Impact investment: The promise of social impact bonds

Social impact bonds offer the enticing prospect of funding preventative social programmes governments couldn’t otherwise afford – while allowing investors to make a decent return.

How do governments persuade taxpayers to fund expensive and unproven social programmes that might save public money in the long run, but the benefits of which (even in a best-case scenario) won’t be apparent for several years? Answer: they don’t, generally.

Social impact bonds (SIBs) are a new kind of financial instrument intended to help private capital fill this gap. The theory is that investors provide up-front funding for these programmes – which are delivered by specialist providers – and are paid according to how well they work. 

For instance, the first ever such bond, in Peterborough in the UK, was designed to reduce reoffending among released prisoners; so investors will be paid based on the fall in the recidivism rate (or not). 

The attraction for governments is obvious: reducing reoffending saves public money (in terms of law enforcement, prison costs, welfare and so on), so they get better social outcomes at a lower cost. And by sharing some of that financial upside with investors, they can encourage more such schemes. As for investors, it allows them to back projects with a very measurable social impact in a more sustainable way – because they not only preserve their capital but make a return on it (all being well).

Bridges Ventures, a UK-based ‘impact-driven’ investor, has just launched a new Social Impact Bond Fund, which recently held a first close on £14 million (including a cornerstone investment from Big Society Capital, the UK’s new social investment bank). The firm had previously backed three UK SIBs through its Social Entrepreneurs fund (which normally provides quasi-equity to help social sector organisations grow). Since launching the specialist vehicle, it has invested in a fourth SIB, and expects to do around ten more over the lifecycle of the fund.

“We need innovative services and interventions to address growing societal problems, and innovative funding sources to provide the investment,” says Anthony Ross, head of social sector funds at Bridges. “It’s early days, but the opportunity is enormous.”


According to Ross, there are typically two big challenges. The first is working out who should pay. At the heart of these bonds is the contract between the provider and the benefiting body. But since something like a reduction in reoffending saves various departments money, it’s not always obvious who the counterparty should be. 

The good news, says Ross, is that the UK Cabinet Office has been actively supporting local authorities on issues like this; it has even established a fund to plug the gaps, to save local authorities having to broker a tripartite agreement with another branch of government.

The second big challenge relates to the vital importance of all those concerned being comfortable with the metrics used – so the provider feels it’s a fair measure of their performance, and the body commissioning the scheme is happy to pay because it saves money overall. One issue can be that the commissioning bodies often don’t have the underlying data to act as a baseline – so there’s often a degree of research and analysis required in the first instance. Then the danger can be that in their eagerness to make sure they maximise their saving, the commissioning body effectively makes it too hard for the provider to get paid.

Obviously, however, this ought to get easier as all those involved become more familiar with the process. As Ross says, having a specialist vehicle, with all its accumulated knowledge, should help the market’s development. “The knowledge base is growing. And managing a focused fund will enable us to bring support and experience to both social sector organisations and commissioners entering the market.”

Bridges analyses these ‘bonds’ much like it would a typical equity investment. “The key requirements for a successful SIB are: an intervention that can deliver real measurable impact, and a team that can deliver,” says Ross. And it works with providers much like it would work with its normal portfolio companies. “The investors need to bring a lot of hands-on support to help with the structuring and performance management, particularly in the early years when the project is being set up and launched.” The difference, of course, is that this is a defined project for a defined period of time – so there’s no need to worry about building it up towards a profitable exit.


The UK may have been leading the way on SIBs, but there’s also been a great deal of interest from overseas, particularly the US. 

In August last year, New York City agreed a deal with Goldman Sachs whereby the bank would provide $9.6 million in financing for a social programme called ABLE, which aims to stop 16-18 year-old prisoners at Rikers Island jail from re-offending. The agreement was that Goldman would loan the money to a provider called MDRC, which would design and oversee the delivery of the programme by a couple of non-profit organisations. If recidivism falls 10 percent over four years, Goldman gets its money back; if recidivism falls more than 10 percent, Goldman can make up to $2.1 million profit.

Although there’s only one investor, this is essentially the same structure as the social impact bonds in the UK – but with one interesting twist. Bloomberg’s philanthropic foundation is guaranteeing up to $7.2 million of the loan, which means the most Goldman could lose would be $2.4 million. This arrangement has attracted a degree of controversy, but the rationale is compelling. However confident the parties involved are that the scheme will work, it makes sense to try and provide some kind of downside protection for the investor – until such time as there is some demonstrable track record.

Indeed, this highlights an important point about the future of social impact bonds. Currently, most of the investors in the UK SIBs have been social investors – foundations or high-net-worth individuals or institutions with a specifically social mission, some of whom now treat social investment as an asset class in its own right that sits somewhere between their commercial and philanthropic investments. 

But if this burgeoning ‘asset class’ wants to attract more large investors from across the spectrum – as it ultimately must if it’s ever going to really scale – it needs to find ways of making the proposition as appealing as possible. 
Long-term, the hope is that SIBs should be able to deliver net returns in the region of seven or eight percent. This will probably be a long shot for a small and experimental fund like that of Bridges, which is still feeling its way in a nascent market. But the hope must be that it at least provides some evidence that returns like that are possible. 

Currently SIBs have attracted what Ross describes as the “early movers”. But if these bonds work as planned – and if they can produce yields in that sort of region – in time there may be plenty more investors of all stripes following in their footsteps.