Will the social impact bond ever attract commercial capital?
At least one professional investor believes it eventually will – although he
doesn’t think it will be quick or easy.
The social impact bond was introduced last year as a means
of funding early interventions on reducing
reoffending, drug use, the number of children in care.
The model for the social impact bond is that investors gives
charities money to carry out a long-term payment-by-contract. In exchange, they
get any profits the contract generates.
In theory, the benefits go to both sides. If the contract
works, the investor can make a large return on his money. In the meantime, the
charity has a guaranteed income and the freedom to work on its project.
However a key question yet to be answered is whether it will really prove attractive to investors.
A pilot project is being carried out in Peterborough, where
charities are working with ex-offenders. The project has attracted £5m from
philanthropists and foundations. If it works, they will receive up to £8m over
six years.
While this looks like a good return, it’s not attracted anyone
primarily interested in profit. Instead it has attracted philanthropic money.
This is all well and good, but if the bond is to be the game-changer many in the sector hope it will be, it will need to attract commercial capital. So what’s needed before non-philanthropic money gets involved?
I recently had a conversation with a charity investment
manager, Andrew Hunter-Johnston of BlackRock, who says it will need five things
before he considered investing: scale, liquidity, a track record for similar
projects, oversight, and the right return on investment.
Scale means that he would like to see at least £100m
involved. Less cash, Hunter-Johnston says, would mean the work involved wasn’t worthwhile for his
company.
“Even then, we’d do it as a joint venture,” he says. “We’d
work with someone like a big foundation who understood the model.”
Liquidity means a secondary market, so that investors can
withdraw their money if they need to. If a project lasts five or six years,
it’s a much more attractive investment if you can pull your cash out halfway
through.
Then there’s the question of a track record. Unsurprisingly,
Hunter-Johnston says, investment professionals will watch this to see if it
works. Only when it’s clear that it makes money will they get involved.
Hand in hand with that goes governance.
“If I put money in, I understand what’s in it for me,” he
says. “But what’s to stop the charities involved just saying ‘sorry’ and doing
something else? What’s to stop their best people leaving?”
Hunter-Johnston says he would like some control before making
an investment. For example, he says, if a special purpose vehicle is set up to
manage the project and employ charities as needed (as was the case in
Peterborough) then investors should be able to have a seat on its board.
Once all of that is in place, though, the social impact bond
must still pay an attractive commercial return.
“The rate of return on the Peterborough project is better
than bonds or equities,” Hunter-Johnston says. “But the risk is higher. This
looks more like a private equity investment, which would typically pay about 20
per cent a year.
“These will only be an attractive investment at that price
if the failure rate is shown to be low enough.”
For a long time to come, he says, charitable money will be
the main investor, followed by private money invested by individuals, perhaps
partly motivated by a social return.
Only after several years of solid, reliable returns will
mainstream investors such as pension funds and insurance companies begin to dip
a toe into the water.