John Anner and East Meets West were featured in Clearview Publishing's Wealth Briefing and Family Wealth Report, highlighting Development Impact Bonds and featuring John Anner discussing EMW's pioneering output-based aid efforts with the World Bank. A portion of the report is reprinted below.
Emerging Sub-Sector of Impact Investments: Impact Bonds
Julie King is a founder and managing director of the Galileo Agency, a commercial agency specializing in the water and alternative energy technology space; digital entertainment sectors; and generating international transactions for clients from developing countries. Here, King provides an overview of how the impact investment sector - which is gaining ground in the high net worth arena globally - is testing a promising new investment structure called impact bonds. Constructed as either social impact bonds (SIBs) or development impact bonds (DIBs), impact bonds are aimed at funding results-based social initiatives, she explains.
Impact bond model
Both SIBs and DIBs share common characteristics. But although the name has stuck, impact bonds are not traditional bonds. They are contract-based relationships between any combination of collaborators, including public agencies, private companies, foundations, governments and not-for-profits. They are for a fixed period, but there is no fixed return.
Impact bonds have both equity- and debt-like features and are used to fund the expansion of services delivered by established not-for-profit organizations with a proven track record of providing social programs. Independent evaluators verify whether program objectives have been achieved and the contracted payer, such as a government or donor agency, is the financial backstop. But repayment of the investment and return on investment are contingent upon the achievement of the agreed social outcomes.
In its report, Social Impact Bonds: An Overview, Social Finance UK explains: “Social Impact Bonds align the interests of non-profit service providers, investors, and governments in an effort to improve the lives of individuals and communities in need. Their core feature is the provision of funding for upstream prevention or early intervention programmes that significantly reduce the need for subsequent and more costly remediation.”
Original SIB
The original SIB was launched in 2010 to fund a medium-term preventative program aimed at reducing the reconviction rates of short-sentence male offenders leaving Peterborough Prison in the UK. For the Peterborough SIB, Social Finance UK secured investments from 17 organizations for a total of £5 million ($8.3 million), working with “one step” service providers, including St Giles Trust, Ormiston Trust and the YMCA.
The Peterborough SIB payer is the UK Ministry of Justice and the Big Lottery Fund. Outcomes for the SIB’s interim milestones were released in October 2013. Since 2008, the numbers show a 12 per cent decline in the frequency of convictions per 100 prisoners. These numbers compare with an 11 per cent increase nationally. The first report of outcomes, which will (or not) trigger payments to SIB investors, is scheduled for release in April 2014.
Development impact bonds
DIBs were originated in response to the awareness by international donor agencies and organizations, young aid workers and not least by beneficiary countries, that after billions of dollars and decades of programs, output-based – as opposed to outcome-based initiatives – have largely failed to achieve the overarching objective of reducing poverty.
“We have found governments and donors alike are struggling to effectively address social issues,” said Avnish Gungadurdoss, managing partner at Instiglio, a not-for-profit implementing DIBs in Central America and Southeast Asia. “The solutions were not keeping up with how fast the problems were scaling up. We are bringing the SIB financing mechanism to help improve the impact of their social programs. By tying funding to verified social impact and aligning the incentives of implementers with the goals of funders, SIBs introduce a new level of accountability to the people that governments and donors serve.”
Social Finance UK and the Center for Global Development have been instrumental in the research and development of the DIB model. In 2012, a DIB Working Group was formed with a coalition of organizations from the UK, the US and Sweden to study the feasibility of DIBs using six pilot programs.
Elizabeth Littlefield, of OPIC and co-chair of the DIB Working Group, says their research concluded that: “Innovative financing mechanisms such as Social Impact Bonds... [as] outcomes-based finance can be a powerful means of enhancing the effectiveness of aid and development finance. But SIBs are “more than a new financing model: they are a new business model for delivering public services that provide the flexibility to focus on addressing individual needs and a clear incentive to re-engineer delivery and innovate to reflect learning as it is gathered.”
