Christopher O’Dea speaks to the McKnight Foundation of Minnesota about its $200m commitment to impact investment strategies 

• McKnight Foundation
• Founded 1953
• Endowment of $2.2bn (€2bn)
• Impact commitment of $200m

Impact investing has long been associated with projects where financing sources aren’t expecting a return on capital. While there’s still a major need for funding of programmes to address complex social issues, some impact investors are finding ways to deploy endowment capital to ventures in both public and private markets that align portfolio investments with the deeper mission objectives of a foundation – without forsaking market-rate returns.

It is an approach that promises to not only inject additional capital to efforts to resolve some of the most pressing social and environmental problems in the US, but also generate incremental returns that help fund additional disbursements.

A significant example of the market-orientated approach is found at the McKnight Foundation, where the impact investing programme its $2.2bn endowment initiated in 2014 is every bit as innovative as the career of the foundation’s namesake. Based in Minneapolis, Minnesota, the foundation was founded in 1953 by William McKnight, whose accounting acumen and emphasis on research and product development helped 3M become one of the most innovative multinationals. Today, 3M products range from Tyvek, a unique home-protection material that blocks infiltration of air and water while allowing water vapour to escape, to the iconic Post-It note.

It’s perhaps fitting that the company developed Tyvek – McKnight was born in a sod house on the windswept South Dakota prairie. The son of American homesteaders who left the East in 1880 as the US population migrated across the continent; McKnight rapidly rose from a bookkeeper’s role to become president in 1929 and chairman of 3M from 1949 to 1966. 

Today the foundation board includes fourth-generation descendants of McKnight – who have raised the question of how all of the foundation’s resources could be deployed with greater impact as they transitioned into leadership roles. A group of staff and board members worked with Imprint Capital, a boutique that advised foundations on impact investing issues and helped source investments and which is now part of Goldman Sachs. In 2014, McKnight allocated 10% of its endowment capital to a new impact investing programme to seek investments more closely aligned with its mission.

To run the programme, McKnight tapped Elizabeth McGeveran, who joined in 2014 as director of impact investing, after serving as senior vice president for governance and sustainable investment at F&C Asset Management. Today McGeveran is responsible for investing the foundation’s $200m impact commitment in businesses and funds that are aligned with McKnight’s mission, with a focus on accelerating the growth of a cleaner, low-carbon economy, improving the water quality and resilience of the Mississippi River, and contributing to a thriving, sustainable Twin Cities metro area.

elizabeth mc geveran

Impact investing “is a strategy within our endowment and a guide for how we manage the endowment’s overall portfolio,” McGeveran says. Impact commitments are “aligned with the specific areas of interest to the foundation. For example, we’re particularly looking for investments that help us advance the transition to a low-carbon economy.” Overall, “these are topics that are already deeply aligned with markets,” she adds. That’s an important facet of McKnight’s impact approach, as it is seeking market rate returns.

Over two-thirds of the $200m designated for impact investments has been allocated so far, McGeveran says, including about $117m deployed at the end of 2016 and the remainder committed to private-market funds that have not yet closed. 

The allocations include $75m for public market investments, either bonds or stocks, pursuing market-rate returns using conventional benchmarks. A further $75m funds a portfolio for private investments, seeking to generate a reasonable risk-adjusted return across the range of those commitments. Another $50m of endowment capital is carved out for programme-related investments, or PRIs, investments which are designated as having charitable intent under Internal Revenue Service rules governing foundations.

Under IRS rules, US foundations are required to disburse 5% of their endowment each year, and PRIs, which qualify as charitable disbursements, can be counted towards that target. Such projects, McGeveran explains, typically pose risk so high that a foundation normally would not make such an investment and the expectation of any return is clearly below commercial standards. McKnight, which disburses nearly $85m annually, opts not to count PRIs towards its total goal, but those investments amplify the foundation’s impact. Those investments tend to be structured as long-term loans with low interest rates of about 2%, McGeveran says.

The largest commitments are in investments aimed at accelerating the creation of a low-carbon economy, accounting for approximately 50% of the impact capital deployed so far. Part of the reason for that weighting is that although McKnight is seeking to increase the total impact of its endowment, foundation investing is ultimately a conservative undertaking. That leads to allocations to companies and fund managers with demonstrable growth potential. “It’s easier to deploy money in areas where you’re swimming with the economy,” McGeveran says. “We are swimming with markets when you talk about new forms of energy.”

