Positive impact while investing

In July, the first cross-border development impact bond (DIB) announced its first-year results. The UBS Optimus Foundation has provided more than $238,000 (£179,000) to Educate Girls – an Indian NGO established in 2007. The investment was secured by The Children’s Investment Fund Foundation, which agreed to pay UBS Optimus a return of 7-13 per cent if the programme was successful.

The DIB is financing 166 schools in Rajasthan and around 44 per cent of the girls targeted have been successfully enrolled, meaning the UBS Optimus Foundation has recouped 40% of its investment – after only one year – with two years left to run.

What differentiates impact investment from other forms of investment is the positive social or environmental impact. Although there are numerous structures for investment (linked to environmental, social and governance principles), social impact bonds and DIBs have received particular attention from both the investment community and development sector.

A DIB is an impact bond that is implemented in low- and middle-income countries where a donor agency or a foundation is the outcome payer as opposed to the government. The term ‘bond’ is misleading, however, as these are performance-based contractual arrangements rather than capital market securities.

There are a number of parties in any impact bond: the intermediary, who delivers positive social impact against specific, targeted interventions; the investor; the outcome payer; and an independent impact evaluator, who validates the level of social impact achieved.

An attractive feature of impact investing is that the investments are not reliant on the performance of global capital markets, and are not set against the traditional rates or interest on principle, such as Libor. The return is based on the underlying contractual agreement that the investors enter into. Pricing of the return on investment is often aligned with the level of risk that investors take on.

There are, of course, challenges to be overcome for the impact investment market to grow to significant scale. JPMorgan and the Global Impact Investing Network’s impact investing survey cites “a shortage of high-quality investment opportunities with track records” and a “lack of appropriate capital across the risk/return spectrum” as primary hindrances to growth.

Because return on investment is based upon the ‘impact’ of the scheme, it is vital to have clearly defined and measurable success metrics. Investors should be careful that underlying documentation clearly defines the parameters for the outcome, and also how reporting during various stages of the project is to be conducted. The level of information can vary between projects and this is a major challenge in achieving consistency of data.

The development of documentation reflecting the contractual arrangements between the various stakeholders tends to be bespoke due to the fact that each DIB is different. There has been a lot of effort to try and standardise at least the documents relating to the financing framework. With DIBs it is important that appropriate due diligence is conducted to identify underlying risks of performance and measurement of data.

Despite the challenges, social impact bonds offer real potential for investors to structure a return on investment while delivering positive impact. There are currently almost 40 social impact bonds globally and, although the basic investment infrastructure needs to be further developed, impact investment is becoming a stable and sustainable alternative for investors.

Ranajoy Basu is a partner at Reed Smith