In 2005, Merrill Lynch reportedly made a loan to Marvel Studios so that it could begin the development of the movie The Avengers. It would therefore seem anything but unusual that the wealth management firm, now owned by Bank of America, would invest in another partnership, right?
Except this time, instead of Iron Man, Captain America, The Hulk, and Thor, the partnership consists of Bank of America Merrill Lynch themselves, Social Finance Inc., New York State, the Center for Employment Opportunities (CEO), the U.S. Department of Labor, Chesapeake Research Associates, and The Rockefeller Foundation.
Rather than dealing with super villain Loki, the partners are coming together to tackle recidivism through training and employment of formerly incarcerated individuals.
Bank of America Merrill Lynch and company are calling this new $13.5 million program a social impact partnership. Yet upon closer look, it’s a social impact bond as we know it – not a bond in the conventional sense but a type of financial contract nonetheless between multiple parties.
As far as the roles of each party is concerned, Social Finance, a nonprofit dedicated to facilitating the movement of capital towards fixing societal problems, acted as the intermediary by bringing the partners together and helping structure the investment and raise capital.
The project has been in development for over 16 months, with capital raised over the last two months. More than 40 high net worth and institutional clients of Bank of America’s Merrill Lynch and U.S. Trust invested an average $300,000 to fund the program, including former US Treasury Secretary Larry Summers, well-known impact investor James Sorenson, The Pershing Square Foundation, and billionaire investor and oil trader John Arnold, according to the bank. The Robin Hood Foundation committed an early $300,000 investment too.
The initiative targeted ultra wealthy investors who needed to have investable assets greater than $10 million and invest a minimum $100,000, which is not surprising. Over in the UK, an attempt to create social impact bonds for the average investor was unsuccessful. The reasons for failure included high take-up costs and a product too complex to match with consumer’s appetite. In fact, analysts believe this type of contract will remain a product for wealthy and institutional investors.
Funds will be used to finance programs delivered by CEO, which provides training and employment service programs to formerly incarcerated individuals in New York. In this partnership, CEO will provide skills training, transitional employment, job placement, and retention support over a four-year period to 2,000 individuals soon after their release.
During a telephone news conference on Monday, Tracy Palandjian, the head and cofounder of Social Finance, noted that upwards of 50 percent are back in prison within three years of their release. “Correction costs” have tripled over the last thirty years, making prison spending the fastest-growing budgetary item after Medicaid in the US.
If the project reduces recidivism by at least 8 percent and/or increases employment by at least 5 percent, investors will be repaid, according to a news release by New York State. If it performs better than these targets, investors can earn a positive return on their investment that is proportionate to the savings and benefits achieved by the public sector.
Andy Sieg, Merrill Lynch’s head of Global Wealth and Retirement Solutions, said that investors can expect a maximum annual return of 12 to 12.5 percent, although the probable returns are in the high single digits.
Although the investment is for five-and-a-half years, the initiative is divided into two capital calls that will fund services for two different “cohorts” of formerly incarcerated individuals. There will be two payment dates: one at year four and one at year five-and-a-half.
Given this structure, the U.S. Department of Labor will provide outcome-based payments to investors for the first 1,000 individuals served, while New York State will make such payments for the next 1,000.
Outcome-based payments mean that payments will only be made if the project meets identified success metrics. Therefore Chesapeake Research Associates will play the role of referee. As “validator”, they will help determine the program’s success by ensuring that the outcomes are properly measured.
Finally, where there is a social impact partnership/bond, there will likely be The Rockefeller Foundation. Attracted to these contracts because there is more money available in the commercial-oriented capital market than philanthropy and government combined and the potential to bring a kind of rigor that commercially-oriented investment has to the workings of the social sector, The Rockefeller Foundation will be providing a $1.32 million guarantee, or 10 percent of the investors’ principal, should the project fail to repay investors 100 percent of their original investment.
This transaction represents several firsts, said Palandjian. It is the country’s first state-led social impact bond, largest capital raise to date globally, and first-ever offering being distributed by a leading wealth management platform to their qualified investors.
It will likely not be the last too. An increasing number of clients are seeking investment opportunities with greater social purpose, said Sieg, who expects the bank as well as competitor firms will pursue future offerings in social finance. While the transaction is the largest to date, it is still relatively small compared to all the capital that is raised in the marketplace, he said. In North America alone, there are over $12 trillion of individual assets under management, Palandjian added.
“We’re seeing tremendous momentum. Clearly recidivism is one of these favourites, if you will, for pay-for-success structures,” said Palandjian. “The pipeline in terms of geography as well as social issues being explored are truly extraordinary.”
Over 10 US states are exploring pay-for-success contracts including Massachusetts, South Carolina, Michigan, Illinois, and Colorado.
Besides recidivism, areas where pay-for-success contracts may apply include health management of chronic illnesses like asthma, maternal health and early childhood outcomes, elderly care, and any application area where one dollar invested in prevention today will save many more dollars treating the problems down the road.
“We believe that 2014 should be a pivotal year for these pay-for-success social impact partnerships,” said Palandjian, adding that we could see “around $300 to $500 million worth of pipeline over the next 24 months.”
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