By Nick Zelenczuk, Content Associate at Convergence

Despite a recent rise in public spending and development aid towards education, few low- and middle-income countries are on track to meet the basic requirements for quality education under Sustainable Development Goal (SDG): 4. The COVID-19 pandemic has steadily broken the momentum of many developing countries in improving access to quality and affordable education, and the ongoing capital flight from developing countries across Sub-Saharan Africa, South and Southeast Asia and Latin America is contributing to this threat.

The precarious economic outlook for emerging markets is also building hesitation within new investors to financing education opportunities targeting underserved communities. Alternative financing approaches like blended finance are offering a pathway to attract investors and engage private capital on market terms. Some of this activity was recently highlighted in Convergence’s virtual training on health and education, which explored the role of blended finance in mobilizing capital to education interventions. The training drew on perspectives from leading stakeholders in the field, including USAID Catalyze, Palladium and BlueOrchard Finance.

Here are some key reflections based on historical and current market activity:

There is increasing momentum in blended finance for education

Based on all data captured on the blended finance market today by Convergence, especially since 2010, of the total USD 152 billion mobilized towards sustainable development in blended finance, financing for education has accounted for USD 1.4 billion. Despite the low proportion, Convergence has observed continuous growth in both annual transaction count and aggregate financing; about USD 115 million in average market growth per year. Looking forward, around 18% of deals currently fundraising on Convergence’s Deal Platform are interventions for education.

Proven instruments to increase education finance exist, so there are models to replicate

Approximately 51% of blended transactions for education are structured as funds, reflecting overall market trends. This includes funds where education is the sole focus (39% of education funds), and multi-sector funds where education serves as one priority area within a broader portfolio (61% of education funds). BlueOrchard’s Regional Education Finance Fund for Africa (REFFA) is one example of an education exclusive fund. REFFA has a multi-layer structure that leverages first-loss capital from the German Federal Ministry of Economic Co-operation and Development (BMZ) to entice private investment. Funds like REFFA offer institutional investors first-time exposure to education-based investments to build investor knowledge and comfort levels. Generalist funds also provide aggregation benefits for education finance by bringing together various types of investors and offering them portfolio diversification advantages.

The second most popular instrument is social and development impact bonds (DIBs). This pattern sets education apart from all other sectors Convergence tracks: about 42% of DIBs are focused on education development. With DIBs, investors provide upfront capital for an initiative (i.e., an intervention to improve learning outcomes), and are then repaid with interest by public or philanthropic outcome funders upon achievement of predetermined results. DIBs effectively link payments to specific and measurable outcomes while reducing investment risk for public and philanthropic investors. We have seen wide application of these pay-for-success models across education sub-sectors. For example, the Educate Girls India DIB (USD 11.2 million) aims to improve numeracy and literacy among primary school-aged girls in India, while Social Finance’s UP Fund (USD 40 million) takes an innovative approach to reducing unemployment by exclusively investing in Career Impact Bonds (CIBs). CIB investor returns are linked to premiums on future student salaries that are gradually repaid overtime. Structuring and implementing DIBs can be expensive and time consuming, which restricts the potential for scaled results. For example, outcomes must be determined and agreed upon by all the parties involved prior to launch. Hiring necessary third-party verification organizations to assess the intervention’s progress also increases costs. For these reasons, other vehicles, like funds, are better suited to investors looking for larger ticket sizes and are more likely to reach a larger number of beneficiaries.

There is an understanding of the types of solutions blended finance can support

Affordability of schooling is a central issue that blended finance can help address. For example, USAID’s Catalyze Edufinance platform aims to boost schooling affordability by mobilizing private capital for non-state (private) schools in emerging markets. Once reserved for wealthy households, non-state schools have become increasingly accessible for low-income students. Increased demand has created greater access for private financing. Blended finance is also emerging in the Ed-tech sector and in education-related infrastructure. In one example, blended finance is helping advance the construction of six environmentally sustainable student accommodations in Nairobi, Kenya led by Acorn, a local developer. The project is backed by a USD 30 million GuarantCo guarantee and provides low-cost residence for eligible students, contributing to increased affordability and attendance in higher education.

Blended finance can help pave the road ahead for education finance

Blended finance for education is undoubtedly still in a formative stage. We know it is not a panacea for solving the education funding gap. But historical deal data and ongoing activity captured in our pipeline tell a story that should inspire and encourage a deeper dive into how blended finance can crowd in private sector investors and mobilize this largely untapped pool of capital.

At Convergence, we encourage practitioners to focus on instruments and areas of education development where blended finance has already experienced success, like leveraging impact bonds and supporting tech-based approaches. Scarce catalytic and concessional capital should be invested strategically, with additionality front of mind. DFIs and impact investors with flexible capital are well positioned to enable institutional investor participation by taking on subordinated positions to help lower investor risk. They also have an important role to play in ensuring equity and equality remain central building blocks of education investments. Originators of blended transactions active in the education sector should prioritize gender-based outcomes as an essential component of their interventions. Doing so promises to attract new interest from both public and private investors and shorten fundraising timelines to deliver services more rapidly where they are needed most.

While public funding remains critical to achieve quality education for all, there is plenty of space for solutions backed by private investment.

Are you working on a student financing solution to help more young people enter tertiary education? We are currently accepting applications for the Tertiary Education Financing Prize. Click here to learn more and apply.