As Ben Franklin noted, an ounce of prevention is worth a pound of cure and that's true not only for health care but also a host of social problems, including crime, homelessness and teen pregnancy. But governments aren't particularly good at funding preventive services. Spending tax dollars on programs whose outcomes are not immediately obvious or guaranteed is a hard sell for politicians, even though these investments may eventually save big bucks years down the road by, say, cutting crime and prison populations.
The market may overcome the prevention predicament in the form of the social-impact bond (SIB), a new investment product created by Social Finance, a London private-equity firm that backs social entrepreneurs. Funded by private investors (including charities), SIBs which are also gaining traction among U.S. investors and policymakers aim to finance long-term, preventive programs run by nonprofit groups to tackle tough social issues that cost taxpayers money. But investors can also gain a financial return. How? Governments pay for a program's success. If an SIB-funded program mitigates a problem by meeting measurable targets, that saves the government money, and a portion of the savings is used to repay the bondholders with interest. But the bonds are not government backed: if the social project fails to meet its targets, investors are out of pocket, and the government doesn't pay a penny.
Social Finance's first and, so far, only SIB was launched last September: 17 investors, including the Rockefeller Foundation, bought bonds totaling about $8 million to finance an eight-year project led by the nonprofit St. Giles Trust to reduce recidivism among low-level criminals, who in the U.K. have a reconviction rate of 60%. Each recidivist costs the government more than $200,000 a year in judicial and incarceration costs. The St. Giles program, Through the Gate, uses peer advisers most of whom are ex-cons themselves to mentor newly released prisoners and counsel them on issues ranging from housing to employment and training to drug and alcohol abuse. The program will target 3,000 male ex-offenders released from Peterborough Prison in Cambridgeshire. If it cuts the reconviction rate by 7.5% or more compared with a control group, investors will recoup their money plus a graduated return that is capped at 13% a year.
SIBs are the most innovative instrument in a growth area of finance known as social investing or impact investing, which offers to help investors do well by doing good. "Investing simultaneously for financial returns and social returns is not mutually exclusive," explains David Hutchison, Social Finance's CEO. In a recent report, investment bank JPMorgan argues that "impact investments are emerging as an alternative asset class" that channels "large-scale private capital for social benefit."
In Britain, an estimated $300 million has already been poured into social investments, and Hutchison expects that figure to grow quickly. That growth could be abetted by the plan of Britain's coalition government to set up a "Big Society bank" for impact investing that's initially funded with $495 million $330 million from the country's four biggest commercial banks and another $165 million from unclaimed assets in orphaned accounts. Moreover, if U.K. charitable trusts, which are sitting on assets totaling $115 billion, put just 5% of that capital into impact investing, it would enlarge the market by another $5.7 billion. JPMorgan calculates that the global social-investment market could swell over the next decade to anywhere from $400 billion to $1 trillion, generating profits of $183 billion to $667 billion.
The need for social investing is acute, the JPMorgan report claims, because the scope of so many of the world's social problems simply overwhelms government and charity funding. Because many outstanding nonprofits are dependent on the vagaries of unpredictable grants and state funding, their ability to expand their operations is limited. In the U.S., 85% of nonprofits have incomes of $100,000 or less. "Revenue is in short supply, and [nonprofits] haven't the ability to grow from five employees to 5,000," says Toby Eccles, Social Finance's development director. Moreover, private investors typically have greater appetite for risk than do government funding agencies.
So far, investors tend to be high-net-worth individuals, trusts and foundations. Many charitable trusts sit on huge asset bases and rely on interest from that cash to fund their works. But social investments, with their potential returns, would also let those trusts tap into a portion of these assets and put it to use. Institutional investors are likely to enter the market once social investments have established a verifiable track record. Insurance companies could find impact investment particularly alluring, since they would also stand to benefit financially from outcomes like lower crime rates.
The Obama White House is interested. The President's proposed budget for the 2011 fiscal year sets aside $100 million in seed money for a trial of what it calls Pay for Success bonds. Social Finance which set up a U.S. office in Boston in January at the suggestion of several large foundations, including the Rockefeller Foundation has advised Administration officials on SIBs. It's also talking to several U.S. states, municipalities and nonprofits about appropriate projects for SIBs, mostly in the areas of adult and juvenile corrections and homelessness. Tracy Palandjian, CEO of Social Finance's U.S. arm, warns that SIBs will work only with organizations that have good track records and offer solutions whose outcomes can be clearly measured: "We're not in the business of funding start-ups."
But an increasing number of social-impact funds are using traditional forms of funding, including equity and venture capital, to give fledgling social entrepreneurs a boost. London's Bridges Ventures, for example, has $250 million under management in three different funds that invest in businesses not all of them nonprofits that strive to achieve positive social or environmental change.
St. Giles head Rob Owen, meanwhile, is confident that the bondholders funding the Through the Gates project will realize a return on their investment. A recent report by Pro Bono Economics, which studied a smaller, earlier version of the program, determined that it successfully reduced reconviction rates by 11% to 18% and that for every pound invested in the program, the government reaped a savings of £10. That's an ounce of prevention worth millions of pounds.