Parsing Impact Investing’s Big Tent

Former governor Deval Patrick’s decision to join Bain Capital and New York Times columnist David Brooks’ recent op-ed are just two of the latest examples of enthusiastic new voices in the impact investing movement. Last year, we similarly saw impact investing capture the attention of G8/G7 leadership, the World Economic Forum, Warren Buffett and Bill and Melinda Gates’ Giving Pledge, and Pope Francis himself.

As the momentum of impact investing builds, the field attracts new participants that believe in its potential as a powerful tool for good. While these are exciting developments, the lack of proper taxonomy—or classification—poses a significant risk to the movement, especially given recent growth.

When industry leaders coined the term impact investing eight years ago, they used a “big tent” approach to unite diverse players around a shared purpose. The movement aimed to develop a common language for diverse sets of investors—including pension and hedge funds, foundations, and family offices—as well as to attract new capital to the space. A common goal was at the heart of unifying players under the banner of impact investing. It was to dissolve the age-old thinking that doing good and doing well are separate domains—that to “give back” you should first make money and then give some of it away.

This big tent approach has yielded tremendous benefit—as evidenced by all of the recent momentum. Eight years later, however, without defined tables under the big tent, we now face two major issues. 

The first is the difficulty newcomers face in making sense of impact investing’s diversity—of asset classes, geographies, sectors, and goals. Many are now excited by the promise of aligning investment dollars to impact goals; few can easily make sense of this increasingly rich smorgasbord to know what types of products fit their goals.

Second, the big tent has left us stuck in an unrelenting and unproductive ideological debate about whether or not there is a trade-off between financial return and social impact. The “impact-first” versus “finance-first” taxonomy promoted when the term impact investing was coined reinforced the idea of a necessary trade-off. While this framing was very useful for its time, as the industry was still finding its identity, it’s now past its sell date, as both investors and investment options have become more prevalent, diversified, and complex. 

Consider this: Traditional investment theory defines “risk-return trade-off” as “the principle that potential return rises with an increase in risk.” Hence, “invested money can render higher profits only if it is subject to the possibility of being lost.” Initial impact-investing frameworks, however, did not capture this directly proportional relationship. While they retained the financial “return” dimension, they substituted “risk” with “impact,” thereby removing a critical factor from the investment decision equation. What’s not clear is why the field inverted the new “return/impact” relationship, suggesting investors must choose one objective over the other (rather than the multitude of possible outcomes in between) and generating a false perception that investing for impact inherently means compromising returns. 

There are indeed some impact investments where funders would be ill advised to expect risk-adjusted commercial returns. But there are also huge segments of the industry that offer fantastic returns; recent and forthcoming studies by GIIN/Cambridge and Wharton verify this claim. The key is in what problem you are trying to solve. Trying to create manufacturing jobs in Detroit is very different than reducing recidivism in the UK or providing solar lanterns to the rural poor across Southeast Asia. This is precisely why we at Omidyar Network employ a “flexible capital” approach, using commercial investing instruments when they are appropriate (which is for much, if not most, of our portfolio), and using more patient vehicles for problems that don’t lend themselves as well to traditional instruments. 

All of this should be uncontroversial. But until we get clearer on this, we will remain stuck in debate and even run the risk of structuring bad deals. 

That’s where taxonomy and segmentation come in. By “clustering” major fund theses along three variables—risk, return, and most importantly, intended type of impact—we can be far more nuanced about different prospects for investors who are trying to solve a diversity of problems. 

This would yield multiple benefits. For one, helping investors better understand the space would accelerate their assessment of where they can “play,” leading to more-efficient, optimized capital allocation aligned with varying investor risk, return, and impact expectations. This would likely trigger a substantial uptick in blended capital models such as alternative fund structures, social impact bonds, and innovative financial products yet to be designed. It could also spur an exponential increase in early-stage ventures that can access adequate funds to support them across each stage of the capital spectrum and achieve scale by ultimately tapping commercial markets.

At Omidyar Network, we’re actively working to promote next steps in segmentation and supporting related returns-data research efforts to help inform this thinking. While it’s still in the early days, the recent groundswell of impact-investing news and activity signifies a critical juncture in the field’s trajectory. 

We must advance this conversation as a community, and begin to finally parse the big tent in earnest. This is not an easy undertaking—it cannot be a top-down exercise, and we cannot solve it all at once. But until we do so, the industry won’t achieve the growth or the impact we’d all like to see. It may be the only way to truly move forward.

Read more stories by Lauren Booker & Paula Goldman.