SOCIAL IMPACT BONDS - IS MAINSTREAM INVESTMENT A REALISTIC AMBITION?

3 November 2011

A recent analysis in Third Sector magazine asked: “can social impact bonds help to create a better society?” One of the interesting things about this piece was that it raised some concerns about whether the ambition of getting mainstream investment in these kinds of products was realistic in the short to medium term. This is a question I want to pick up on here.

In broad terms, a Social Impact Bond (SIB) is a mechanism that allows social investment to be raised based on a commitment from the government to pay if a set of outcomes is achieved, in order to fund interventions designed to deliver those outcomes. The attraction of the SIB idea is at least threefold:

• it offers the public sector a way of overcoming its aversion to funding risk
• it offers CSOs a means of raising the working capital they need in order to take on end-loaded payment by results contracts
• it offers a product that can potentially deliver both financial and social returns to socially-motivated investor

If we assume that the SIB model becomes established, we can consider whether each of these will still true and relevant in the future, which can give us some clues about the long-term prospects of the SIB.

At the moment, the risk aversion of the public sector makes it difficult to get funding for innovative approaches, which do not have sufficient track records for them to be judged as “safe investments”. One of the main motivations behind the SIB is to overcome this problem by creating a structure that can allow public sector funders to fund innovation at little or no cost.

The question this throws up is what the intended end result is: to prove the effectiveness of the interventions the SIB invest in, and thereby create a track record? If so, then one would suppose that the goal is to reach a situation where the government is able to fund the intervention directly, without the need for a complicated (and costly) financial structure in the middle.

If this is the goal of an SIB, then it is hard to see how the model will be sustainable in the long term. As soon as a particular SIB proves successful, it will become a victim of that success because the government will no longer need the bond structure in order to invest in the underlying interventions.

Of course, there will always be other areas of social need where there are new interventions that are not sufficiently proven for the government to be comfortable funding, and therefore where social impact bonds could play a role. But this then implies a picture where SIBs are only ever a tool to pave the way to government funding by reducing the risk of investment to a level that fits with public sector prudence. Some people might think this is OK, and that this is how SIBs should be understood, but it is unlikely to be a view endorsed by those working to develop the SIB model.

It has been said by many proponents that the ultimate aim is to get to a position where SIBs are suitable investments not only for philanthropically-motivated individuals and charitable trusts, but also for mainstream institutional investors such as pension funds. Of course in order for this to be the case, the perceived risk of investing in the SIB would have to be low enough to fit within the risk profile of institutional investors.

And in order for this to be the case, the underlying interventions that the SIB is funding would have to have sufficiently strong track records for the likelihood that they will deliver the desired outcomes to be seen as high. But then, won’t these interventions be sufficiently well-proven that the government could just fund them itself without the need for a bond structure? Or is there a “sweet spot” we should aspire to find, of interventions that are sufficiently tried-and-tested to provide the basis for an SIB that can attract mainstream investment, but which are still too risky to allow direct government funding?

If this is the case, then it is possible to see how we could have a longer-term SIB that serves a social purpose and also offers a realistic mainstream investment opportunity. There may be plenty of situations of this kind, in which case SIBs have a clear future as part of a new class of “social” or “impact” investments within the spectrum of asset types. On the other hand there may be very few, in which case it will be difficult for SIBs to develop to the point where they can feasibly attract mainstream investors.

I don’t wish to second guess which of these scenarios is likely to be true. The important thing at this stage is just to be aware of these issues, and bear in mind that they still need to be addressed before we can claim with certainty that SIBs are a viable long-term solution. It is encouraging that the Minister for Civil Society appears to be aware of these issues, and is tempering his enthusiasm with some realism about the challenges of getting mainstream social investment.