By REBECCA THURLOW
SYDNEY—Plans by Australian state governments to save money by keeping people out of jails, hospitals and foster care are creating an opportunity for yield-hungry investors.
The states are increasingly turning to a new type of debt—dubbed social-impact bonds—which are tied to programs aimed at saving billions of dollars in dealing with issues caused by criminality, family breakups and other major social problems.
Australia is the first country in the Asia-Pacific region to tap bond markets for social-welfare programs. It works like this: Investors buy the bonds at a certain price and the government uses the cash to pay for social programs run by local charities and community groups. The bondholders are rewarded if the project’s goals are met.
It could mean a yield of as high as 12% in a given year, compared with as little as 2.3% for 10-year Australian government bonds currently. Governments pay the coupon, as well as repaying the principal when the bond matures.
Successful results would include things like lower reoffending rates for ex-prisoners, reduced homelessness, and better self-management of chronic health problems—reducing the need for foster care, hospital beds and bigger prisons. Governments can use some savings to pay the return to investors and still come out in front.
New South Wales will this month seek proposals from nongovernment organizations as it considers innovative funding schemes for welfare programs, including social-impact bonds. Australia’s most populous state said it was encouraged by two recent programs that helped raise 17 million Australian dollars (US$13 million) and reduced the number of children needing foster care.
It is a boon for yield-starved global investors desperate to discover pockets of value in an ultra-low-interest-rate world. Both of New South Wales’ trial offers were oversubscribed and attracted high-net-worth trusts and individuals, as well as pension funds.
Australia’s first social-impact bond, known as Newpin, was launched in 2013 and returned 7.5% in its first year. “These things feel like they are a fabulous, innovative creation whose time has come,” saidGary Brader, chief investment officer at QBE, an insurance company that has already allocated US$100 million to social-impact bonds globally.
In the U.S. and Europe, the market is also in its infancy. Social bonds started life in the U.K. in 2010, and about three years later New York City launched the first U.S. social-impact bond to reduce reoffending rates among Rikers Island prisoners.
Several U.S. state and local governments have since launched pilot schemes. In February, Portugal launched a bond to help fund a school program to teach computer coding, mirroring similar schemes in Belgium, the Netherlands and Germany.
“Most of what state government does is really waiting at the bottom off the cliff catching people as they fall,” said Jack Snelling, health minister for South Australia, which is about to launch its first social-bond test program. “We really don’t invest enough to stop people falling off.”
The state is assessing everything from reducing homelessness to lowering the number of Borderline Personality Disorder sufferers needing hospital treatment as it prepares for its first social bond trial.
Governments understand that they can save money through these kind of early intervention programs. Foster care is more expensive than a parental support program, for instance. But shifting budget funds away from crisis management is difficult—getting the private sector involved solves the problem of sourcing the extra upfront capital.
Social impact bonds, also known as pay for success bonds, can also be a more efficient way of delivering services as they only pay if the service actually works. And whereas traditional procurement contracts specify every step of an intervention, social impact bond contracts, by paying for outcomes, also leave room for innovation that can drive up the quality of outcomes and reduce costs.
Many local fund managers are delighted by the new investment trend. “Bring it on,” said Anthony Rodwell-Ball, chief investment officer at NGS Super, which invested in the A$7 million Newpin bond. “We’d like to see more opportunities.”
Mr. Rodwell-Ball said he was evaluating a social-bond proposal aimed at helping young South Australians find jobs.
The Newpin bond funded the expansion of a scheme run by UnitingCare Australia for children facing violence or neglect at home. The program helped restore 28 children to the care of their parents by creating safer family environments, and prevented 10 from at-risk homes from having to enter care.
One person who benefited from this program was Sarah (who asked for her surname not to be mentioned), whose two young children were placed in foster care to protect them from the violence of her then-partner. The 29-year-old from Sydney’s western suburbs said Newpin gave her the emotional support and guidance needed to establish a stable life without her abusive partner. Her children were returned to her care in December following a 15-month separation.
“Newpin rebuilds your life and your family from the ground up,” she said. “If I hadn’t have come here and got all the support I needed, I wouldn’t have my children back.”
Investors can’t ignore the significant amount of risk they shoulder when it comes to social programs tied to targets exposed to so many variables, such as people’s ability to recover from serious addictions. After all, if a program doesn’t deliver on its goals, bondholders may not receive a payout or might even incur a loss on the principal.
Still, investors like QBE’s Mr. Brader believe the size and number of social-impact bonds will only get bigger as investors look to diversify their portfolios to hedge against the performance of other asset classes amid economic uncertainty.
“Hopefully, it’s the calm before the storm,” he said. “There is clearly a lot of interest in this space.”
Write to Rebecca Thurlow at email@example.com