Social impact bonds: why investors put $5 million into reducing youth unemployment

By Stephen Easton

Tuesday April 16, 2019

Australia’s latest social impact bond sale has collected $5 million to help fund a four-year program that aims to reduce youth unemployment, and provide investors returns as high as 12.4% per annum.

That’s only if the program is wildly successful. The target set by Social Ventures Australia, a not-for-profit group managing the financial arrangements, is 7% yearly returns. There is also a risk of losing up to half the principal in the event the youth employment program fails badly.

It all depends on whether 870 young people identified as having “high barriers to employment” can be coached into undertaking significantly more hours of work or “work-like activities” than they would have otherwise, through the Sticking Together program.

Volunteering, training or work experience can make up 25% of their total, the investment brochure explains. The agreed assumption is each would have normally done three hours a week on average, without the coaching.

Contractual arrangements define success and how it is measured, which determines how much the government will estimate the program has saved the taxpayers of the future, and therefore how much the investors get in return.

From the taxpayer’s perspective, that estimate of theoretical future savings best be accurate. The risk to investors, on the other hand, depends on the agreed goals being clear, measurable and somewhat achievable, along with all the other details of the deal brokered by SVA like its early-termination clauses, for example.

Social impact bonds are based on ideas that have floated around for decades, but still leave a lot of people wondering how they work. A common question is: why shouldn’t governments just deliver more and better preventative social services directly, or fund other organisations to do so?

The aim is to attract private investment in social services that can reduce the future cost of public services — hopefully making more funding available in the short term than governments are willing to commit, particularly for new or unconventional approaches.

Advocates also generally emphasise the idea of paying for results through outcome-based contracts and suggest the involvement of impact investors can help social programs succeed, essentially because they have an incentive to be helpful.

Through SVA, the investors in Sticking Together are represented in a working group monitoring its performance, alongside the service provider SYC and the NSW government.

The only certainty, of course, is that investors have an incentive to see the program meet whatever targets were set for it on paper.

If re-elected the federal Coalition proposes to spend almost $20m in the next financial year on social impact investment initiatives, including trials and a new taskforce to come up with a strategy for how the Commonwealth can stimulate the market. It has appointed the founder of SVA, career banker Michael Traill, and impact investing entrepreneur Amanda Miller as expert advisors.

The New South Wales government, starting under the premiership of banker Mike Baird, has jumped right in and the Sticking Together social impact bond is only the latest of several forays into new funding arrangements for social service programs.

How does it work?

Sticking Together was created by SYC, a not-for-profit organisation that helps disadvantaged young people. It is being scaled up and delivered on behalf of the New South Wales Department of Planning and Industry, with funding from the SIB.

The department inked a payment-for-outcomes contract with SYC to provide “intensive coaching support” to 870 new participants who are aged 18 to 24, meet a list of criteria for having “high barriers” to employment and live in parts of Sydney, the Southern Highlands region and its neighbouring coastal area, the Illawarra.

Over four years, the aim is to put them each through the 60-week course and count how many extra hours work they do during that period. The coaching has already begun, according to an April 2019 investor update.

About 20% are expected to exit early for reasons like leaving the area and there’s an allowance for another 30% to disengage from coaching. If too many quit, the social investment pact could head for early termination.

The expectation is SYC will receive about $10 million in total, mostly paid in the final years of the contract and dependent on results. Under the contract the government pays $4m in fixed payments during the program and this is the absolute minimum cost, while the maximum is about $12m.

Bonds were sold to investors with a term of four years and seven months, returning 3% fixed interest in the first two years with variable rates after that, calculated on five set interest payment dates and paid at the end. The “target performance scenario” is 7% per annum returns and, according to SVA, as much as 12.4% p.a. is a possibility.

The $5m this raised goes to the early phase of Sticking Together, and half of this capital is at risk. For the other 50% of the principal to be paid back in full, participants have to clock up at least 220,000 cumulative hours in productive activities, according to the agreed formulae and definitions, with partial returns for results above 80,000 hours.

All going according to plan, and all estimates being accurate, the benefits generated by the program will lead to government savings in the long run that justify the extra outcome-linked payments to SYC, in turn allowing the investors to get back their initial outlay and then some.

Of course, a canny investor would have lots of questions about the key assumptions, and what happens if they prove to be wrong. Like any investment, buyers of social impact bonds want to know as much as possible about what they’re getting into, and hammering out the conditions of the deal with the service provider and the government is a big part of SVA’s role.

Prospective investors might want to know about how the program is designed, the problem it aims to address, or perhaps how “high barriers to employment” are defined, and it’s SVA’s job to answer their questions.

They would find that SYC’s payments, and hence their returns, are linked to the total number of hours all participants spend working or in “work-like activities” added together, minus three hours a week per person.

In the target scenario the youths do an additional 8.5 hours per week on average. The most optimistic forecast has them doing 14.5 hours on top of the base of 3 hours, and in the most pessimistic they still do 2.5 extra hours.

Investors were told the baseline figure of three hours a week came from “analysis of the employment experience of young people in the targeted service areas” and would be reviewed via new analysis “conducted on a similar basis” in each of the first three years.

The size of the intervention group is also monitored as a shrinking group would reduce the benefit that can theoretically be ascribed to the program, and therefore the future cost savings on which the bond returns depend.

If either changes by 20% or more from the original assumptions, all bets are off. A four-month negotiation period is triggered and any party can walk away if they’re not satisfied at the end of it, and there are again various arrangements for payments in the event of this and other early-termination scenarios.

This is just a brief overview of how the Sticking Together program’s potential success has been quantified and converted into a financial opportunity.

Like hotcakes

The minimum outlay was $50,000 and in the end 33 keen investors snapped up the Sticking Together SIB. Demand was strong, the bond issue was significantly oversubscribed and it closed earlier than expected, according to SVA director of impact investing, Elyse Sainty.

“It’s inspiring to see the SIB model support an innovative and evidence-based program such as the Sticking Together Project, which I am confident will change the trajectory of many young people’s lives,” she said in a statement.

Major investors were an impact investment fund run by Light Warrior Ventures, clients of private wealth management firms Koda Capital and Ethinvest, the Wyatt Trust and NGS Super, which has bought into all social impact bonds brought to market by SVA.

Several years ago, the Wyatt Trust funded SYC to develop and pilot Sticking Together, and its CEO Paul Madden said it was satisfying to now be able to invest in its expansion. SYC chief executive Paul Edginton was also pleased to see the $5m target easily achieved and took this as a show of faith in the program.

“SYC is thrilled that investors have seen value in the work that we are doing to improve employment outcomes for young people in New South Wales,” Edginton said in his contribution to the announcement. “By sharing the risks and rewards, the interests of investors, the state and SYC are all aligned and focused on making a positive impact.”

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