the interest of getting better broader outcomes for people, place, and planet.
You know, Dana, that was a really good example, the Corrections Corporation of America. We've all used this as an example of discrete impact versus thinking about holistic impact. When we were looking at CCA, which is a real estate investment trust, actually, we saw 25,000* jobs in their SEC filings, and we had a question, how many of those people are not employees or to what degree is prison labor represented or not represented in their filings? Then that led to the question of what jobs are we talking about and for whom? Is for-profit prison a good business model for the people and the communities that we're trying to make a difference in?
In the last five years of doing this work and doing it across all asset classes, how do you define and report on impact performance, and what does it mean writ large? Not in a discrete way of, "Oh, I just want jobs," right, because jobs could be prisons. It could be Walmart. It could be a whole host of things that don't necessarily represent the end goal of better prosperity for people at the lowest part of the economic scale.
In the last year or so the Heron Foundation has been working on this idea of net contribution and a net contribution framework for reporting and thinking about impact performance across the entire portfolio across all asset classes, so it begs the question of what the hairy heck is that?
It's a great question, and one we get asked and we ask ourselves all the time. I think it helps to give a little bit of an example. The example with the private prison we were just discussing really emerged during Heron's "portfolio examination project." That was our attempt to say we're an asset owner. We're not starting from zero. We have existing positions. Perhaps one way to approach this investing 100% for impact is to understand what we already owned. As we started looking though the underlying positions, back to this notion of trade-offs, sometimes things looked really good until you got additional data, and then they didn't.
This nascent language started to emerge, honestly a little bit out of frustration, around, "Great. That's a great data point, but on net would we choose to own this company? Or on net would we choose to make this investment?" And in part that language evolved into this net contribution framework, where we tried to look really across the aggregate effect of an enterprise. So if you have a business doing what it does, we're not going to isolate and look at jobs. We're not going to just look at products and services, but try to ask the question across the totality of what an enterprise does, from employing people to potentially polluting or creating a product and service that may or may not be a great health outcome for example, would we want to own the company?
We don't do ourselves a favor when we think the move is from whatever we own now to something that is precisely on mission… it's a spectrum.
I think on this journey, by the way, we had a lot of naïve assumptions over time that fell by the wayside. One of these was, I think we thought the framework would help us have answers, and what we've learned is that the framework just really helps us ask better questions.
From the lens of a net contribution approach, we look at a couple of things. We look at human capital, so the enterprise employs people. It interacts with supply chains. What can we know about that. We look at natural capital. Enterprises of all types consume things, water, air, and they release things as part of their operations, again, potentially pollution or so on. We look at civic capital, sort of a second order magnitude of effect. How does a company influence the environment meaning the people, the community where it operates or where it's supply chain has operations.
We look at financial capital, the way an enterprise interacts both with the capital available to it and with its environs relative to financial capital. We try to weigh all those things. None of them, I think, are always going to show positive, but the framework is flexible enough to allow us to say, "This company is an awesome employer; they could do better on the environment." How do we think about their net contribution to people, place, and planet, really trying to answer the question, is the world better off with or without this enterprise in it?
It's interesting because one of the things that I always thought was not unique about Heron's mission, but sort of puts Heron in a place to be able to do this work is that the mission is really designed around economic development, economic prosperity for all. This seems like a framework that could be for anybody, your 401k, your Wallace Global. There seems to be some flexibility in there. Can you talk a little bit about how you perceive in looking at the sector how this might be applied outside of Heron's walls?
Totally. It was something, again, that we evolved our thinking to over time. Initially we came very strongly through- if you think about human capital, natural capital, financial capital, and civic capital- we were emphasizing human capital a lot, because that seemed to be more consistent with Heron's mission. But one of the things we learned over time as we started to talk about the framework as an organizing principle for our thinking, other funders, other investors started to say, "Those really resonate with me, but I would probably emphasize the natural more," for example if they're an environmental funder.
I think what we're learning is the data environment is pretty established, and it's how we cut and weight the data that is our different expressions, if you will. In the same way, Heron may look more intensively at the human capital pillar, an environmental funder could pretty easily apply a tilt, if you will to use portfolio language, to natural capital.
Or for example one of the other interesting inquiries we had was, I think, back to presumptions. I think we assumed our fishing pond, if we're going to build a portfolio, would start with only companies that were positive net contributors would be the things we want to own.
