In February, UK-based charitable social investment company Allia launched a social impact bond (SIB) aimed at individual investors. This gave the public the opportunity to invest, for the first time, in a SIB, which are generally funded by institutional investors and a small number of foundations and high-net-worth individuals. At the same time it tested whether retail investors had an appetite to invest in such a product, as it would open up extra sources of capital.
The Future for Children Bond
It’s difficult to establish a common ground for SIBs given that they are a work-in-progress and that SIB contracts have tailored features. In New York City’s bond, Bloomberg Philanthropies contributed a $7.2 million grant to “insure” the $9.6 million loan made to fund an intervention program to lower recidivism. With the same goal to reduce recidivism, UK’s Peterborough SIB, which raised around $8 million from 17 investors to fund a program, does not have this investment guarantee.
Still, both SIBs were formed with the intention of raising private capital to address social problems. They would both repay investors from public sector savings if readmissions decrease by a predetermined percentage.
Allia’s Future for Children Bond, which was created to improve the outcomes of children aged 11 to 16 at risk of going into care, has two distinctive features. Aside from being open to retail investors, it invests in two programs rather than one and it doesn’t need to rely on public sector savings to repay investors.
Of all the funds raised, 78 percent is used towards a low-risk, fixed rate loan to Places for People for affordable housing. For instance, if £1,000 were invested into the Future for Children Bond, £780 would be loaned to Places for People. Repayment of the loan plus compound interest by Places for People would equal £1,000, as this SIB offers a minimum 100 percent return to investors.
Another 20 percent is used towards the Essex County Council’s SIB (ECC SIB) where a return is not guaranteed. The ECC SIB funds a Multisystemic Therapy program by Action for Children for 380 children and their families, with a target of diverting 100 children from entering care.
Although the ECC SIB had already raised its required £3.1 million from institutional investors, one of the investors, Esmée Fairbairn Foundation, offered to scale back their commitment by £200,000 to accommodate the Future for Children Bond. This would allow a no-risk opportunity to test the appetite of retail investors as the ECC SIB would go ahead regardless of whether the Future for Children Bond raises its £1 million target. If the program is successful, the cost savings for Essex County Council would be used to provide a return to investors.
The remaining 2 percent goes to Allia for management fees. With respect to other features, the Future for Children Bond has a term of 8 years and requires a minimum investment of £15,000 – above the ISA allowance of £11,520 – to encourage investors to conduct due diligence on this unfamiliar product. As another precaution, investors must apply for the bond through a financial advisor.
The bond was launched on February 4 with a closing date of March 15. There was substantial interest from investors, but the uptake was slow. The offer period was then extended for another four weeks ending April 12. Despite the extension, subscriptions remained too low for Allia to cost effectively manage the bond, so they decided not to issue it in the end.
Why did the bond fail?
NPC, a London-based consultancy firm and think tank for the charity sector, was asked by Allia to perform an independent evaluation of the Future for Children Bond. They released a report last month on the lessons learned from the bond. It examined potential factors that led to the bond’s failure and their implications for the future development of these bonds as well as social investment products in general.
Timing was an issue for this bond. Advisors felt the offer period was too short, which could have been avoided had Allia decided not to invest at the same time as institutional investors for the ECC SIB. If they invested at a later date it would have resulted in additional legal costs and made interim valuation difficult.
Because of confidentiality clauses with the Essex County Council, Allia experienced some delays in producing the offer document and had to cancel some marketing initiatives planned before the launch. This could produce some issues in cultivating investor knowledge, given the social investment market’s embryonic state and the product’s complexity.
In fact, The Sunday Times previously reported on a range of potential returns for the Future for Children Bond, not realizing that the returns should only be attributed to the 20 percent portion invested in the ECC SIB. The product is no less confusing for the retail investor. In one application that Allia received, the investor wanted to put £40,000 into the bond, but did not understand that the product would not generate regular income, even after he was required to apply through a financial advisor. Upon this discovery the investor withdrew his application. The challenge for Allia and other bond managers is to ensure they do not draw claims of mis-selling the bonds.
A lack of established distribution channels in the social investment market for a wider pool of retail investors made it difficult to market the bond. The reality is that there aren’t a lot of financial advisors in the mainstream firms interested in social investment products, especially since product offerings are limited. Allia’s efforts may have also been hampered due to its low recognition and limited direct relationships with advisors.
The bond offer period coincided with a busy time for financial advisors – the end of the tax year. Coupled with an unfamiliar product requiring time-consuming advisory services, the bond may have been destined for failure after all. Adding to the strain is the Retail Distribution Review which, effective December 31, 2012, requires advisors to provide their clients with a charging structure before giving any advice, described in the report by one advisor as “the biggest change the adviser market had seen in 20 years.”
The cost of advising on social investment is therefore high. Advisors are required to get training, educate clients, and conduct additional due diligence, among other things. A couple of advisors told NPC that they estimate full costs of advising on a social investment product to be £1,000. Yet their costs can’t be recovered from such a small number of clients.
In light of this, NPC proposes “that advisers should be able to rely on independent due diligence conducted by experts in social investment with the approval of the Financial Conduct Authority (FCA).” For greater autonomy, NPC suggests the “FCA should work with social investment product providers to develop appropriate investor self-assessment so that such investors can independently check, and affirm to the product provider, that they understand the nature of the offer and consider it suitable for them.”
Advisors felt the bond was too complex. Although one advisor believed the bond offered “dual social impact” – affordable housing and support for children, another thought the investment in Places for People to be an “unnecessary complication”. Overall they understood that the housing loan provided a low-risk element.
Some advisors thought that having protection measures such as the minimum £15,000 investment requirement was too much for most retail clients. Because Allia had to protect itself from mis-selling and potential investees from mis-buying, advisors carried the burden of ensuring clients made an informed investment. Some felt unable to advise interested investors without taking on a full assessment of the client’s financial suitability.
Other issues with the bond include a term of 8 years to be too long, the impact of inflation, and a lack of transparency surrounding the returns of the bond, such as the source of the outcomes data, as a result of confidentiality causes in the ECC SIB contract. Overall these added to the perceived risk of the bond.
Let’s do without SIBs
The research by NPC suggests that offering the Future for Children Bond to retail investors was an idea ahead of its time.
Early adopters would have had to undertake high set-up costs due to the small and nascent social investment market. Plus, the tailored nature of SIBs pushes up the cost to carry out contracts. Think tank Social Market Foundation predicts “mainstream investment into prospective SIBs is very unlikely” and that in the foreseeable future SIBs will likely “remain reliant on philanthropists and social investors”.
Furthermore, demand from retail investors have much to do with their knowledge of the product but also their appetite in regards to risk and rewards. SIB contracts are generally longer-term and don’t carry a fixed rate of return unlike conventional bonds. Upon realizing this, one investor opted to withdraw his application in the Future for Children Bond.
Investors also risk their principal investment if programs are ineffective. In reality, this is a major concern for investors. The Future for Children Bond, for instance, tried to lower risk by funding the Places for People initiative. New York’s bond, as another example, brought on a philanthropic foundation to cushion the investment, even when the investment was made by billion-dollar bank Goldman Sachs.
While policy for the UK and US social finance market focus greatly on SIBs, NPC argues against developing a market focused on SIBs and instead, for developing simpler social investment products to appeal to a wider range of investors and their advisors for sake of unlocking additional sources of capital.
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