Social impact investing: good for society – and potentially for your portfolio
Social impact investing: good for society – and potentially for your portfolio
Today’s markets put long-term investors in a difficult position. Equity and bond valuations are high, while investors face the risks of rising inflation and an eventual end to central bank stimulus.
In this environment, portfolio diversification is all the more important – but getting it right will be difficult. Government bonds tend to underperform in an inflationary environment, while many alternative investments may also struggle amid rising rates and lower growth.
Social impact investments – such as the Schroders BSC Social Impact Trust (SBSI) – could play a valuable role in diversifying portfolios. They offer the prospect of returns that are largely uncorrelated to mainstream financial markets and have historically achieved a high degree of inflation protection. In addition to their economic advantages, they can deliver significant benefits to disadvantaged communities across the UK.
SBSI is structured as a “closed end fund.” Its shares are traded like any other, providing investors with liquidity, while the fund invests in unlisted markets that are otherwise hard to access. This approach should reduce the risk of the investment managers, Big Society Capital and Schroders, being forced to sell illiquid assets to meet redemption requests. However, the share price of the trust could trade at less - or more - than the reported value of the underlying holdings.
SBSI invests using a range of approaches, as we explore below, but there are some important common features: “Over 75% of our revenue comes from government or government-backed entities – and around 2/3 of our revenue is inflation-correlated”, explains Jeremy Rogers, Chief Investment Officer of Big Society Capital and portfolio manager of the trust. “That makes us attractive to investors who are seeking returns ahead of inflation – but don’t want excessive credit risk or the volatility of equities.” While returns often follow trends in revenue, this is not always the case and cannot be relied upon.
A good diversifier
Trust investments fall into three broad categories: high-impact housing, debt for social enterprises and social outcome contracts. The distinct approaches often target similar social problems, while allowing the trust to carefully manage its risk and return profile.
One of the investments in the high-impact housing asset class is Resonance Real Lettings Property Fund. The fund owns property which is made available to vulnerable people moving on from emergency accommodation. The investment is intended to generate a return through both rental income and property appreciation.
Another project meeting the need for supported living is funded very differently – and provides a very different kind of return. Golden Lane Housing, a charity providing housing to those with learning disabilities, has issued a bond with a fixed annual return (though this is not guaranteed). This and other charity bonds are examples of “debt for social enterprises.”
Social outcome contracts, the third and smallest category of investments, differ yet again. Here, the trust backs projects which receive compensation based on the achievement of social outcomes. These investments are currently made through a specialist fund manager in outcomes contracts. One example is Stronger Families Norfolk. The organisation runs evidence-based therapy programmes to help vulnerable children and young people address behavioural and emotional issues and stay with their families safely. If they do not go into care, the project receives a payment from Norfolk County Council, reflecting the young person’s improved life chances.
This high degree of investment diversification can help smooth overall returns. Rental and interest payments provide a steady stream of income. Meanwhile, rental growth and property price appreciation should support an increase in the value of investments over the longer term.
A defensive asset
SBSI is inherently focused on fulfilling basic needs that are independent of the economic cycle. Sadly, demand for many of these services tends to rise in tougher economic environments. This has been especially true over the past 18 months. The pandemic hit disadvantaged groups the hardest, with many people unable to access support services they depended on and exacerbating long-standing problems.
For investors, this means that the trust can be considered a defensive asset. Its revenues are largely government-backed and are not dependent on economic growth. Such investments typically exhibit a low correlation to equity markets.
Of course, governments can and do face pressure to reduce budgets for essential social services. This has not yet occurred following the pandemic - but the years of austerity that followed the financial crisis of 2008/9 serve as a reminder that it is a risk.
However, there are several reasons to think that the trust – and social impact investment more generally – should enjoy continued political support.
Many of these projects deliver savings to the government that are many multiples of their cost. Further comfort comes from the fact that the trust is focused on areas of social need that have support across the political spectrum. For example, both the Labour and Conservative parties highlighted improved care for those with learning disabilities as a priority in their 2019 election manifestos. It is an area that SBSI targets through a number of its investments.
Two-thirds of SBSI’s investments are inflation-correlated. Payments for many of the services provided by trust-backed projects increase in line with an agreed measure of inflation. And several of the trust’s debt for social enterprise investments have floating interest rates – so as and when the Bank of England raises rates, interest payments on the bonds will also increase. Over the longer term, interest rates tend to move in line with inflation.
This kind of protection provides greater comfort in the trust’s ability to meet its target return of 2% above the UK Consumer Price Index on an annual basis (once the portfolio is fully invested and averaged over a rolling three- to five-year period, net of fees).
It is not just investors who stand to benefit from social impact investing in an inflationary environment. Rising prices accentuate many of the challenges faced by lower-income and disadvantaged communities. They could also lead to more unemployment as companies look to reduce costs, especially in sectors that face long-term scarring from the pandemic.
Delivering social impact is key
We believe there is clear need for the services and interventions backed by SBSI, which is focused on areas that have suffered from significant underinvestment over the years and are now a priority across the political spectrum.
This creates an exciting opportunity for social impact investors who can identify well-run projects that are likely to enjoy continued political support, while delivering both genuine social impact and attractive financial returns.
What are the risks?
- There can be no guarantee that the company will achieve its investment objective or that investors will get back the amount of their original investment.
- The company has limited operating history and investors have a limited basis on which to evaluate the company's ability to achieve its investment objective.
- The company has no employees and is reliant on the performance of third-party service providers. Failure by the AIFM, the portfolio manager or any other third party service provider to perform in accordance with the terms of its appointment could have a material detrimental impact on the operation of the company.
- The financial performance of the company will depend upon the financial performance of the underlying portfolio. The company's portfolio will include social impact investments over which the company and portfolio manager have no control. In particular, investments in impact funds and certain co-investments will be managed by third-party managers. The company's performance and returns to shareholders will depend on the performance of those social impact investments and their managers.
- The company's objective is to deliver measurable positive social impact as well as long-term capital growth and income and these dual aims will generally be given equal weighting. Social impact is the improvement of the life outcomes of beneficiaries in a specific target group or groups. There is no universally accepted definition of 'impact', an assessment of which requires value judgments to be made. The company's impact focus may mean that the financial returns to shareholders are lower than those which might be achieved by other investment products.
- The company depends on the diligence, skill, judgement and business contacts of the portfolio manager's investment professionals and the information and deal flow they generate, especially given the specialist nature of social impact investing. The departure of some or all of the portfolio manager's investment professionals could prevent the company from achieving its investment objective.
- The company will make investments where commitments are called over time. Due to the nature of such investments, in the normal course of its activities the company expects to have outstanding commitments in respect of social impact investments that may be substantial relative to the company's assets. The company's ability to meet these commitments, when called, is dependent upon the company having sufficient cash or liquid assets at the time, the receipt of cash distributions in respect of investments (the timing and amount of which can be unpredictable) and the availability of the company's borrowing facilities, if any.
- The company's investments may be illiquid and a sale may require the consent of other interested parties. Such investments may therefore be difficult to realise and to value. Such realisations may involve significant time and cost and/or result in realisations at levels below the value of such investments estimated by the company.
- Any change in the company's tax status or in taxation legislation or practice generally could adversely affect the value of the investments held by the company, or the company's ability to provide returns to shareholders, or alter the post-tax returns to shareholders.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.