The Hedge Fund Formula For Philanthropy

18/10/2013 11:11 BST | Updated 23/01/2014 23:58 GMT

The financial crash posed a series of questions about capitalism, many of which have not been adequately answered. Most significantly, a majority of people now expect companies, and especially those in financial services, to have a purpose beyond simply making money. They need to articulate their role in society, it's not enough simply to be the tendons of Adam Smith's invisible hand.

Nowhere is this more necessary than the hedge fund sector, which has in the past often been happy for most people to remain in the dark about what it does and why. Its most successful participants have, with a few exceptions, been reluctant to talk about their business, and cautious about engaging directly in a wider social agenda.

Of course, many have participated in impressive fund raising exercises, such as the ARK events. However, sometimes this has been the extent of the relationship - (generous) payments made to satisfy the philanthropic urges of hedge fund executives and support the causes closest to their hearts.

But hedge funds can do so much more than just raise money - we can harness the skills and expertise we use every day to fundamentally enhance the way charities operate. Focus on the efficiencies of the charities, the impact of how donations get spent, and the multipliers of these investments in benefits to society are all relevant and now well practiced by many. Helping others to be able to help themselves, offering guidance and inspiration, and creating ultimately self-funding business models are all dream outcomes. It is all achievable.

At Caxton Associates, the organisation that I have led for the past few years, we have significantly increased our involvement with charitable causes. My experiences have convinced me that applying the intellectual approach that governs our investments - structured pursuit of realistic, measurable returns, with intense focus on managing risk at all times - can revolutionise the way we tackle the most pressing issues facing our country today.

Take crime, for example, which remains a huge social and economic challenge that blights peoples lives and imposes an enormous burden on the state's finances. Government and other traditional funding sources have run dry and yet we appear no closer to tackling effectively the cycle of re-offending and shutting the "revolving doors" of our prisons.

With government finances now so tight, only by embracing the resources and expertise of the private sector will we be able to test out alternative solutions to this seemingly insurmountable challenge. Critically, this commercial involvement works best not when it is a simple act of charity, but when there is a clear business case for companies to get involved.

That's why I was so enthusiastic about joining the board of Social Finance, an organisation that, to detail just one example, introduced the first Social Impact Bond to enable individuals and companies to invest in offender rehabilitation services - supporting sector and community programmes that mentor prisoners pre and post-release to reduce the likelihoods of them being sent back to prison. The financial savings to government from successfully re-integrating offenders back into society are obvious and easily quantifiable. Innovation is now active in many more social areas, all of which are measurable.

As with hedge funds, returns are linked to hard readily quantifiable results, not just good intentions - so re-offending decreases the bonds pay out with capital losses if basic performance criteria are not met. Although the definitive results from the pilot programme in Peterborough Prison are still awaited, broad data trends are encouraging, with re-offending rates down. The use of Social Impact Bonds is subsequently being rolled out to try to benefit vulnerable children, the unemployed, and the homeless.

What Social Finance offers is a business model where it literally pays for companies to do the right thing, ensuring that professionalism and a results-based approach are rewarded by further investment. The schemes that secure the best results are the ones that grow - meaning philanthropic efforts are targeted towards the programmes making the biggest difference. Investor appetite for socially responsible investing will only grow over time, and it is incumbent of the financial services industry to boost the supply of such innovative product.

Whilst traditional focus on what percent of charitable giving makes it through to the target groups of people is always important, donors must also finance start-up enterprises and markets in the social sector to cover their running costs in the early years. One day they will be self-funding from their own revenues, but like similar commercial firms, they need seedcorn capital.

Once these markets are established Foundations and other charitable benefactors will be able to invest in these new products on a grand scale, generating healthy financial returns on their investments, in addition to the wider social benefits they bring. No wonder then that most experts predict that the Social Finance arena is set to see major growth in the coming years.

Of course, not all charitable missions can provide such clearly measurable outcomes. Caxton and I fund Speakers for Schools, a charity set up by Robert Peston, the BBC business editor, with the vital but less easily measurable objective of inspiring the next generation of state school students and breaking down the barriers that limit their aspiration. However even there, the careful use of target metrics and research helps ensure the best possible outcome for the maximum number of young people.

We recently conducted in-depth research with secondary school students and teachers to understand the impact of inspiration on aspirations and used that data to shape Speakers for Schools Week - an incredible cast list of British talent, with 25 of the UK's most influential leaders from politics, business, sport, science and the arts this week (14-18 October) visiting state schools across the country to give inspirational talks.

Whilst I do understand that not everything in the third sector can be measured and weighed, that there may never be an index for aspiration - although the government has had some success in beginning to measure happiness, so anything is possible.

But I also think that the most valuable asset that my industry can bring to society is not philanthropic funding - however necessary - but the very expertise that allowed us to generate those funds in the first place.

In doing so, I hope that we will begin to answer those questions about capitalism, and our industry in particular, that remain unanswered in the wake of the credit crunch.

Andrew Law is a Board Member of Social Finance, Chairman of the Trustees of Speakers for Schools, and chairman and CEO of Caxton Associates, a global hedge fund.