By Emilie Goodall
Around the world, there’s a growing belief that social impact bonds can not only help communities solve some of their most complex problems – but also provide investors with attractive risk-adjusted returns.
Traditionally, governments and other donors have looked to address tough social issues by paying for a set of activities that they hope will eventually lead to better outcomes. Social impact bonds (SIBs), by contrast, allow governments and donors to define a set of outcomes with a service provider – such as improving adoption rates for harder-to-place children – and only pay if those outcomes are delivered. The investors’ role is to fund the up-front cost of delivering the programme, on the basis that their returns will be contingent on the programme’s success. So while SIBs are like traditional bonds in that they operate over a fixed time period, their risk profile is actually more like equity, because returns vary according to outcomes.
Although this is still a new idea, it’s gaining traction globally. Some 26 SIBs are already in operation around the world (of which Bridges Ventures’ funds have invested in seven), with dozens more in the pipeline. They span a wide range of social issues – from reducing rough sleeping in London, to helping immigrants out of unemployment in the Netherlands, to keeping children out of care in Australia. Together, these SIBs have raised around $120m in capital from both individual and institutional investors, including pension funds, foundations and investment banks. And there’s already evidence that the model is leading to better outcomes – which should ultimately result in strong financial returns for these early adopters.
In compiling our new report, ‘Choosing Social Impact Bonds’, we spoke to a number of other SIBs practitioners worldwide. The consensus was that SIBs have a number of attractive characteristics for investors with an interest in impact. They allow investors to address the sort of social issues they might not be able to access elsewhere in their impact portfolio – precisely because these issues are normally the preserve of governments or donors. Since payment is directly linked to the delivery of outcomes, there’s a clear alignment of interests between all the parties involved, which should increase the likelihood of success. And they establish a clear value for a particular outcome.
What’s more, the hope is that SIBs can deliver attractive risk-adjusted returns over time – and that their performance won’t necessarily be correlated to the broader economic cycle.
The risk for investors, of course, is that they end up paying for services that fail to deliver the desired outcomes. To mitigate this, prospective investors need to be asking three questions. Are the right incentives in place to make sure better outcomes are achieved and rewarded? Does the service provider have the right team? And what evidence is there that the proposed intervention – however innovative – actually works?
Experience from the early SIBs suggests that hands-on engagement is key, both in terms of analysing risk and managing performance – just as it is with the private equity investments in Bridges’ Sustainable Growth funds.
If investors lack the capacity to do this themselves, they can use a trusted intermediary to assess and manage the SIBs on their behalf. Around 80% of investors in the early SIBs have used an intermediary in some capacity, including the Greater Manchester and Merseyside local authority pension funds, which have both invested in the Bridges Social Impact Bond Fund.
We’re already seeing some pioneering large institutions start to test the market by allocating small amounts of capital to SIBs, often with some downside protection from investors more familiar with the risks. Once SIBs start to fulfil their potential, others are sure to follow.
Emilie Goodall is Director of Projects at Bridges Impact+, the advisory arm of Bridges Ventures.
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