In fact, McKnight considers climate risk to be a systematic economic risk; “We want to think about systematic economic risks across our portfolio, full stop,” McGeveran says. While there are “good opportunities in the transition to build up our economy, and we want to be sure that we get our share of them, we want to make sure that our fund managers across the whole portfolio are thinking about climate risk.”

Water is another clear example. “Water used to be considered a free input,” McGeveran says. “It’s not a free input anymore, certainly not an abundant free input,” she adds. “Companies need to have really fundamental, deep planning around water, particularly if it’s an important part of industrial processes.” One of the direct equity impact stakes is in Midwestern BioAg, a 30-year old firm that helps farmers use its organically-based products to improve the nutrient profile and yield of their soil while using less nitrogen and phosphorous, which are a primary source of pollution of the Mississippi River and its tributaries. The company helps farmers capitalise on the dramatic increase in demand for organic grain or to meet higher environmental standards from powerful consumer brands like General Mills.

To develop its impact investing programme, McKnight reviewed how its current investment managers could help the foundation meet its objectives. One of the first exercises was to check the carbon intensity of the portfolio by totting up the greenhouse gas production per unit of sales of the companies owned by each investment manager. 

That turned up a $75m allocation to a Russell 3000 index tracking fund managed by Mellon Capital Management; with broad exposure, the fund held some large greenhouse gas producers. McKnight asked Mellon to maintain the low-cost tracking structure with a maximum tracking error of 50bps, with a twist. “To have it serve the same function in our portfolio, could we tilt our exposure away from inefficient producers and tilt it towards efficient producers,” McGeveran says.

The result was the Mellon Carbon Efficiency Strategy. “Our goal was to work with Mellon to build something that would hopefully be commercially viable, so as not to be so tailored to McKnight’s interests that it wasn’t something the manager could grow.” McKnight seeded the carbon strategy with its $75m of existing capital topped up by an additional $25m allocation.

Perhaps mirroring the fortuitous invention of the Post-It note, adopting an impact investing approach has produced unexpected benefits. “Not only have we been deploying the dollars at a relatively rapid rate to impact investments,” says McGeveran. “We’ve also found that the act of asking ourselves about new types of investments has opened opportunities in the broader endowment to achieve better alignment between our investments and our mission,” she adds. “That was an interesting, and I think not entirely expected outcome.”

IImarinen seeks companies that benefit from sustainable development

• Total invested in sustainable development: €520m
• Includes direct equity investments in listed companies where 50% or more of the business relates to sustainable solutions
• Proportion of net turnover of direct listed equity holdings related to sustainable development solutions: 5.7 % of which 2.2 % relates to social impact and 3.4% relates to environmental impact.

As part of its broader sustainability investment activities, Ilmarinen actively targets companies involved in renewable energy, clean water and resource efficiency.

Within its equities investment, the €37.2bn Finnish earnings-related pensions provider searches for companies that benefit from providing solutions for sustainable development, says Tiina Landau, senior adviser, responsible investments.

net turnover of direct listed equity holdings related to sustainable development solutions

“The idea is that we find companies that can grow at above the market rate, and we believe this can go hand in hand with sustainability goals,” she says.

Since sustainability is one of the pension insurance company’s core values, this type of investing matches its general corporate approach, she says, but stresses that the individual investments also have to make sense from a risk-return perspective.

“We have been looking for companies that benefit from the megatrend towards sustainability, and last year we got a tool to report on that in a more specific way regarding our direct investments in listed companies,” she says. MSCI is the provider of the new analysis tool.

“Now we are able to find out detailed data about these companies, showing where revenue comes from, and this enables us to find more of these investments,” Landau adds.

Having this data to help with the search for good opportunities, Ilmarinen now wants to double its listed equity investments in companies involved in renewables, clean water and resource efficiency from its current level. Establishing a baseline to show the proportion of revenue these companies derive from sustainability activities enables Ilmarinen to do more.

Currently 5.7% of its equity revenue comes from sustainablity activities, and it aims to increase this to 12% by 2020. “Within these investments, we have companies that are producing renewable energy technology, for example wind farms, and we also have companies that are involved in combatting major diseases, for example HIV, or hepatitis,” she says.