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What is Social Impact Bond and Why invest?

What are the advantages of Social Impact bonds? should you invest in a Social Impact Bond?

Financing social policies and essential social services are always important. It ensures that whatever benefits that every citizen must enjoy are available to the fullest and that everyone will have access and are entitled to it. It also ensures that no one is left behind, and whoever may be lagging will be accorded help and given what is due to them.

But financing them is a tricky and contentious issue worldwide. There is a considerable debate about who must fund or finance the essential social services. Should the government do everything in its power to uplift everyone in society? Or should the private sector shoulder most of the burden? There is even debate whether the government should be involved in it.

Whatever the case may be, both the government and the private sector, at various times, have partnered and teamed up for social amelioration projects. One of the ways they have worked together to improve society is through social impact bonds. But what are social impact bonds?

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What is a social impact bond?

Definition of the social impact bonds

Social impact bonds are forms of financial investments which bind the government and the investors to a specific social project or policy, the success of which will ultimately determine whether the investment will be profitable or not. It is an innovation in finance, incorporating the old notions of a financial partnership between the private and the public sector.

The usual definition of social impact bonds is a non-tradeable bond used to financially support particular policies or services. It is already a curious animal. It is different from the usual concept of bonds as we know it and differs from the usual private-public partnership that characterizes most government and state-sponsored projects.

Social impact bonds are not your usual bonds. They do have a fixed term, yes, but they do not have a fixed rate of investment return. Everything will depend on the success of a particular project or policy. If the project is a success, the investors will make money. The reverse is equally true: investors will lose money if the project fails.

Unlike the usual bonds, they are not guaranteed by the government. The price will rise or fall depending on how the particular project develops. The nearer the stakeholders are to their professed objective, the higher the price, and the farther they will fall. Therefore, the success of the investment is predicated on the progress of the project itself.

Another difference is that, unlike usual bonds, social impact bonds are non-tradeable, and you cannot sell them nor trade them for any other asset. It ensures that those holding the social impact bonds remain committed to the goal and the partnership’s success.

The rationale of the social impact bonds, after all, is to get the commitment of the private sector to finance a particular project, not simply to raise funds for the government, which is the rationale for bonds. More than the profit, it is to the social responsibility that the public appeals to the investors.

What are the Advantages of Investing in Social Impact Bonds

Why invest in social impact bonds?

 Since social impact bonds are not your usual bonds, some of the risks associated with usual bonds are absent in social impact bonds. For one, since it is not subjected to a fixed rate, it is not susceptible to the market fluctuations that usually characterize the bonds. Social impact bonds are mainly immune to market forces.

Discussing the concept of social impact bonds, further, social impact bonds are immune to factors such as interest rates and market volatility since the SIBs are tied to specific projects or programs. Since it is non-tradeable, it is also free of the usual risks associated with reinvestment. As such, social impact bonds, high-risk it may be due to contingency, do not increase it by spreading it to other investors.

So why invest in social impact bonds? High-risk, it may seem, safety mechanisms mitigate those risks and allow the investors to profit from the investment. Those mechanisms are embedded in implementing the program financed by the social impact bonds and how it works.

 Also, unlike the usual bonds, there is the possibility of an even greater profit for less time, unlike most government-issued bonds that usually take even longer years to mature. Depending on the program’s success, more significant profit is always possible, more than those afforded to the investors by the usual bonds guaranteed by the government.

To explain further, we must understand how social impact bonds essentially work.

The social impact bonds: how does it work?

So how do social impact bonds work?  In some ways, it works like the usual bonds: the government will issue it, people and investors will buy it, and wait for a fixed term. After some time, the investors can redeem the bond for a certain amount.  The government issue bonds to raise additional funding for its social services.

Here though, the similarity ends. In the case of the social impact bonds, there must be a specific program or project to which those funds will be allotted. And it involves some basic steps that deviate from the usual process but still retain the characteristics of the usual public-private partnership.