I think we learned fairly quickly that there are some companies who have room and will to improve that maybe aren't net contributors today but are on a path to be net contributors. That may be a worthwhile company to invest in as well, to engage with in part because maybe on a portfolio level you'd see alpha for doing so. All hypotheses at this point, but it's been an interesting exploration thinking about how we would change the coefficients, again to borrow a portfolio term, around the capitals.
I just want to backtrack to something you were talking about earlier, which was around the data, and the data environment. There's a lot of data out there. It's becoming more and more a data jungle, and maybe the jungle's still not going in the way that you want it to go, but can you talk a little bit about the experience of different data providers and how this has come to play in building this net contribution framework?
I think one of the unintended things Heron ended up doing, when you start asking questions, very quickly you discover there are many providers, lots of them using the same data and cutting it differently. Some using different data. We really tried to get under that and understand more of it. We discovered a couple of things. What passes as data is different than what you might assume. For example Clara pretty famously inside our walls talks about polices, promises, and pledges passing as data.
That really manifests as true for us in that if you want to understand the environmental footprint of a company you're often pointed to their environmental policies, but their environmental policies often are pretty disconnected from how they actually behave when they're making those decisions that pollute rivers or pollute air. It was harder and harder to find actual data that was evidence of how their operations manifest despite the field looking largely to policies, promises, and pledges.
For us it's been a constant learning curve. We meet with nearly every data provider we can find to ask what constitutes data? How do they get their data? What is the reliability of their data? How broad is their data? You talked about across asset classes. Is is for a subset of a sector or is it across all publicly traded companies? It's been a learning curve, a giant, I would say, body of work unto itself.
Just to bring this back to Heron stakeholders, I'm reminded of a debate that's going on right now between the right and the left about how you count poor people. Do you count them before the safety net or do you count them after the safety net? That actually does skew what is real data. There's analysis that has to happen on top. There's assumptions that have to made. We're never going to necessarily all agree. I think that's okay, but as long as the actual data is there you can say, "Okay, here are a bunch of people. This is how much money they do or do not make" before the safety net.
Then we can decide whether they're poor based on subsidies or not. It's a real challenge. It's ridiculous in a way, and it's not ridiculous in a way. These decisions that we make shape the world, so it's really exciting to see Heron take a journey into a place of embracing complexity. It seems like this net contribution framework embraces the complexity and says the conclusion you're going to come from depends on where you sit. It depends on what your investment philosophy is, which is actually what all investors do.
As we're thinking about this, and it sounds maybe a little cuckoo bananas for some, just remember all investors do this. They sit there, and they say, "Ah, am I interested in emerging markets? Do I want to tilt toward energy or real estate? We all make these decisions as investors. This is just one application of it, and in our view it's an application that hopefully will push things toward a better place.
On that note, here we are, very challenging time for the social sector. Being Heron, being both philanthropy and also an innovator in this space, talk a little bit about this push/pull challenge of gotta make grants, gotta deal with nonprofits, gotta do those really discrete impactful things versus building this net contribution framework and thinking about pushing toward a more complex bigger future.
It's a great question. I think it's where the richness of being in the space resides, honestly. A couple of ways … Looking backwards actually are the best examples hoping that in the future we can spot them looking forward. For us it's a couple of things. It's learning that on the ground activities absolutely reflect the behavior of companies or enterprise, and learning that enterprises, their operations, their investment, all the analysis we and other investors do, hit the ground somewhere.
Understanding what those things look like, so for example going way back, one of the earliest examples that kind of piqued out interest, in the early days of the mortgage crisis we grant funded vertically integrated nonprofit housing developers down in South Texas, really productive housing developers who were doing, again, vertically integrated, so from credit counseling to pre purchase counseling to subdivision development, sticks and bricks, the whole thing. We were grant funding their general support operations. We were providing program-related investment as acquisition and pre development capital, so they could get affordable subdivisions underway.
As an impact investor, our first foray into market rate impact investing was in our bond portfolio, working in partnership with one of our bond managers, Barbara Van Scoy, then at CCM. She was able to help us look at pools of mortgage-backed securities. We knew that home ownership at the time was something we were supporting, so we had pools of mortgage backs and thought of them as impact investments.
