Anti-social investors?

Social investment probably hasn’t crossed the radar of many institutional investors yet; the market is still too new and too small. However, it’s clearly on an upward curve: a new report by The Boston Consulting Group, commissioned by Big Society Capital, suggests the UK market alone could be worth £1 billion ($1.6 billion; €1.2 billion) by 2016. 

According to Adrian Brown, who co-authored the report for BCG, there are a number of trends underpinning this – the key one being the changing role of the state. “The government is increasingly opening up public services to competition, and it’s increasingly moving to a model where it’s purchasing social outcomes – which means more payment by results,” he tells Private Equity International. “That’s really interesting as far as this market is concerned, as it creates lots of new investment opportunities for those prepared to share the risk of delivery.”

The UK also has a head-start in this area due to the investment talent and financial expertise available in the City of London, he adds.

At the moment, social investment tends to be the preserve of high-net-worth individuals and foundations with a philanthropic bent. Here, the attraction is obvious: if the alternative is giving your money away, any sort of return is a bonus. 

But the big goal for many involved in the field is to attract more institutional capital into this burgeoning asset class – because ultimately, that will make it easier to solve big social problems.

At the moment, there are some obvious obstacles to this. One is size; as BCG points out, even at £1 billion, the market would only be about 1 percent of that for small business loans, which makes it hard for big investors to write meaningful cheques.

Return expectations can also be an issue, he suggests. “[Investors are] unlikely to accept lower-than-market returns. That’s particularly true as it’s so hard to assess the level of risk – these are new markets, and the organisations involved have no real track record. So if anything, investors might demand higher returns.”

However, the BCG report also hints at one potential attraction for institutional investors: the possibility that the returns from social investment will actually be uncorrelated – or even negatively correlated – to the economic cycle. For instance, an organisation that makes its money trying to get unemployed youngsters back into the workplace might actually be busier when economic times are tough. So social investment could turn out to be a useful diversification strategy.

Previously, this argument has been used to justify investment in private equity and other alternative assets. But these days, more and more people are questioning this supposed lack of correlation. If the social investment market does manage to scale up substantially, could it eventually come to be seen as a better way to hedge against the cycle – and thus eat into private equity allocations?

Perhaps – but that day remains a long way off. In the meantime, as with any virgin investment territory that isn’t particularly well understood, there are likely to be good returns available for the brave pioneers. “This market is very new and evolving quickly,” says Brown. “So investors who are prepared to put in a little bit of legwork with the relevant organisations can uncover opportunities that have not been available before.”