EXCLUSIVE INTERVIEW: Social Impact Bonds - Harnessing Wealth For Good

Tom Burroughes, Group Editor, November 21, 2016


This publication recently interviewed the Darden School of Business at the University of Virginia about trends in what is called impact investing, and new structures that are taking shape.

Doing well by doing good is the kind of move many people will want to make but profitable forays into investments designed to change society for the better aren’t easy to measure. But as more ventures get under way and more data comes in, the picture of what works clarifies.

This at any rate is the hope and aim of the University of Virginia’s Darden School of Business, which is, along with other organizations, working to push forward knowledge in impact investing, a field gaining increasing traction in the US and beyond. 

Impact investing was first conceived by foundations and philanthropists as a way to use their capital to support their charitable objectives alongside their grant-making activities; it has, however, moved beyond that to a form of investing where non-financial, but still concrete effects, or “impacts”, form part of a decision to commit money to a project over a period of time. 

A particular development has been that of the “social impact bond”, an arrangement lasting, say, three to five years where money is committed to a particular project with a social goal in mind – such as reducing reoffending rates among people sentenced to imprisonment. A positive result (low recidivism) produces a financial return to investors, whereas a negative result would mean a loss of capital. SIBs have been around since 2010, so this is a very young market.

The prisoner re-offender rate example was given to Family Wealth Report by Mary Margaret Frank, who is based at the Darden School of Business and is an academic director of Darden’s Institute for Business in Society.

“These are 100 per cent variable returns,” Frank said. “They are contingent on outcomes.”

In the case of a prisoner re-offending case, lower re-offending rates reduce costs to society (policing, court time, lawyers’ fees, damage to victims, etc). The first social impact bondor SIB, in the U.S. involved the Rikers Island prison, New York City, and funded a behavioral therapy program for young people detained at the prison. Wall Street titan Goldman Sachs lent $7.2 million to fund the project to cut recidivism; according to the project, an 8.5 per cent drop in the rate of recidivism would have triggered repayment of some of the capital investment, and greater than 10 per cent reduction would have led to a returne for Goldman Sachs. In the end, Goldman Sachs walked away with a $1.2 million loss when the reduction in recidivism did not meet required outcomes.  Goldman Sachs did not lose all of its $7.2 million investment because Bloomberg Philanthropies guaranteed the first $6 million in losses to bring the parties to the table.

Another example of  loans used to finance impact are the “green bonds” that have been issued by the likes of Bank of America Merrill Lynch. (The bank issued a $600 million green bond in May 2015.) In these cases, the metrics for judging the success/failure of a green project (reduction of C02 emissions, production of energy per unit, etc) are easier to identify and monetise, in contrast to say, those for changing human behaviors such as prisoner re-offending, she said.  These bonds have less risk because they provide a fixed return and fund multiple projects which diversifies the risk from a project failing.
The SIB is, as the example suggests, no ordinary “bond”. There is not a fixed income element to this such as a coupon payment or compensation for erosion of inflation of principal; there are multiple entities involve in determining whether a payout can occur at all and if so the amount. To some degree, these SIBs involve the kind of intensive due diligence on specific, direct investments one associates with areas such as private equity, Frank said.

Impact investing has a way to go in terms of size, but the amounts are already large. There are $60 billion of impact investing assets under management, and $12.2 billion of fresh investment was expected to be put in place last year, according to the Global Impact Investing Network, a forum for the sector.  One forecast has impact investing AuM topping $3 trillion over the next decade. 
What sort of investors are interested?

“People who have the ability to do the due diligence on these [SIBs] are the family wealth firms and they have the ability to take large and meaningful positions,” she said. “if they want to see outcomes-based policies,” Frank told this publication.

As social impact bonds are barely half a decade old, there isn’t yet a great deal of data generated to give the likes of rating agencies much to bite on in terms of measuring risk and other performance characteristics, Frank said. 

A future source of SIB issuance is state governments in the US, facing spending limits, could turn to such alternative, private-public forms of money-raising to finance projects for which there is a need, she said. 

The market has tailwinds. According to a survey of US asset managers by Cerulli Associates, the analytics firm, a rising percentage of asset managers look at environmental, social and governance factors alongside more traditional financial tests to identify opportunities and risks. And a recent report by Boston Consulting Group and MITSloan Management Review found that investments that deliver financial results are closely correlated with those that are deemed sustainable (Investing For A Sustainable Future, 11 May 2016). Separately, a study by Barclays found that investment-grade bonds with higher ESG scores outperformed those with low ESG scores between 2007 and 2015 (source: MSCI).

One assumption by impact investing evangelists is that millennials are keener than their parents on the idea, and this is significant because a large volume of financial assets are expected to transfer from baby boomers to their millennial heirs over the next 30 to 45 years, with an estimated $30 trillion changing hands in North America alone. 

There is also a change likely to continue encouraging SIBs that comes from younger investors’ desire to promote good causes while also earning a meaningful financial return. Given the continued disenchantment some people still feel with routine “capitalism” almost a decade on from the financial crisis of 2008, such alternatives are likely to encourage interest for some time to come.


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