Glenn Yago
Senior Fellow; Founder, Financial Innovations Labs
Capital Markets and Emerging and Frontier Markets and Environment & Natural Resources and Finance and Financial Innovations and Global Economy and Middle East and Sustainable Development
Dr. Glenn Yago is a senior fellow and founder of the Institute's Financial Innovation Lab. He is a leading authority on financial innovations, capital markets, emerging markets and environmental finance.
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Emerging domestic markets revisited

By: Glenn Yago
March 06, 2012

More than a decade ago, the Milken Institute conducted a series of studies, supported by the Ford Foundation and the U. S. Department of Commerce, examining the capital access gap for emerging domestic markets. (We defined and measured these market opportunities in terms of both people and places.) We looked at emerging domestic markets that were driving business formation in demographically diverse markets in California and other urban population centers throughout the United States.

Hispanic, African-American, and Asian firms were found to be growing at three times the rate of other firms (with the number of African-American businesses increasing at almost four times the rate). Women-owned firms also showed high growth rates, particularly so among ethnic women entrepreneurs -- these firms were increasing at a rate five times that of all firms. The added diversity had increased the range of places where the new owners live or locate their businesses, leading to demands for capital in a wider variety of locations.

These demographically driven changes created a new investment opportunity, one we identified as "emerging domestic markets". EDM referred to people, places or enterprises with growth potential that face constraints due to systematic undervaluation based on imperfect market information and access to resources. The markets include ethnic- and women-owned firms, urban and rural communities, companies serving low-to-moderate-income populations, and other small- and medium-sized businesses. The lessons of entrepreneurial finance could be effectively applied, we argued, to support those new business models and entrepreneurs that were driving economic growth within new markets in old urban centers and rural areas throughout the country.

We had hopes, but no idea, that in coining this phrase new waves of investment-led growth and market-based solutions would be so successfully launched (even spawning a new professional publication, "Journal of EDM Finance," launched by the trade association of asset managers working in this space.

Our data and analysis was widely reported and appeared in private placement memorandums for new investment funds and asset managers across the country, and in our work on entrepreneurship in emerging domestic markets.

At the time, we concluded that those emerging domestic markets remained "overlooked and untapped due to misperceptions and lack of information … leaving demand for capital unsatisfied." The Federal Reserve Bank of San Francisco later published a history of this phenomenon of emerging domestic markets.

At the Federal level, those findings were embraced in the New Markets Tax Credit Program, promoted by both the Clinton and Bush Administrations. We were honored to work on this initiative through presentations at the Clinton National Economic Council in 1999. Last year, the New Markets Tax Credit Program was named one of the Top 25 Innovations in American Government at Harvard's JFK School of Government. Permits to individual and corporate taxpayers granted $29.5 billion of tax credits against federal income taxes for making qualified equity investments in investment vehicles.

At the State level, further pioneering work in investing in emerging domestic markets started when California launched the California Initiative -- the first $1 billion institutional investment. In 2001, Phase 1 of the California Initiative was launched by CalPERS, the nation's largest public pension fund, with a $480 million commitment. Phase II came in 2007, known as the Golden State Initiative, with a commitment of $560 million. An assessment last spring of this initiative demonstrated positive risk-adjusted rates of returns of 16.2% (comparable median private equity returns for the same period were 2.02%) for the $757 million currently invested in 141 active portfolio companies.

Beyond the financial returns, a social bottom line was also served by those firms that generally employed workers located in low- and moderate-income areas and accounted for 68,000 jobs created. Forty-five percent of the companies were in under-served areas that historically had never received institutional equity investment. Forty-two percent had women executive officers, and 61 percent employed more than one minority officer. Referring to our research, then State Treasurer Phil Angelides referred to this movement of capital as the ability to "to marry the jet stream of finance and capital markets with public purpose."