Poverty is prevalent in nearly every facet of urban life. Few cities lack corners with tents of homeless individuals struggling to get by. While there is no easy solution to systemic issues that often perpetuate such examples of destitution, there are a few avenues that investors can take to help combat the issue of urban poverty and homelessness while still building a robust portfolio.
When it comes to socially responsible investing, many might immediately consider the prominent environmental, social and governance, or ESG funds, but these broad-strokes solutions do little for the local dysfunction that cities now face. Understanding poverty’s historical trends is the first step to realizing the best solutions to change its trajectory — and will show why a little-known option is one of the most effective ways to combat poverty through an investment portfolio.
How Did We End Up Here?
Tracking urban poverty remains a daunting task. It’s easy to get lost in the many ways that poverty emerges and reinforces itself. Examining access to housing and financial services, however, is a good place to start.
Candice Jones, president and CEO of the Public Welfare Foundation, emphasizes that “a critical part of really transforming our system of safety in this country is about reinvesting in communities.” She adds that transformational success of impoverished communities doesn’t happen “unless we pool together and get resources.”
A clearly defined gap in banking services first emerged in the 1950s, when swaths of American cities were designated as “hazardous” lending zones by the federal government, largely due to their racial composition. The agency that was in charge of making these declarations, the Home Owners Loan Corporation, or HOLC, was charged to grade cities on the basis of their lending viability. This data was then used by banking institutions to issue home loans, but also to determine the creditworthiness of inhabitants. Green areas, or grade A, were considered “best”; blue areas, being grade B, were “still desirable”; yellow was considered grade C or “definitely declining”; and red, or grade D, were areas noted as “hazardous” — hence the term “redlining.”
An example of how this played out can be seen within the Alberta suburb of Portland, Oregon. HOLC officials marked a particular Portland neighborhood as grade D (“hazardous”) but clarified that “on the basis of physical appearance and nature of improvements this area would be entitled to be classed as [grade C, or “definitely declining”], but the racial composition of its population is subversive.” This difference of distinction, grade D over C, would make obtaining credit nearly impossible.
Redlining, as practiced by the HOLC, was outlawed in 1968, but the lending zones it produced stuck. The Chicago Federal Reserve Bank conducted a longitudinal analysis of the effect HOLC maps had on homeownership in the decades following its inception. It concluded that “the maps led to reduced credit access and higher borrowing costs which, in turn, contributed to disinvestment in poor urban American neighborhoods.”
Poverty has persisted where these banking gaps emerged as individuals lost out on stable access to capital. Today, 74% of the neighborhoods that HOLC graded as “hazardous” investment areas are still low-to-middle-income areas today. Closing that gap will require a close look at what services are needed, and how your investment portfolio can help provide them.
Common Solutions Fall Short
Traditional ESG funds. As awareness surrounding social issues like poverty continue to rise, investors naturally see an opportunity to combine their social and financial goals. Just look at the rise of ESG-branded funds. An April report by Deloitte Insights found that in 2021, the one-year growth rate in ESG-branded fund launches was 80%, more than double the 34% growth in non-ESG-branded fund launches. The impact these funds have, however, does little to combat the localized nature of poverty.
Individuals who struggle financially need a stable source of capital. ESG funds simply highlight companies that are environmentally friendly or have equitable pay scales — notable factors that are nonetheless far-removed from the daily needs of individuals.
Municipal bonds. Municipal bonds are another common socially responsible investment presented to investors. Raised by cities or localities to fund capital-intensive projects, municipal bonds are an effective way to fill government funding gaps. As the market for these funds has become more complex, the funding direction for these bonds has changed, too. Some states, like California, are even using municipal bonds to build affordable housing in an effort to provide greater resources for its homeless population.
However, the way that funds are spent can be poorly defined, and they will likely not go directly toward impoverished individuals. “Depending on the municipal offering, some of those are general obligation bonds or broader in their use of process, so it’s always hard to understand what the issuance is being used to finance,” says Beth Bafford, vice president of syndications and strategy at impact investing firm Calvert Impact Capital.
And even with the funds allocated, municipal bonds are not able to achieve quick results in the same way that a hyperlocal approach can. Take California’s affordable housing projects that are to be funded by municipal bonds. Nearly all of these developments have been slow to take off, bogged down by regulatory approvals and rising costs. The funding may seep into needed communities through these projects, but the solution they offer is not timely nor direct enough to maximize each dollar invested.
