Investing for social impact: new signs of promise

Some bond investors aim to earn a return by putting money toward achieving a social good, such as lower recidivism rates. In the process they're upping the ante for governments to better measure progress – not just how many people a program serves.

It started with a simple premise: Private investors could help reduce the rate at which released British prisoners commit new crimes.

Seven years later, the recidivism project at Peterborough Prison stands as a success. Its intensive work with male prisoners who serve less than a year offered help with housing, training and employment, parenting, substance abuse, and mental health. It reduced recidivism by 9 percent among 2,000 prisoners, saving the British government enough money in prison and other costs that the investors who funded the experiment got a 3 percent annualized return over five years.

Since then, the mechanism behind this success story – known as pay for success or a social impact bond (SIB) – has spread to 24 countries, according to a report released this week by Social Finance, a nonprofit that sets up such bonds. So far, private investors have funded 108 projects aimed at saving governments money with innovative projects serving everyone from homeless youths in Australia to parents in need in Germany to blind people in Cameroon.

It's a novel idea with big potential implications, but also relatively new, and its success depends on how one counts. The new report sheds light on the progress SIBs are making. The investors – typically institutions and wealthy individuals who want their money to have a social impact – have been paid back in 10 of the 27 projects that have wrapped up, according to the Social Finance report. Just one project failed (a New York City recidivism effort), and 16 others have not made their results public. [Editor's note:  The number for finished projects has been updated from the original version of this paragraph.]

For governments and social-service providers, even failures can provide valuable insights. And since private investors foot the initial bill and only get paid back if the project saves taxpayer money, SIBs allow them to experiment without risking government funds.

The most important impact of SIBs, however, may be a shift in thinking.

“We’ve really begun to change the way [our partners] look at the world,” says Tracy Palandjian, chief executive officer and co-founder of the US arm of Social Finance, based in Boston.

Because SIBs require metrics of success to determine whether investors should be paid, they are causing governments, social-service providers, and social-minded investors to change their focus from the number of people they’re serving to the effectiveness of those programs, she says. “The mind-shift is our proudest accomplishment.”

It is also quite rare, at least in the United States. In a 2013 article for The Atlantic, former government officials Peter Orszag and John Bridgeland wrote that they were flabbergasted when they calculated that less than $1 of every $100 of government spending was “backed by even the most basic evidence that the money is being spent wisely.”

The idea of wiser spending can attract politicians from across the political spectrum. In Britain, the groundbreaking Peterborough SIB was initiated under a Labour government, carried forward by a coalition government, and has earned kind words from Prime Minister Theresa May's Conservative Party, says David Robinson, chair of the Peterborough program for the British arm of Social Finance. “What I hope will be the long-term outcome is that government performance does improve.”

Here in the United States, the spirit also has been bipartisan. In Massachusetts, for example, SIBs initiated by former Democratic Gov. Deval Patrick have been taken up by his successor, Republican Gov. Charlie Baker. This past June, as the national debate heated up over immigration, Governor Baker and Social Finance announced a new program to help improve immigrants’ reading skills and provide them with job training in six Massachusetts cities.

Not everyone’s a fan, and even at their best SIBs won't be the answer to every social problem.

When the Maryland Department of Legislative Services looked into the feasibility of an SIB to reduce recidivism, it concluded: “Even when using a set of highly optimistic assumptions, it is clear that pilot reentry programs cannot self-finance their operations. Because pilot programs cannot create a large enough reduction in demand to close a facility, the cost dynamics are driven by much smaller marginal cost savings.”

Even several of the successful SIBs come with caveats for investors. They used multiple targets, some of which were met and paid investors a return. Other targets were not met and did not pay out. 

And while some SIBs offer a sizable return – an ongoing Australian program to reunite institutionalized kids with their families paid out 8.9 percent per year in its first two years – returns are often quite small versus comparable investments. SIBs typically come with a much higher risk of losing one’s capital than traditional bonds, so their appeal is mainly to so-called impact investors, who are willing to accept a less generous risk/reward profile.

Even successful SIBs don’t always change minds. The Peterborough project, for example, which officially launched the SIB movement, was cut short so that a national prison reform could be implemented. The reform didn’t embrace the lessons that the Peterborough project had uncovered about recidivism, says Mr. Robinson. Under the reforms, “the rehab work that has been done by the contractors is tiny or nonexistent.”

In Britain, which has hosted more SIBs than any other country, momentum has slowed. In 2015, the country initiated 15 of them. In the following two years, it averaged only five a year. Social Finance blames the slowdown on the government, which has establishment a bureaucracy to deal with the projects, which means more consistent vetting of new projects, but which has also slowed down the pace of approvals.

SIB proponents are quick to point out that the bonds can’t substitute for government funding. They only allow government experimentation and close tracking of results. Also, they’re not the proper tool for all social problems.

“It's a work in progress,” says Ms. Palandjian of Social Finance. “It's one of the many tools in a toolbox for governments to use.”

Still, investor interest remains strong. "We are looking to do more pay for success projects on a national level," Miljana Vujosevic, director of impact investments at Prudential Financial, writes in an email. Since investing in the Massachusetts SIB for immigrants, the investment firm has invested or provided grants to other foundations and funds involved in SIBs.