McKnight Foundation: Investing for climate impact

divestinvestfi

EEMPicUsed

In the world of philanthropy, the divestment movement is known as Divest-Invest.

"Divest" has gotten most of the attention. "Invest" will make more of a difference.

Divesting ownership of fossil fuel companies won't have much direct effect on the fossil fuel industry, as I've written, in part because most of the world's reserves are held by state-owned oil companies that are not traded on the capital markets. As 350.org says on its Go Fossil Free website: "Divestment isn’t primarily an economic strategy, but a moral and political one."

By contrast, investing is climate solutions is a moral, political and economic strategy. It offers foundations, particularly the biggest ones, an opportunity to have a direct and meaningful impact on climate change. That's why I decided to talk with Elizabeth McGeveran, director of impact investing at the McKnight Foundation.

McKnight's big: It has an endowment of about $2.1 billion, placing it among the top 50 foundations ranked by assets. The Minneapolis-based grantmaker, which was started in 1953 by William L. McKnight, a CEO of the 3M company, has not signed the Divest-Invest pledge. But Ted Staryck, who chaired of the foundation board from 2011 until 2015, was one of several fourth-generation McKnight family members who wanted to make more of a difference on the investing side. In 2014, McKnight announced that it would invest $200 million, or about 10 percent of its assets, for "impact" as well as financial return, a decision explained by foundation president Kate Wolford in this 2014 blogpost. 

So how's it going? So far, so good, McGeveran told me by phone.

McKnight's commitment to impact investing enables the foundation to use its assets, as well as its grants, to serve it mission. Some investments support economic development in the Twin Cities and the resilience of the Mississippi River -- both McKnight priorities -- but most are aimed at accelerating the transition to a cleaner, low-carbon economy. While McKnight has made a couple of higher-risk bets, most of its impact investments are designed to match or perhaps even outperform the rest of its portfolio. 

“The vast majority of this carve-out has expectations for market rate returns,” McGeveran said. Done right, impact investing is a win-win for foundations.

McKnight's most innovative idea was to put $100 million on the table as an inducement to Mellon Capital, one of its longtime endowment managers, to create a broad-based carbon-efficiency fund that underweights carbon-polluting firms and overweights companies that are carbon-efficient. So, for example, the fund owns more shares of a utility that uses lots of renewable energy, fewer shares of one that burns lots of coal. It would overweight a retailer with rooftop solar and an efficient supply chain, and underweight one that generates more greenhouse gas emissions per unit of revenue. The theory behind the strategy is that environmentally-efficient companies will enjoy a long-term competitive advantage; arguably, carbon efficiency is also a proxy for smart management.

“With about 1,000 holdings, the fund reduces the carbon intensity of our investment (a.k.a. greenhouse gas emissions per dollar of sales) by 53% compared to its benchmark," McKnight reports.  McKnight and Mellon also eliminated coal companies from the portfolio which, in hindsight, turned out to be a smart move, as some of America's biggest coal companies have since gone bankrupt.

Since its inception, the Mellon Carbon Efficiency Strategy has grown by 0.7 percent, outperforming its Russell 3000 benchmark, which is up by 0.4 percent. That doesn't mean much--two years is not long enough to judge a strategy--but it's promising.

“We’re not expecting this particular fund to have tremendous outperformance," McGeveran told me. "Is it going to have slight outperformance? We hope so.”

Just as important, if the fund gathers assets from other foundations or pension funds, it will send a market signal to companies that institutional investors are willing to reward firms that are good environmental stewards. “One of our goals was the make sure that Mellon was building a product that could be viable in the marketplace,” McGeveran said.

So far, only one other institutional investment has put money into the fund, Mellon Capital told me by email. But it's still early days.

Interestingly, Goldman Sachs last year launched its carbon efficiency strategy with $2 billion from a New York state pension fund, and State Street Global Advisors created a carbon-efficient ETF. Hugh Lawson, Goldman's head of ESG (environmental, social, governance) investing, saw the business potential of impact investing after helping the Rockefeller Brothers Fund divest, as I reported last year in the Guardian. Goldman also bought Imprint Capital, an impact investment boutique that advises McKnight.

McKnight has done even better with a $25 million investment in Generation Investment's Global Equity Fund, which has grown by 12.1 percent, well ahead of of its MSCI World benchmark, which is up just 0.2 percent. Generation, you may recall, is the London-based investment management fund started by Al Gore and former Goldman partner David Blood. The global equity fund holds a concentrated portfolio of 30 to 60 companies that have a deep understanding of how social and environmental risks and opportunities drive their long-term financial performance. McKnight has pledged another $7.5 million to Generation's Climate Solutions Fund, which is still acquiring assets.

Two other climate-related investments at McKnight are worth noting. The foundation made a small equity investment in a startup called Generate Capital, which finances clean infrastructure technology for businesses, governments or nonprofits. It has financed about $250 million in solar, lighting efficiency and water efficiency projects in its first 18 months, according to Scott Jacobs, its co-founder and CEO. "Our biggest impact will be showing the world that you can make a lot of money from sustainable infrastructure," Jacobs told me.

McKnight also made a $1 million, 10-year loan at 2 percent interest to the Natural Capital Investment Fund, which supports small businesses in Appalachian regions that are suffering from the coal industry's decline. Why? "Just as it’s essential to invest in a cleaner energy future, it’s essential to support coal-dependent communities seeking to reinvent their economies," McGeveran recently wrote. The Natural Capital Investment Fund, she said, has backed a large animal veterinarian clinic, a historic downtown in need of renovation, an eco-tourism venture, and loans to 88 West Virginia companies for cutting energy consumption and reducing costs. Foundations are well positioned to help communities that grew up around the coal industry, whose workers powered the rest of America for decades.

All of these investments -- the Mellon low-carbon strategy, the Generation investments, the investment in Generate Capital and the loans for Appalachian businesses -- have direct impact, the potential to leverage other investments and symbolic value.

On its website, McKnight reports on what it has learned from each investment. According to McGeveran, it has exceeded the 10 percent target for the carve-out, and now has devoted 19 percent of its endowment to impact or program-related investments.

None of this is new, or unique to McKnight. Other foundations began impact investing sooner, and some have gone further.(See my blogpost about F.B. Heron.)  But McKnight has shown how a big foundation can deploy all of its assets -- grants, investments, knowledge and influence -- to fight climate change. Other big foundations that are engaged with the climate issue could have more of an impact if they brought more of their resources to bear.