Here are the steps you implement a social program using social impact bonds.

1) Identifying some initiatives

The first step is to know what type of program or project should be funded.  Social groups or categories in need of help or very much needed funding. Marginalized sectors of society in need of various social amelioration programs and social and public policies that are in dire need of support from various sectors are the usual beneficiaries of social impact bonds.

Experts will study the program, including those from the government and the private sector. They will make a feasibility study, both on the possible positive social outcomes and the possibility of profit for the investors based on those outcomes. Once feasibility is decided, the government will usually initiate the deal.

But it is possible too that a program may be initiated through public-private initiatives. Since 2010, various programs involving government and public-private initiatives were started and implemented

2) Identifying possible investors and asking for their support

The government and its partners would then look for possible investors for financing. The investors would be the stakeholders for the program or project, most likely to have a keen interest in making the program successful. Those investors would not be entirely driven by profit, but must also be interested in promoting social good.

For instance, if a government wants to finance some housing programs, those interested in housing projects and the like would most likely be interested in it. They could be tapped to be investors for a particular housing project and would be interested in acquiring social impact bonds specific to the project.

Holding social impact bonds, those investors, in various ways, will see to it that the program would be a success. Otherwise, they risk considerable losses. Either they will actively participate or lend a hand helping those in charge of the project, ensuring that the project is implemented or completed.

Those in charge of the project must inform the investors about the parameters and metrics of the project. How much interest would be paid, for instance? And relative to the outcome or success of the project, how much profit is expected. What are the possible risks, how great it is, and how could the program impact both investors and society?

3) Putting the project at work

Once the necessary capital for the program is available, the project manager tasked to handle the project will implement the program according to the plan and as envisaged by the government or interested parties. The project manager will ensure that everything is in place, completed, and achieved the desired results.

The implementors of the project have the duty to inform the government and the stakeholders about its progress. Are the targets being met? Are there any roadblocks or hindrances in implementing it? How successful is it? Could it be finished on time?

The implementors have to be transparent, for a lot is at stake. It is a project for the good of the society and community, something entrusted to them by the government, and which good money was put and invested by the stakeholders. Whatever pitfalls are out there, the stakeholders, government, and the public have to know.

4) Evaluating the success

As they implement the program or the project completed, it must be evaluated, based on the feasibility study made before and the projections made, whether it was a partial or complete success, whether the targets were achieved, or a miserable failure. Assessment of the project’s overall social impact will also be considered.

An independent evaluator would do the assessment. It could be a panel of experts, a think tank, or an individual, group, or institution that has the expertise about the matter. It is the final stage in the transparency, which would declare whether the program or project is a success or a failure.

And based on their judgments and predetermined parameters, the investors will either profit or take a loss. The actual amount of profit depends on how the program impacts the community, how large or small the difference it makes, or whether it has achieved all the desired results or just achieved some of those projected.

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Social impact bonds: invest in sustainability

Since the profitability of social impact bonds ultimately depends on the success of a particular project, we can say that the primary theme that underlies all this relatively new concept is that of sustainability. As long as the program achieves its target, taking big or small profits is always a real possibility.

To invest then in social impact bonds is to invest in sustainability. In itself, it is not an unusual investment, for some can honestly wait and be patient as they see the positive results start to trickle in, slowly but surely.  Businesses thrive by piling on small successes and building on them as time progresses. Investing in social impact bonds is no different.

And those who have faith in the experts and trust them completely to do their job would genuinely be well-advised to invest in sustainability. Although policymakers and experts may be fallible, their studies are generally sound and reliable, as they are mostly guided by science and rigorous methodology.

The Disadvantages of Investing in Social Impact Bonds

Ever since it was first used to finance a social program in the UK in 2010, it has achieved multiple and varying levels of success.  However, much criticism has been leveled against it, owing to several disadvantages that seem inherent in the program. Some point out that the disadvantages of investing in social impact bonds outweigh the advantages.

