Investment Strategies

Muni Bonds And Tax Breaks - Old, New Forces In Impact Investing

Tom Burroughes Group Editor March 26, 2018

Muni Bonds And Tax Breaks - Old, New Forces In Impact Investing

As the buzz around impact investing continues it is worth considering how very traditional US financial instruments fit into the picture. New tax breaks may also boost the market, practitioners say.

Impact investing is one of the hot terms in wealth management and it looks new but arguably the idea of putting money to work for social, environmental and other non-financial reasons dates back decades. And one force at work is the good old tax break.

In the US, for example, an aspect of impact and ESG-based investing that, in retrospect might be so obvious that it can be overlooked is the $3.8 trillion market for US municipal bonds. “Munis” typically are used to finance infrastructure such as roads, bridges, water treatment plants, schools, public parks and museums. Many such area of spending fall into the “impact investing” bucket. Most munis are exempt from tax payments on interest earned, as a way to encourage citizens to lend to their localities; they are subject to capital gains taxes, however. (Returns tend to be positive, but low, except in cases, for example, when rates rise sharply - as in 1994 or 2013. Investors need also to consider the credit-worthiness of their locality or state.)

(Below: S&P Municipal Bond Index, over 10 years. Source: S&P Dow Jones Indices.)

An organization which says it is democratizing access to munis and ticking the impact investing box is San Francisco-headquartered firm Neighborly, a registered broker-dealer. It works with individual investors, professional investors such as RIAs, and issuers seeking to raise capital. 

“In many cases we are seeing a considerable pickup in awareness that the municipal bond is an impactful investment,” the firm told Family Wealth Report. “The rise in positive impact investing we’ve witnessed across other asset classes over the last decade  is now being mirrored in the municipal space, but remains in a nascent stage. Our investors understand that the capital they invest in municipal bonds is translating to tangible and positive changes in their communities, while advancing causes that they deem important - whether it be the environment, education or human health, to name just a few,” the firm said.

“The municipal bond market funds a wide array of initiatives that stand to benefit the public. This includes everything from water remediation projects and public schools, to environmentally friendly projects such as micro-grids, community solar, and energy efficiency upgrades in both public and private buildings,” the firm continued. 

As outlined at a FWR conference in New York City last October, some large investment houses are blending the traditional case for holding munis with the growing enthusiasm for impact/ESG investment. Alliance Bernstein explained the range of sectors that are affected: mass transit; energy production (such as renewables); water conservation/quality; economic development in underserved areas; education, and healthcare. Other commentators at the same conference highlighted areas where investment can have a clear social impact such as work to reduce criminal re-offending, or development of technologies to alert law enforcement to gunshots.

It gave the example of how, in 2017 it financed bike path restoration for the city of Burlington, Vermont. In California, its bonds helped fund upgrades to various children’s hospitals, and the capital program for California State University. Neighborly, meanwhile, has even helped to raise capital for a fire truck for the city of Lawrence, Kansas.

Impact investing relates to the idea of putting money to work to generate financial and non-financial returns. GIIN, aka Global Impact Investing Network, in May published a survey from respondents in the sector collectively overseeing $114 billion of such impact investments, a likely “floor” for the size of the market.  

With munis, there is a large secondary market for the paper, while with contemporary impact investments that are billed as such, a secondary market is virtually non-existent, a practitioner in the space told FWR recently in New York. The type of people buying municipal bonds tend, on the whole, to be more at the institutional and retail end, while impact investing seems to be getting traction among high net worth investors.

As far as Neighborly is concerned, the sector continues to expand. “The Smart Cities program and Rockefeller Foundation’s 100 Resilient Cities initiative offer a new paradigm to how to approach urban areas,” it said, referring to a couple of initiatives.

“Whether it be clean energy through community solar panels, microgrids or new water filtration and storage concepts, the municipal market will likely play a significant role in financing our future.

Tax incentive
The US government’s tax cut package, the US Tax Cuts and Jobs Act, involved a measure – not garnering a lot of noisy headlines – that offers tax incentives to people putting money into poor neighborhoods, in some ways ticking the boxes impact investors seek. (There may be some issues, however, if the investments under the tax incentive aren’t environmentally acceptable in some way, for example. This is not a straightforward issue.) 

James Lang, a shareholder in the Tampa office of Greenberg Traurig, explained how the measure was already galvanizing interest from wealthy investors. 

“Calls from family offices and others are pouring in” [about the new incentive scheme], he said. “We can see this being a provision that takes trillions of dollars in captive capital and frees them up,” he said.
At the moment, capital gains are locked up in commercial real estate; if an owner sells at a profit, the gain is subject to CGT and the only current way to avoid paying it is to reinvest the money into another commercial property. The situation is akin to a hamster on a wheel, Lang said.

Putting money into qualified opportunity zones, as they are called, gives investors a chance to finally secure a capital gain free of tax provided the investment is held for a period of time.

At present governors in the US states are submitting their choices for opportunity zones – drawing from certain metrics such as median income, unemployment and poverty levels – and waiting for their choices to be approved by the US Treasury Department.

“We’re at the spearhead of this and getting calls from people every day. But a lot of folk still don’t know about it,” Lang said. If money is held in an “opportunity fund” for ten years then all the gains that are acquired are tax free, he said.

There are parallels between this idea and that of impact investing – the approach of putting money to work to achieve non-financial as well as financial returns. “This is a tool of impact investing; these are working hand in hand with the mission of impact investing,” Lang added.


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