Social impact bonds offer investors the chance to make a difference, but do the risks outweigh the feelgood factor? Sebastian Cheek reports.
“If I put £100,000 into the project I have to hope that business delivers very good results, because if they fail there is nothing I can do as they don’t have to pay me back.”
Ed Siegel
The term social impact bond (SIB) is somewhat misleading for investors. Bonds generally offer investors a regular and fixed form of income, but SIBs essentially operate on a ‘payment-by-results’ basis.
SIBs were launched to help improve the social outcomes of publicly-backed services by making funding conditional on achieving results. The first, launched in 2010 by not-for-profit organisation Social Finance, aimed to reduce the number of reconvictions among Peterborough Prison’s 3000 short-sentence prisoners by 7.5% over an eight-year period.
Today a total of 14 exist in the UK and 25 globally, with other initiatives such as supporting children and young people not in education through to employment or training.
A SIB is a financial mechanism in which investors pay for a set of interventions to improve a social outcome that is of financial interest to a government commissioner. If the project backed by the bond achieves its goals, investors get paid by the government commissioner for their initial investment plus a return for the financial risks they took. However, if the social outcome fails to improve above the agreed threshold, investors risk losing their investment, and it is this which could prove to be the stumbling block for take-up among many insitutional investors.
One investor who has accepted the risks involved with SIBs is Big Issue Invest (BII), the social investment arm of the Big Issue magazine group.
Director of investments Ed Siegel explains: “It is 100% payment by results and in that case we will be asked to invest into a special purpose vehicle which holds the contract and in some cases directly to the businesses holding the contract. We don’t have recourse to the business so if I put £100,000 into the project I have to hope that business delivers very good results, because if they fail there is nothing I can do as they don’t have to pay me back.”
One option for reducing the risk is to access SIBs through a fund investing in a number of projects. Such funds are currently hard to find, but the few out there are growing in popularity. The Greater Manchester Pension Fund and the Merseyside Pension Fund have both recently invested in the Bridges Ventures Social Impact Bond fund, which reached its final close at £25m in September. The fund, which was launched with backing from Big Society Capital, the world’s first social investment bank created from dormant bank accounts, provides up-front capital for projects commissioned by the public sector and targets a net return of over 5%.
Bridges Ventures partner and head of social sector funds Antony Ross believes the risk of investors not receiving their money back is “low”, adding in order to avoid underperforming projects the fund seeks opportunities where the provider has a track-record in delivering a social good.
“We look at their performance and price the payment such that in a reasonable scenario we would expect to make some form of return,” he says. “If the outcomes do better we expect to get higher returns and if they do worse we expect lower returns, but the likelihood of a full capital loss is low.”
He adds: “Investing in a fund you get the benefit of portfolio spread and we would be expecting to invest in 15-plus investments across this fund which gives investors the opportunity to benefit from both ups and downs. It is a fund that has higher risk than a normal debt fund but lower risk than a conventional equity fund – the risk profile is more akin to mezzanine.”
Another option for funds wanting to invest in social projects but without the risk associated with SIB performance is a fund which invests in corporate bonds issued by companies which support and fund socially beneficial activities and development. Late last year, Threadneedle Investments partnered with BII on a listed social impact bond fund which now has £48.5m under management and invests in typically single-A-rated bonds, which are heavily scrutinised by BII for their socially impactful credentials.
Simon Bond, the aptly-named manager of the fund, believes such an approach is less risky than a pure payment-by-results SIB, something he describes as a “misnomer”.
“They are not a financial product as far as I am concerned,” adds Bond. “They are not a bond and certainly not a conventional financial product. Because it is so hard to determine the returns upfront you can’t do any of the maths or risk assessment a conventional investment would require you to do – I struggle to describe them as a financial instrument. They are a fantastic social instrument, don’t get me wrong, but we are looking to provide a financial and a social return.”
Another plus point around investing in a corporate bond fund is the daily liquidity it offers which most SIBs cannot. Indeed, in Bridges Ventures’ fund most contract durations run from five-to-seven years and often have a 10-year window. Pension funds however, should be able to handle the illiquidity if they are in it for the long haul.
This leaves socially-conscious investors with a dilemma: a social investment corporate bond fund is more liquid and behaves more in line with a traditional and familiar fixed income security, but SIBs offer the ability to chart the progress of the underlying social project and the potential for solid returns if they do well.
However, they are illiquid and underperforming projects can affect returns. Both methods offer the opportunity to tap into the social sector, investors just have to decide on their risk and liquidity appetite before choosing.
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