Social impact investing: Good for society and beating inflation – This is Money

Social impact investing: Good for society and beating inflation This is Money

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The Schroder BSC Social Impact Trust’s defensive characteristics can help investors navigate more volatile market conditions, while many of its investments benefit from in-built inflation protection.

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 will be all the more important – but getting it right will be difficult.

Government bonds tend to underperform in an inflationary environment, while alternative investments may 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 helping to diversify 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 an investment trust and so is structured as a closed end fund.

Its shares are traded like any other stock market listed investment, 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, as can happen with open-ended funds.

However, the share price of the trust could trade at less – or more – than the reported value of the underlying holdings.

SBSI uses a variety of approaches to structure its investments

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. We explore how to spread your risks while doing some good, too.

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 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.

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 largely 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 interest rates, interest payments on the bonds will also increase.

Over the longer term, interest rates tend to move in-line with inflation (though this has not been the case recently).

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).

Markets have generally accepted that the recent spike in inflation is ‘transitory,’ to use the term favoured by central bankers.

Even if inflation does fall back in the second half of the year, markets may be underestimating the risk that it remains elevated in 2022 and beyond.

The very strong demand for inflation-linked debt clearly suggests that many investors are willing to pay up for long-term inflation protection. The trust could be a far cheaper way to achieve this, while generating a positive real return.

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. Rising costs could lead to more unemployment, especially in sectors that face long-term scarring from the pandemic. Higher housing costs could also make it even harder to find the right accommodation.

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.

Contact Schroders BSC Impact Trust to discuss how they could meet your requirements.