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How Socially Responsible Investing Strategies Are Built: A Case Study

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Identifying partners that share values is a critical part of a firm’s socially responsible investing strategy, according to a case study by the Saïd Business School at the University of Oxford. “Getting to ‘yes’ can be an iterative and contentious process, even for partners who want the same result and who have built a trusted relationship over the course of several decades,” the report noted.

The case study was published in April 2016 and drew from the experiences of BNY Mellon, Mellon Capital Management and the McKnight Foundation as they developed their Carbon Efficiency Strategy. The case study is part of a series by the Saïd Business School to examine how global leaders can address pressing issues such as climate change, water crises and cybercrime.

The Carbon Efficiency Strategy was launched in October 2014. CES is a $100 million portfolio of lower-carbon emission investments developed by BNY Mellon, MCM and McKnight, and several other partners.

The UN Intergovernmental Panel on Climate Change found in April 2014 that between 2000 and 2010, emissions increased more quickly than in each of the previous three decades. Although political initiatives to address climate change have stalled in North America, “the global business community has been steadily increasing the connection between profitability and sustainability as it assesses the future of its bottom line,” according to the report.

As demand for impact and sustainable investments have grown over the last few decades, BNY Mellon, MCM and McKnight were “quietly amplifying” their individual approaches to reducing carbon emissions, according to the study, which eventually coalesced into the CES.

Climate and energy is part of McKnight’s mission. MCM manages about 27% of McKnight’s $2.2 billion endowment, and has managed a portion of McKnight’s investments since 1987. BNY Mellon formally established its corporate social responsibility strategy in 2007. Today, BNY Mellon’s Social Finance approach covers approximately $22 trillion in assets, according to the study, and offers mainstream investors access to strategies that focus on socially responsible investing, environmental finance, impact investing and development finance.

MCM, a wholly owned subsidiary of BNY Mellon, manages almost $44 billion in SRI and ESG investments, and became a signatory to the UN Principles for Responsible Investing in 2013, and the Carbon Disclosure Project in 2014.

Planning for the strategy began in 2012, and involved multiple stakeholders, according to the report, including Imprint Capital, an impact investment advisory firm, and Mercer, a global consulting firm.

An examination of the McKnight’s carbon exposure in December 2013 found that the Russell 3000 Index held by MCM had the highest exposure to companies on the Carbon Tracker 200 (CT200) and Filthy 15 (F15) lists. Product development began in early 2014.

The CES started by excluding the top 20 carbon emitters in the Russell 3000, which the team found “could potentially reduce emissions exposure by 75% (versus the stated benchmark) with 40 basis points (bps) of tracking error.” That early version of the strategy was called the Carbon Emissions Reduction Strategy, and included five scenarios that resulted in between 75% and 95% reductions in exposure to high-carbon-emitting companies.

Early setbacks in the strategy included poor quality of data and lack of innovation. To improve the quality of data, the team incorporated the MSCI index along with the CT200 and F15, which were outdated and ambiguous. Unfortunately, that index only included 600 of the companies in the Russell 3000.

Simply removing large carbon emitters resulted in a strategy that performed like an investment screen, something “many investors had used for years to filter out companies that were not aligned with their values.” It also created a bias against company size, excluding larger companies that naturally had a larger carbon footprint without analyzing them for desirability.

To compensate, the team underweighted non-reporting companies and those with poor performance. As of July 2014, McKnight was able to present formalized goals for the strategy, including: “overweight strong greenhouse gas performers and underweight weak ones using apples-to-apples industry sectors, based on relative performance not size; include strong integrated proxy voting and shareholder engagement; and exclude coal.”

However, to reach a proposed 90% exposure reduction, the strategy would have to cut so many companies that “tracking error would be severe,” and CERS was scrapped for a more practical strategy.

In August 2014, the CES was presented to McKnight as a way to “provide broad equity exposure cost-effectively while assessing, recognizing and supporting strong climate performance.” It did so by using investment screens, penalties and rewards for companies’ climate-related behavior, and proxy voting to support shareholder resolutions.

After screening out coal companies, remaining companies in each sector were given a carbon intensity score based on greenhouse gas emissions normalized by revenue. Those with a low intensity were overweighted and those with a high intensity were underweighted. 

A carbon readiness score measured how well companies managed emissions risk in their business, and the strategy overweighted more efficient companies.

The strategy received final approval from the investment committee in September 2014, and it received a $100 million investment from McKnight on Oct. 31, 2014.

“Creating strong working relationships was also part of the development and refinement process,” the case study found. “All the participants brought unique and important strengths to the table, and the product likely would not have been as strong had there been fewer or more similar points of view in the discussions.”

The case study noted that State Street Global Advisors and BlackRock iShares launched their own low-carbon products soon after, in November and December 2014, respectively.

— Read Can Calpers Live With Responsible Returns? on ThinkAdvisor. 

— Correction: This article was edited to clarify that companies are overweighted in the Carbon Efficiency Strategy if they receive a low-carbon-intensity score.


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