The 95/5 Rule: Why Ford Foundation’s Announcement Really Matters for Impact Investing
No doubt you know the 80/20 rule, but do you know the 95/5 rule? It’s a principle laid out by Dr. W. Edwards Deming, a prolific 20th century scholar best known for his pioneering work on systems thinking and its application to modern industrial organization. He argued that 95% of an organization’s performance depends on the quality of the system, and that only 5% is attributable to the actions of discrete individuals. The implication is that we spend too much time focused on discrete performance at the micro level, and not enough time thinking about the bigger system.
Ford Foundation’s announcement committing $1 billion of its endowment to Mission Related Investments (MRIs) is a big deal, as many in the impact investing industry have noted. It is the latest milestone in a wider movement in which private philanthropy and other large asset holders are seeking to leverage the totality of their assets to drive positive social and environmental outcomes. This move recognizes the inherent impact of all investments, and it signals an important shift from thinking about impact investing as a “niche” to something more profound — large scale systems change. And here’s where there are parallels to Dr. Deming’s work.
The first parallel is clear — 95/5. Under U.S. tax law, foundations are mandated to pay out 5% of their assets each year in line with their charitable mission, most frequently via grants but also through program-related investments (PRIs) that meet legal standards for having a charitable purpose. The other 95% is invested with the aim of achieving financial returns that can sustain the organization and its charitable giving over time.
Were Dr. Deming to critique the impact investing sector’s focus to date, he’d say we’ve spent too much of our collective effort trying to optimize the 5%, and not enough looking at the 95% that’s deployed in the heart of the larger system — global financial markets. Ford’s announcement is the biggest commitment yet of a U.S. foundation’s endowment to impact investment, and they join a number of pioneering philanthropies that have paved the way, including some like the F.B. Heron Foundation who’ve sought to align 100% of their endowment investment to impact.
At Omidyar Network, we see this as a big step forward in strengthening the impact investing movement. It engages a wider set of stakeholders in impact investing — most directly foundation trustees, investment committees, and the ecosystem of intermediaries that work with them. And looking ahead, the increased use of MRIs by private philanthropy provides a model for university endowments, pension funds, and other institutional investors to learn from and emulate.
The second parallel to Dr. Deming’s work is the notion that the impact investing movement is fundamentally about systems change. Darren Walker’s announcement makes clear that looking above and beyond their own commitment, the Ford Foundation’s end goal is to seize the “opportunity to help capital markets become accelerators of justice.” That bold vision will take changing one of the most complex economic systems out there — global financial markets.
At Omidyar Network, we believe effecting lasting social change is fundamentally about systems change — and we apply that mentality to our work in areas ranging from improving financial inclusion in emerging markets to strengthening citizen engagement in our democracy in the United States. It’s why we vehemently agree with Ford Foundation that philanthropy needs to embrace the full range of options for deploying capital across the returns continuum — because you need all the tools in the toolbox to influence any complex social or economic system.
So what do we need to do to change the system that impact investing is seeking to influence? A lot. And it will take a long time. But there are a few things we think are particularly important.
First, we need to better understand and map the system to make it more intelligible. Impact investing currently encompasses a diverse array of strategies across asset classes, geographies, sectors, and goals. It’s messy. And we believe a critical way to drive towards greater clarity and efficiency in the system is to better segment the market. This means providing investors with clear eyed expectations on risk, returns, and impact for different types of impact investing opportunities, and providing better tools to enable investors to target the opportunities that meet their particular objectives.
Second, we need more risk capital to pioneer nascent markets for impact investing. It’s no coincidence that the Ford Foundation is initially deploying its MRIs in U.S. low income housing in the U.S. and financial inclusion in emerging markets. These are sectors that align with Ford’s mission, have matured over decades, are large enough to absorb significant pools of capital, and have a long track record of performance. These sectors reached this stage of maturity thanks to years of patient investment and market development from those willing to provide risk capital, as well as enabling policy reforms from governments. Many other impact investing sectors offer tremendous promise, but are not yet at the stage of maturity to meet the needs of many large institutional investors. That’s why Omidyar Network continues to call for more stakeholders to provide risk capital to earlier stage sectors that can become the next big markets to reach scale. And that’s why the PRI side of foundation impact investing remains important — as it can be more readily deployed to grow earlier stage, higher risk enterprises and markets.
Finally, we need leadership. Deming said, “A bad system will beat a good person” — but we’d counter that good leaders have the power to transform bad systems. And good leadership is what we are seeing from Darren Walker, Ford’s trustees, and the Foundation’s impact investing team. We commend them and the growing number of foundations that are aligning their endowment investments to their mission and values, and in so doing, building a better system for investing and contributing to a more just and equitable world.