In the early days of the housing crisis we started hearing from our grant and PRI portfolio that something weird was happening in the system. There were families they were providing credit counseling to that they knew were not credit worthy, credit ready. They were engaging in credit repair, but the families were coming back with mortgages from third party providers. We kept hearing this from our PRI and grant developers. In conversation with Barbara as our fixed income manager we ended up putting a mandate on that account, on our fixed income account, that said we liked mortgage backed securities. We liked them, however, most when they were indexed as affordable to the borrower at the time of origination across a full 30-year amortization, in part because we were seeing with our grant-making partners that mortgages that were not 30-year fixed weren't working very well for low income people."
Fast forward many years, we have language like predatory, exploding arms. We now know what those were, but at the time we didn't. The mandate on our fixed income portfolio really came from a place that was mission-driven. These are not working for low income people, and therefore we didn't choose to own them. It was an interesting example, and not one that we could easily repeat for many years.
A more recent example in the last many weeks was PACE, the Property Assessed Clean Energy bonds, generally pretty unassailable. These are loans that help low income people often, although not exclusively, do energy retrofits to their homes. The Wallstreet Journal started writing about how some of these loans were starting to look like the early days of the mortgage crisis. They weren't income underwritten. They didn't seem to be sold with very much, thorough anyway, information to the borrower.
There was a question about whether or not these loans were actually causing people to lose their home because, as we know now, they actually are the senior. They become the senior most lien on the person's home. Even though it's a small loan relative to the size of your mortgage, since it's senior if it goes delinquent it causes a cascade that your underlying mortgage goes delinquent, and potentially people were losing their homes.
As part of that exploration, you asked about narrowness. It was a really interesting conversation. We did own pools of PACE residential mortgages. We engaged in conversation with some of our bond managers who were, I think, using a narrow lens to say these are great bonds. They lower the carbon footprint. They create energy efficiency. In theory through the energy efficiency, low income homeowners have savings that will pay back the loan. I think that's all true on paper. But when you, again, go back to broadening your aperture, for a foundation who's focused on low income people and communities and sustainable livelihoods, we ended up feeling the risk that these were not working for low income people, and we were actually causing more damage, not through the lens of the environment or the tilt, if you will, the emphasis on environment, but through the lens of the human and societal capital.
We actually ended up issuing a sell order on that account. We didn't want to own those bonds. But to be clear, not to throw the baby out with the bathwater, PACE commercial bonds actually have many of the protections that would have prevented the things we were seeing in the residential bonds. We had the opportunity in part because we operate in a bigger ecosystem with environmental funders and others. We had the opportunity to say through a broad aperture we want to sell those loans, but we want to replace them with PACE commercial bonds. It's a complicated set of trade-offs and on what your point of view is as you view the transaction.
It's interesting as we think about these things. A lot of people don't know, first of all, that bonds, just straight bonds, not social impact bonds, can have a huge impact and can be used as an impact instrument in a market context. But the second bigger issue is that, again, we wanted to go for simplicity. What I was thinking about was all this talk about coal and coal country. You and I have talked a lot about Appalachia, and you've had a long experience there, but it's really complicated. It's a system. The economy is a system. People exist in a system. The environment is a system. They're not just discrete levers we can push to go to Clara, that you can just slap a dollar on the forehead of a child and the kid's going to learn to read.
There's a whole group of things that go into educational outcomes, environmental outcomes, and economic outcomes particularly for people who aren't the most resilient people in the economy. So, Dana, is there anything else you'd like to say, anything top of mind?
I think one of the things we learned most, and anybody who listens who wants to move in this direction, was that we don't do ourselves a favor when we think the move is from whatever we own now to something that is precisely on mission. I think what Heron's learned is that it's a spectrum. Our goal is to make progress on that spectrum. From whatever we owned originally to examining that. From examining that to trying to make some incremental better shifts. To your point about the discrete, that often meant we were making shifts to be better in areas that are not our core mission area, but were compelling enough to make the shift anyway and that the journey is from where we are now, which is 100% examined or invested for impact to closer and closer to invested for mission, but that's going to be an optimization process that probably takes years.
Terrific. Thank you so much. For Heron.org, this is Toni Johnson.
Click here to hear more podcasts with leaders in the social/impact sectors.
*According to their 10-K from February 2015, the number of people employed by Corrections Corporation of America was 14,040. Heron was not able to independently verify the 25,000 figure cited in the podcast.