Social benefit or impact bonds are only just coming onto the radar, but early indications are that they can produce very good returns for investors who want to put their money into something that's doing social good.
A handful of social benefit bonds have been launched under the auspices of state governments to support preventative programs that address areas of pressing social need - whether it's homelessness, indigenous Australians or children at risk, among others.
For example, the Benevolent Society is running the Resilient Families Program, on behalf of the NSW government, which is aimed at keeping children out of foster care and with their families, where possible.
Research shows children do better in their own homes when it's possible to keep them there.
Investors have a view that a private provider such as the Benevolent Society is likely to deliver better results at less cost than if a government agency was to run the program.
Governments pay interest on the bonds to investors from the savings they make on their budget bottom lines.
Social benefit bonds are complicated to understand, which is one of the reasons they are available to "sophisticated" investors only - those with high incomes or substantial assets. This might include many self-managed super funds.
As sophisticated investors, they agree to forgo some of the protections given to small investors.
Part of the complexity is that the performance of the private provider has to be measured against a benchmark.
As these services are usually provided by the welfare arms of governments, it's the performances of these agencies that are used as benchmarks.
Much depends on how the performances hurdles are set and the credibility of the organisations providing the programs.
And the better the performance of the program provider, the higher the interest paid on the bond. That's in contrast to vanilla corporate bonds, where the interest rates are known before investing.
In the case of the Resilient Families Program, it's more complex again as there are two classes of investors in the bond. With one class, the capital is returned. With the other, the investors' capital is at risk.
The Benevolent Society bond runs for five years with one year to run. The interest is only paid at the end of the five years, but so far the bond for which the capital is protected is tracking 7 per cent average annualised and 15 per cent for the capital-exposed class of investors.
That's a juicy return on the capital protected when you think that the guarantor of the capital is the NSW government. And the 15 per cent return is also very high, even considering the capital is not protected.
Another thing about social bonds is that their performances are not correlated to any other markets or to interest rates, which makes them a good diversifier.
That makes them of interest not only to high-net-worth investors who meet the sophisticated investor test, but to institutional investors, particularly those that invest with an ethical bent.
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