 What to watch out for with social impact bonds

High risk

Critics argued that investing in social impact bonds is highly risky. Especially so because profiting from these bonds is ultimately dependent on a program’s particular outcome rather than the government’s guarantees. The government, after all, has all the necessary resources to cover the possible losses that may result in investing in social impact bonds.

The criticism is not entirely unfair. Bonds, after all, are usually guaranteed a fixed rate of return, and their absence in the social impact bonds may be considered an anomaly. And no matter how rigorous the methodology of any feasibility study is, the possibility that a project may fail due to some factors and other variables can never be discounted entirely.

The risks are real, but they are also exaggerated. For one, investing in social impact bonds is as risky as any other investment. It is entirely no different from investing in other ventures, like the stock market or other businesses. Risks are ever-present in any investment, but there is no reason to believe it is as risky as any other.

More so because the social programs or projects usually outcomes of meticulous study. Everything is scrutinized thoroughly even before the government or a private organization makes a case for a project. In short, though they may be at risk because of the lack of guarantee, it is not as high-risk as supposed to be by some of the critics.

It could go wrong, but those risks could be mitigated with the private and public institutions sharing responsibility. Ultimately, the absence of guarantee seems to be the strongest case against the social impact bond, but considering its contingent nature, the possibility of profit could also be more significant compared to usual bonds.

Non-tradable asset

But one significant limitation of the social impact bonds is that they are non-tradable assets. Once you buy, your commitment to a project must be absolute, and you cannot exchange horses in the middle of the race. Unlike the usual bonds where you can profit through a trade before maturity, such is not possible in social impact bonds.

That could be a significant disadvantage to some who are impatient and are more into a quick return of investment. That is why those who invest in the social impact bonds must be wholly sold to the idea of commitment to community and helping others through social programs to remain wholeheartedly committed.

And there lies the trick. The social impact bonds being non-tradable, this fact could significantly contribute to the desire of every stakeholder, both public and private, for the whole endeavor to succeed. There is no other way around it, and all of them will gain or lose depending on the project.

Conclusion: Start Investing in Social Impact Bonds Today and Do Good While Doing Well

Weighing the pros and the cons, investing in social impact is a bright idea. Despite everything, money and profit are significantly possible. The best argument for it is you make money as society makes progress, and you help yourself as you help others have a better life and better future.

But the best thing, aside from making money, is that you contribute to the betterment of society. As you invest in social impact bonds, you create and increase social capital, contributing to the atmosphere of trust between the private and the public sphere. Trust between government and private institutions is vital for continuing the partnership and the cooperation between the two.

As for you, you expand your reach, social base, and influence if you invest in social impact bonds. Every company participates in some form of social activity and willing to take some responsibility. But some are more responsible than others, and those willing to extend their hand further to help others certainly deserve a lot more from society itself.

Social Impact Bond

Jess M

Social Impact Bond definition
Pros and Cons of Social Impact Bond
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What is a Social Impact Bond?

Social impact bonds are forms of financial investments which bind the government and the investors to a specific social project or policy, the success of which will ultimately determine whether the investment will be profitable or not. It is an innovation in finance, incorporating the old notions of a financial partnership between the private and the public sector. The usual definition of social impact bonds is a non-tradeable bond used to financially support particular policies or services. It is already a curious animal. It is different from the usual concept of bonds as we know it and differs from the usual private-public partnership that characterizes most government and state-sponsored projects.

References:

https://www.adb.org/sites/default/files/institutional-document/691951/ado2021bn-developing-social-impact-bonds.pdf

https://www.cgdev.org/page/investing-social-outcomes-development-impact-bonds-0

https://www.oecd.org/cfe/leed/UnderstandingSIBsLux-WorkingPaper.pdf

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About the author

Naia Toke

Naia has over 15 years of experience advising Fortune 1000 employers in Diversity and Inclusion. Naia holds a Master's degree in Human Resource Management with a research focus in workplace equality.