The shrinking state: should investors fill the gap?

The shrinking state: should investors fill the gap?
The Financial Times, by Adam Palin
07.08.15

 
Generous tax breaks for social investment granted in last years’ Budget provoked much interest from philanthropic-minded investors, though there has been a limited take up.

 

This could change later in the current tax year. A huge increase is anticipated to investment limits, which is expected to galvanise interest in the sector.

 

So what is powering the drive to encourage social investment? Against a backdrop of welfare cuts, the government is pushing for the private and non-profit sectors to step forward as the state retrenches from the provision of social care and services.

 

The tax break to encourage private investors to fill the funding gap — social investment tax relief (SITR) — was the first of its kind in the world, the Treasury claims.

 

By subsidising investment, the government hopes to make it cheaper for charities, social enterprises and community groups to access private finance, thereby allowing them to expand the scope of their work.

 

But investors shouldn’t get too carried away. Whilst such investments have a high “feelgood factor”, is it realistic for them to expect financial returns? While there are few projects to judge performance by, the high-risk and illiquid nature of social investing is already apparent.

 

Ahead of the anticipated expansion of the sector, FT Money examines the opportunities and risks facing prospective social investors.

 

The social investment market

 

Social enterprise is of course nothing new. According to government data, social ventures employ 2m people and contribute £55bn to the economy each year, plus intangible benefits to communities around the country.

 

The UK is already a trailblazer in the launch of social impact bonds — vehicles for funding social projects that promise returns contingent on their success.

 

There are 31 social impact bonds operating in the UK — roughly three-quarters of the worldwide total, according to Matt Robinson, head of strategy at Big Society Capital, a social investment bank funded by dormant UK bank accounts.

 

Against the countervailing impact of fiscal austerity — local authority spending in England was cut by a fifth between 2009-10 and 2014-15 — it is clear why the government wants to expand social investment. It introduced SITR in 2014 to make it easier — and more financially attractive — for individuals to become social investors.

 

The reliefs offered to SITR investors closely mirror those accompanying the enterprise investment scheme, designed to encourage taxpayers to make higher-risk investments into smaller UK companies.

 

Frustrated ambitions

 

The government has yet to collate data on how widely used the tax relief has been in its first year, but it is universally seen as hamstrung by low investment limits.

 

With projects only able to raise the equivalent of roughly £250,000 through SITR, it has limited capacity to get projects off the ground. It is also too small to spark most fund managers’ interest, particularly when limits for other tax-efficient investment vehicles — namely EIS and venture capital trusts (VCTs) — are much greater.

 

The UK government is looking to correct this, and has applied to the European Union for state aid clearance to raise the amount of SITR investment that a social enterprise may receive to £5m a year up to a maximum of £15m — the same of EIS.

 

Damian Hinds, exchequer secretary to the Treasury, says, “With the extension of the scheme, [the government] looks forward to more charities and social enterprises benefiting from private investment.”

 

Aside from raising these limits, perceptions of social investment as a form of philanthropy must be overcome in order for the sector to progress.

 

“A lot of investors will see the words ‘social investment’ and think the two can’t mix,” says Matt Taylor, managing partner of Rockpool Investments. “There is an adage, ‘if you try to make half a profit, you’ll make a loss’.”

 

Nevertheless, there is evidence that socially-minded investors are still keen on the idea.

 

In a survey of independent financial advisers, conducted by Worthstone in 2013, a large majority (71 per cent) reported that their clients “would be prepared to accept a reduced potential return in order to achieve their philanthropic or community based goals”.

 

Gavin Francis, founder of Worthstone which provides due diligence on social investments, believes SITR provides a timely solution for the funding of services traditionally provided by the state, and that the range of options for investors will be great.

 

“There’s nothing to stop [SITR] investment going into a myriad of potential enterprises tackling some of the most hard-to-reach problems in the country,” he says.

Tom Hall, head of philanthropy services at UBS, adds that although it may be counter-intuitive to expect social enterprises — including charities — to pay interest, investors can reasonably expect financial returns. “We shouldn’t be presupposing any capital loss using SITR,” he adds.