First ever independent data centric study into a key segment of the UK social investment market.
Key lessons and reflections
The data demonstrates the activity in the social investment market over the last 12 years, 2002 - 2014. A number of key insights have come from the outputs produced by the project:
- Risk and pricing - The data sample analysed relates to a high-risk portion of the market by definition. Many of the SIFIs implemented a policy for only considering investment applications for organisations that had been refused finance from mainstream or retail providers. Capital pricing was often on an affordability basis and not always adjusted to the inherent risk of the deal. The combination of these two aspects means that although on aggregate the SIFIs did have a strong appetite for taking on risk, and this is evidenced in a concomitant capital loss rate, however the SIFIs were not able to recoup all of these losses from surpluses on successful deals as is the case in, for example, the traditional venture capital market.
- Blended return and Implied Impact - a principal objective of the SIFIs was to focus on deploying repayable capital that created positive social impact. Although the social impact performance has not been analysed as part of this project, it is evident that this investment strategy resulted at times in below market rates of financial return. EngagedX refers to this fade off from market rate returns as the Implied Impact of social investments, this is to differentiate merely poor financial performance from intentional lower financial performance when combined with the intentional creation of social impact. In other words, the Implied Impact is the capital pricing discount that investors are prepared to accept in exchange for positive social impact. Implied Impact is not a measure of social impact per se. It is recommended that the extent of the Implied Impact should infer the level of rigour that might be applied to evidencing social impact so that it can be articulated as a bona fide return on investment as part of a blended return investment model.
- Motivation and performance - There was a broad range of financial motivation and risk appetite held by the wholesale capital providers. This was reflected in varied performance, generally with greater net losses on funds that might have been more focussed on testing the principles of social investment and getting the capital working in the market. On balance those that were set up to be more financially sustainable did perform reasonably well. Further analysis and segmentation is recommended based on fund motivation to understand the complexion of the market.
- Customisation and tailored investment approaches - A very high level of product customisation was observed as typical in the market. This lack of standardisation can make comparative analysis more difficult, particularly in terms of forecasting the performance for the remaining term of investments. For this reason only closed deals were studied and it was not attempted to provide a yield to redemption forecast for open deals. The high complexity and small size of deals often make it disproportionally more difficult for SIFIs to invest in the appropriate systems to collect and process information on those deals. One of the hallmarks of the social investment market is that investment managers are very engaged in the performance of the investees, viewed both through a social and finance lens. This means that they are more likely to actively work with the investees whilst the investment is outstanding to adjust the terms or conditions of the investments to suit the specific requirement of the investee. This often results in unscheduled interest free periods, repayment holidays or restructuring of the deal in its entirety. This adds to the data system requirements of the SIFIs to manage this high level of change and to keep a record of all this data in a way that will allow these variations to be modelled and analysed after the event.
- Engaged investor approach and transaction costs – a general observation from the data reveals how closely and effectively the SIFIs work with their investees in order to make sure that each investment has the best chance of a successful outcome for all involved. This is labour intensive and highlights the tremendous skills and deep understanding that the SIFIs have of their investees. This project did not obtain any specific data on transactional costs or the costs in actively managing the deals. All returns are gross and are not net of costs. Management costs may appear on face value to be disproportionately high when reviewed against the investment size, but the anecdotal evidence suggests this highly engaged approach is key to being a successful social investor.
- Finally - the total financial returns of the sample of investments studied is negative 9.2% but it would be disingenuous to interpret this as bad. In light of the points mentioned above, it is impressive indeed that the SIFIs have successfully been able to achieve capital preservation of about 90% (including interest payments and charges). This high level of capital preservation suggests that the social investment market is indeed investable, however the key issue to address in terms of sustainability is that of capital pricing. An ongoing challenge is to reconcile the conflicting requirements of affordability for the investees and risk adjusted pricing for the capital providers. The story told by the data is arguably an optimistic one and provides a very useful basis to better understand the requirement for explicit and implicit subsidy in the market. In time, with greater segmentation and categorisation, it will be possible to form a much more granular picture of which parts of the market need a greater or lesser degree of subsidy. Overall it is hoped that improved data transparency will help the market get better at deploying repayable capital when it is affordable and the appropriate form of capital, thereby allowing better use of the scarce and highly valuable resource of grant funding.