“There are essentially two basic funding models for international development,” said an Omidyar Network spokesperson: “being entirely reliant on grant money or being entirely reliant on private sector capital. For private sector capital you will need a viable revenue model and be able to show that an investor will receive a running return on their investment. This means there is an on-going cost of capital.”
“DIBs provide medium-term risk capital to prove out something without the continued need for for-profit returns once that has been proven,” the spokesperson added. “Someone needs to take the up-front risk to establish the [solution]. The DIB investors provide the risk capital, knowing they are paid back first by the government when it sees what works. The government has the payment obligation. At that point, there is a functioning, built asset and the government covers the on-going costs at its own lower cost of capital.”
“Foundations and high net worth individuals making philanthropic investments are taking on risks that others won’t take,” said Gungadurdoss. “But they are understanding that investing in SIBs can potentially renew their funding streams, providing sustainability to their funding practices. If a program works, they recover their funding. SIBs thus offer an interesting advantage over traditional grant financing.”
“The real value generation of DIBs is about backing an innovation of some kind – whether that is an innovative business model or solution,” the Omidyar Network spokesperson said. “DIBs are best placed for this role. [They] are most intriguing for two areas: delivery capacity, where there is risk in the set up-sector and delivery system, and secondly, for a new approach tied to a specific problem. They are probably not the best solution for something that is already known to work and where delivery capacity already exists – they would not typically be the most cost-effective solution in those circumstances.”
The East Meets West Foundation in Oakland, CA, is well beyond the pilot phase for DIBs. To date it has executed $25 million in “results based financing”, which is the DIB model in the water and sanitation sector. It currently has 2 DIBs structured with funds from the Australian government and the Gates Foundation.
“We were the first non-profit to get a grant from the World Bank for $4.5 million for a piped water system in Vietnam,” said John Anner, president of the East Meets West Foundation. “The World Bank hired an independent evaluator to review delivery of household connections to confirm that the objectives had been met. It was a very successful RBF and the World Bank is now using this model.”
Increasing interest from institutional investors
Until recently, institutional investors have shown little interest in impact bonds. But this may be changing.
“Institutional investors care about volume, return and volatility or correlative risk”, the Omidyar Network spokesperson said.
“Impact bonds are interesting in this regard: if the impact bond gets set up, then the potential supply is much bigger. The absolute return may be lower. But it is not tied to a company being built and sold. Instead it is tied to the achievement of a specific result. Therefore it is a non-correlative risk within the equity market. Impact bonds become an asset diversity play. Institutional investors are starting to look at this aspect now in considering impact investments as an asset class. Impact bonds become an economically sensible combination to have.”
Still early days
Can capital actually grow at the same time it is deployed to solve society’s problems? Gungadurdoss, at Instiglio, says it can. “SIBs solve a major challenge for impact investing, which is having a consistent double bottom line. Traditionally, impact investors trade off between social impact and financial impact,” added Gungadurdoss. “Impact investors understand that they are sacrificing a financial return to create space for accomplishing a social goal for a vulnerable population.”
“SIBs offer a complete alignment between social and financial returns,” he added. “If programs achieve a higher social return, then there will be a higher financial return for the investor. The double bottom line dilemma is solved: achieving the maximum social impact generates the maximum financial impact.”
Anner continued: “RBF is a powerful mechanism for maximizing returns on financial and social impact. But they are not market returns. There are three parties to a DIB contract: the payer (government, donor agencies, etc.), the lender (impact investors) and the implementers (not-for-profits). Bringing DIBs to scale requires all three. Institutional investors will lend. It is the payer who is harder to find.”
Conclusion
There is a saying in Swedish: “out of chaos comes order”. It won’t be the status quo again; it might not be the order one expects. But a new order will come. From the impact investment sector, disruption is occurring to how society finances solutions to its greatest problems. That new paradigm is beginning to take shape. But it is still under construction.