child's hands covered in goop
Helping hands: children in Essex have benefited from a low-risk loan to a social housing provider

They are called bonds but do not work like them. They were created in the UK three years ago. They are cutting edge and starting to take off around the world. Enter social impact bonds: high-risk philanthropic investments with the allure of double-digit returns.

Essentially, SIBs are loans that enable social enterprises to participate in “payment by results” contracts. PbR is being pushed aggressively in the UK in an attempt to cut public spending, in part by outsourcing core services.

Inevitably, big companies, such as support services groups Serco and G4S, will win most PbR contracts. However, a small but growing number of philanthropic investors are backing SIBs to help social enterprises stay in the game.

James Perry, chief executive of Panahpur, a family-run charitable foundation, was a cornerstone investor in the first dedicated SIB fund – the £14m Bridges Social Impact Bond Fund – having heard about SIBs at a conference. “I thought it was crazy that [many social enterprises] had no access to capital [to take on PbR contracts]. Interventions work best on a local level,” says Perry.

The first SIB provided £5m for a programme led by St Giles Trust, the charity, to cut reoffending among inmates released from HM Prison Peterborough. The bond was launched in October 2010 by Social Finance, the sister organisation to Big Society Capital, the government-backed social investment bank.

Critically, SIBs remove, or reduce in the case of more recent issues, the risk for social enterprises. If PbR targets are missed, SIB investors suffer the loss. If successful, the social enterprises repay SIB holders, plus pre-agreed interest, out of the PbR proceeds.

Prospective yields vary widely. Peterborough is capped at 13 per cent a year, while the SIB arranged last year by Triodos Bank, the ethical lender, for St Mungo’s is aiming for 6.5 per cent, in part because the homelessness charity is co-financing the initiative. The bank raised £650,000 via a placement involving three private investors and two financial institutions.

SIB investors bring in more than money, says Nick O’Donohoe, Big Society Capital chief executive. As of July, the bank had invested in six of the UK’s 14 SIBs. “They bring another level of governance,” he says, but adds: “They are also not philanthropic donations. Investors aim to get their money back and recycle it.”

Despite strong global interest, O’Donohoe says retail investment in SIBs is some way off, being too risky and illiquid at present.

The recent Essex county council SIB – the first commissioned by a local authority – to help children stay out of state care is seen as a promising model, however. It has two elements: a low-risk loan to a social housing provider to repay investors’ capital, and a high-risk investment with a variable return linked to the success of the PbR care contract.

“The Essex SIB was beautifully put together,” says Dan Hird, head of corporate finance at Triodos. “There has been strong feedback from all of us that the government has to share risk or else the segment will not grow.”

To date, SIBs have been expensive to set up, often relying on pro bono work, adds Adrian Brown, a social investment specialist at Boston Consulting Group. He says there is not enough philanthropic funding to support them in their present form.

The critical next step is to get local authority commissioners on board, commentators say. But Hird says council staff often lack the skills to negotiate these complex contracts. Spending cuts, meanwhile, have hit capacity.

Antony Ross, co-manager of the Bridges SIB fund, says it aims to establish a track record for SIBs and generate high single-digit returns.

“The most interesting element is funding support services to avert future problems,” he says. “The savings can be dramatic and there are great benefits [for society].”

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Guarantee grabs Goldman

It did not take long for one of the world’s most famous entrepreneurs to jump on the SIB bandwagon. Michael Bloomberg, mayor of New York, was behind the first SIB in the US, bringing in Goldman Sachs. Backed by a $7.2m guarantee from the mayor’s personal foundation, the investment bank is the first global financial institution to invest in a “pay for success bond”, as SIBs are known across the Atlantic.

Last year, Goldman invested $9.6m in a SIB aimed at reducing recidivism among male adolescents from the city’s Rikers Island prison. MDRC, a local social services provider, is running the project. If reoffending is cut by 10 per cent, Goldman gets all its money back; any further cut and it stands to make a profit of up to $2.1m. Thanks to Bloomberg’s guarantee, the most the bank could lose is $2.4m.

Having a name like Goldman Sachs on board is a significant landmark, says Russ Bubley, an ex-Citi banker turned social investment strategist. But he says investors in the British SIBs have had to be much bolder without the safety net of someone like Bloomberg.

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