Looking Toward Community Development With CDFIs
Community development financial institutions, or CDFIs, focus financial capital in low-income areas that are historically underserved by traditional banking institutions. CDFIs were created as part of the Community Reinvestment Act, or CRA, of 1994, which was an attempt to combat historical redlining by redirecting private financial capital into low-to-middle income areas. The CRA requires that large banks put a portion of their balance sheet to work in disadvantaged communities. Since they exist as large national institutions, large banks lack the needed understanding of local communities to invest knowledgeably. So, rather than try to loan this money to communities themselves, banks give funding to CDFIs that already have working relationships with their local communities.
CDFIs have this local approach because of their design: They are required to direct at least 60% of their loan operations toward low-to-middle-income areas to maintain their accreditation. In essence, “the benefit of investing in a CDFI is really the confidence that 100% of the use of the proceeds is direct, intentional and measurable community impact,” Bafford says.
According to the CDFI Coalition website, there are six different types of CDFIs, with the most popular being community development banks, community development loan funds and community development credit unions. Each has a different role in serving disadvantaged communities, so let’s unpack which institutions do the most direct work with disadvantaged urban populations and how your investment decisions can bring both economic and societal returns.
Here are some ways to vote with your portfolio and have an impact:
— Find your local CDFI branch.
— Find savings options offered by your CDFI.
— Invest in CDFI fixed-income funds.
Find your local CDFI branch. The easiest way to make a difference is by utilizing your local community development banking and credit union institutions. These function just like any other traditional bank or credit union, offering checking and savings accounts, credit cards and even certificates of deposit, or CD, options. The main difference, however, is that 60% of their loan activity must be concentrated in low-income communities. These accounts are pivotal for CDFI operations.
“When customers choose to place their deposit relationship with us, it makes it more possible for us to have the liquidity and capital needed in order to help reach communities that have been underserved,” says Michael Pugh, president and CEO of Carver Federal Savings Bank, a CDFI that invests 80% of its portfolio into low-to-middle-income areas.
Keeping a checking and savings account at a local branch is something that Bafford has done herself, and recommends others consider doing. “I know that all my deposits are being used to make local investments in low-to-moderate-income communities,” Bafford says. Putting your deposits in your local CDFI bank or credit union is the easiest way to ensure that your money is going directly toward marginalized communities in your city, through means such as affordable housing projects, auto loans and other banking services.
Find saving options offered by your CDFI. Long-term saving options, like CDs, differ between CDFI banks and credit unions, but you can find rates that are favorable for your portfolio goals by comparing bank options.
Trailhead Federal Credit Union, a CDFI located in Portland, offers a range of options for personal investors. It offers certificate accounts with maturities ranging from six to 60 months. The minimum amount to open an account of this type is $500, and the annual dividend rate is 0.2% for a 6-month maturity, but jumps to 1% for the 60-month maturity. For those with less than $500, Trailhead also offers a Money Builder Certificate that has a 12-month maturity but only requires a minimum balance of $10 to open. This will pay a 0.1% rate, which is compounded and credited monthly.
Invest in CDFI fixed-income funds. Another option for retail investors is investing in securities that direct funds into CDFIs. Calvert Capital offers one such security, dubbed the Community Investment Note, which deploys funds in a range of ventures across the U.S. and the globe. In a nutshell, “We raise money from retail investors, and then we use those funds to invest in a broad range of financial intermediaries including CDFIs in the U.S.,” Bafford says.
You can invest in the Community Investment Note for as little as $20 and opt for a maturity range of one, three, five or 10 years. The interest rate paid varies: For one year, it’s 0.5%; three years offers 1.5%; a five-year maturity reaps 2.5%; and the 10-year note jumps up to a yield of 3%. Importantly, since the fund’s inception, it has a historical repayment rate of 100% for the principal and interest. And the best part: The fund has no fees because “investor dollars are not used to pay sales commissions, existing debt or any other Calvert Impact Capital expenses,” according to the website.
You can even select a social issue that is most important to you in order to inform how Calvert allocates the portfolio, such as combating homelessness. The fund has provided real results, too. The company reported in its 2020 Social and Environmental Impact Performance that its borrowers created or preserved 36,700 homes throughout the year.
Investing Close to Home
With urban poverty visible on the street and in neighborhoods that feel unsafe, exacerbated by ever-climbing living expenses, finding ways to help with greater financial capital is something socially conscious investors are striving to do.
CDFIs are not on the typical investor’s radar, unfortunately. For those who want to make a difference, it’s worth investigating their benefits, as they are hyper-focused on those who are most vulnerable to poverty. They may not offer the most extravagant financial returns, but they are a surefire way to raise the social impact of any portfolio. In urban settings mired in a past of delineated investment zones, CDFIs offer the most viable path to closing the financial gap that continues to affect millions of Americans.
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