Social bonds offer charity investors possibilities, but there will need to be developments before they will fit into a traditional portfolio, says John Hildebrand of Investec Wealth & Investment
Charities have traditionally invested to maximise their returns. However, they are now also beginning to become interested in using investment to achieve a social end.
Before a charity can make an investment because it helps people, it must make sure that investment fits with its charitable objects. This is a hurdle that will be more difficult for some charities to overcome than others, depending on their objects.
Even if a charity finds it difficult to justify an investment purely for social reasons, it may well be able to make an investment that will achieve a positive social goal and achieve a financial return at the same time. In its guidelines, the Charity Commission says charities can make this sort of investment as long as the "likely financial return justifies it". They refer to these as "mixed-motive" investments.
The next issue is where these assets fit into an investment portfolio. At present the two main vehicles charities can invest in are the Peterborough social impact bond and the Scope bond. The former, administered by Social Finance, is a payment-by-results mechanism that allows investors to receive cash based on charities' success in achieving a particular goal - in this case, tackling reoffending among ex-offenders released from Peterborough prison. The Scope bond is more similar to a regular corporate bond, and the charity will use it to raise cash to hire fundraisers, among other things.
Most charities whose funds we manage restrict us to investing their fixed-interest assets in government bonds or investment-grade corporate bonds: the latter implies they have been given a credit rating by an external credit rating agency. The two investments mentioned above are too small to merit having an agency examine their bonds because agencies charge for their ratings.
Consequently, though charities can invest in these new bonds, the trustees have to understand the risks they are taking on. The Charity Commission recommends that trustees take an active involvement if their charity is investing in this area and that they report on it separately in their accounts.
This means that investment managers are likely to want to draw up rules before investing in this area, such as: the stock must be listed on an exchange so it can be priced; there is some sort of secondary market in the stock in case the fund manager wants to leave; it offers something close to a market return; the issue size is at least £5m; and it should be part of a separate portfolio. They might also prefer to invest smaller amounts in a number of bonds rather than a large amount in one bond, so minimum investment size is also a consideration.
These issues are not insurmountable, and over time we would expect this market to develop. While these investments are unlikely to lead to higher returns, some charities could feel they are using their assets more effectively if they invest in these products. For a charity using them to finance its operations, a bond issuance provides a new source of finance and so opens up a range of new opportunities.
John Hildebrand is an investment manager at Investec Wealth & Investment