As the global market for social impact bonds gathers steam, local experiments are demonstrating the potential of these innovative finance structures. However, they still need industry collaboration and government support.
A 2016 report by Impact Investing Australia estimated the value of the Australian impact investment market at $32 billion, with private equity, venture capital and pay-for-performance instruments the sector’s most frequent vehicles.
The most common type of pay-for-performance instruments are best known internationally as social impact bonds.
These instruments, which are often labelled social benefit bonds here in Australia, are an exciting emerging asset class to watch. Already, a handful of institutional investors, including HESTA and QBE Insurance, are supporting the nascent market, while the country’s three biggest banks – Commonwealth Bank, Westpac and NAB – have worked on assembling the structures.
It is in the interests of institutional investors to collaborate with government and the social service delivery sector to ensure this market can grow. It would help communities, take pressure off budgets, and develop a new institutional asset class offering a highly diversified source of returns.
Social impact bonds are not actual bonds. They are transactions that enable the government to attract investors to social interventions that would otherwise have a higher upfront cost to the taxpayer. The government uses those savings to repay the investors, including a dividend based on predetermined outcomes.
The first social impact bond was the United Kingdom’s Peterborough Prison bond, launched in 2010, aimed at reducing recidivism among 3000 short-term offenders over six years.
A 2015 review of the first five years of social impact investments, by The Brookings Institution in Washington, DC, found 44 had been issued in advanced economies. One year later, 96 were implemented or designed in such economies. The Brookings review found the issues typically raised between US$2 million and US$5 million, with one raising US$24 million.
Globally, returns on social impact investments have ranged from 3 per cent to 7.5 per cent, with most returning about
5 per cent. Payments often increase over time and with better success at achieving a particular outcome.
These investments are transforming how governments fund service provision. However, to date they are mostly small and targeted at philanthropic family trusts and endowments.
The Australian experience
In Australia, New South Wales was the first state government to back social benefit bonds, launching two in 2013. One was to support families of children who might be at risk of going into care (the Newpin bond) and another was to divert children from out-of-home care (the Benevolent Society bond).
To date, Newpin has delivered a 12.2 per cent return to investors, restored 130 children to their families and helped 47 families prevent their children from entering care. Also, 61 per cent of children referred to the service provider have been returned from out-of-home care.
New South Wales is now supporting the development of more social impact bonds to finance programs aimed at managing mental health hospitalisations and early-childhood education, and helping vulnerable young people transition to independence.
The Queensland Government has issued an Indigenous-focused Newpin bond, and in June 2017, it announced its second bond, Life Without Barriers, for youth aged 10-16 with ‘high to very high’ risk of re-offending.
Queensland is now also looking at areas such as families with young children experiencing housing instability, young people exiting statutory care at risk of homelessness, and chronic illness.
Social Ventures Australia announced in March 2017 that it had raised $9 million to fund the South Australian Government’s Aspire Program, which aims to build the independence and resilience of people experiencing homelessness in Adelaide. Investors include Coopers Brewery Foundation, HESTA and Future Super.
Up to 600 people in the program will each be supported for three years, with accommodation, case management, pathways to employment and life skills development.
Meanwhile, the Victorian Government has announced it is examining investments for drug and alcohol treatment programs and young people leaving out-of-home care.
Canberra late to party
The Australian Government has been investigating social impact investment models since 2011. The Senate Economics Committee has held an inquiry into the sector that is focused on options available for developing a mature capital market for the social economy in Australia and the barriers in the way.
The inquiry’s main recommendation was to establish a Social Finance Taskforce, which the government supported in principle but has not established. The committee also found that company directors, senior managers, investors and financial advisers should undertake training to become more aware of social investment opportunities.
The 2014 Financial System Inquiry, led by David Murray, noted that there is no inherent conflict between fiduciary duty and making social impact investments. The inquiry recommended the government provide more guidance to superannuation trustees and update the rules for private ancillary funds investing in social impact bonds.
In response, changes announced in the May 2016 federal budget allowed private ancillary funds more opportunity to invest in social impact bonds and to make, or guarantee, loans to charities.
For super funds, however, trustee fiduciary ‘sole purpose’ duty to maximise returns to members is still often seen as an impediment to investing in these assets.
Treasurer Scott Morrison described a social impact investing discussion paper released this year as “the next step in implementing the Financial System Inquiry’s recommendation to explore ways to facilitate the growth of the social impact investment market”.
The Turnbull Government’s response to the paper – the consultation closed in February – should help frame government action around barriers to impact investing.
Overall, the federal government has been slow to move on efforts to support the social impact market and risks impeding maturation of this growing opportunity.
Bringing market discipline
Despite a pressing need to attract institutional capital to help solve social issues, there remains a supply side problem too. The lack of offerings coming out of the social sector is not least because not-for-profit organisations (NFPs) face many challenges becoming ‘investment ready’.
An NFP looking to develop a social impact bond offering must identify an existing program or service that is generating a positive social outcome. The program or service should focus on one outcome to make it more readily measurable. This program should then be independently evaluated to determine its benefits.
Based on this review, the program may need to be redesigned and expanded to maximise the benefits and then operated for a period (typically two to three years) to gather data on its impact and cost. Philanthropic funding may be sought for this.
That data can be combined with information on the potential client/beneficiary base to calculate the possible savings to government. The organisation and private funder are then well placed to take an unsolicited proposal to government.
A key risk for NFPs is that outcomes-based funding could lead to ‘cream skimming’ or ‘cherry picking’ by service providers, in which beneficiaries close to the outcome necessary for a payment are prioritised. Service providers may also be inclined to ‘park’ certain projects – working only with beneficiaries most likely to achieve the outcomes that trigger payment.
Tiered payments – differential pricing for outcomes in different subgroups – are a way to limit cherry picking and parking. Under this approach, higher rates are paid for outcomes achieved for harder-to-help groups. Partners can also minimise these practices by agreeing on clear metrics and strong goal alignment early in contract design. Robust performance management and independent evaluation, which the private sector can bring to partnerships, also helps.
The legal fees paid for framing agreements are another big challenge to the development of pay-for-performance mechanisms. The development of one bond in the US reportedly involved writing 27 contracts and more than 1100 hours billed for legal services.
A role for patient capital
A broad concern for social service providers is that the role of these bonds lies in individual interventions and may have minimal impact on the social determinants of the issues being tackled. While initial investments may target the acute problem, investors and governments could look at secondary bonds that are more preventative.
These, however, would probably require much longer lead times to achieve measurable results. Such investments are most likely the domain of capital with a higher risk tolerance and a longer horizon. This is an area where the $2.1 trillion superannuation sector could play a role.
Investors should look for not-for-profit partners that have a good capacity for data collection, sound governance and financial controls. A record of managing large projects, organisational longevity and strong growth are also good indicators of capacity to enter into social benefit bonds. One bond service provider has its own research team and three former investment bankers on its staff. NFPs and investors may want to consider specialist intermediaries, at least during start-up.
Kyrn Stevens recently completed a thesis on social investing for his executive master’s of business administration at the University of Wollongong’s Sydney Business School. He is a corporate affairs and marketing professional in the community health sector and a non-executive director of the Fairy Meadow Branch of Bendigo Bank.