A Value-Chain Analysis | May 2016
This case study examines the challenges and lessons learned during the 10 month development of the Carbon Efficiency Strategy, a joint venture between MCM and the McKnight Foundation, offering carbon-conscious investors a way to invest in companies whose practices could reduce carbon emissions.
In late October 2014, Gabriela “Gabby” Franco Parcella, chairman, president, and CEO of Mellon Capital Management1 (MCM), and Kate Wolford, president of The McKnight Foundation, announced a joint venture called the Carbon Efficiency Strategy (CES). The CES represents a landmark product that offers investors a lower-carbon solution to equity investing while also fulfilling their fiduciary responsibility.
The CES Case Study examines the development of Mellon Capital’s CES and explores the challenges and lessons learned throughout that process — insights other innovators may want to consider when creating new financial products that balance financial returns and social outcomes with the added dimension of a carbon-specific focus.
The study looks at the creation of the CES strategy through the concept of Deliberate Leadership (DL). DL is a framework for leaders to use in tackling problems with no easy or consensus solutions.
Creating a strategy designed to ‘fill a gap in the universe of investment products’ is no easy task.
Gabby Parcella, Chairman, President, and CEO of Mellon Capital Management
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McKnight had set the stage for the CES portfolio through its commitment to impact and responsible investing, which included addressing climate change. Mellon Capital has managed a portion of The McKnight Foundation’s investments since 1987, establishing a deep relationship as the groundwork for this partnership. Mellon Capital is a wholly-owned subsidiary of BNY Mellon, one of the world’s largest and most established financial services corporations. While McKnight was evolving its impact program and refining its focus in the area of climate change, both BNY Mellon and MCM were on their own paths to move beyond innovative investment products to incorporate social responsibility across each firm. BNY Mellon engaged in a redesign of its corporate social responsibility (CSR) strategic framework, which evolved to include Social Finance – any investment activity with a positive social and/or environmental impact. Likewise, Mellon Capital concentrated on providing solutions that tackled its clients’ greatest concerns, often seeking to bridge the gap between market risk and the clients’ objectives.
In addition to McKnight, Mellon Capital, and BNY Mellon, there were two other firms involved in the process of creating the CES. Mercer (also a partner of McKnight since the 1980s) leveraged its ESG research capabilities to meet McKnight’s financial and social needs. Also joining the process was Imprint Capital, an impact investment advisory firm new to the McKnight relationship that works on social investment issues with several large foundations in the U.S.
Creating a strategy designed to “to fill a gap in the universe of investment products” is no easy task. The partners knew from the beginning that this was a unique project that involved multiple partners, divergent interests, strong opinions, conflicting values, confusion about responsibilities, and a context that was both urgent (climate change) and reluctant (the traditional financial sector and the traditional philanthropic sector). Getting to “yes” was an iterative and contentious process, even for partners who wanted the same result and who have built a trusted relationship over the course of several decades. It was no different for McKnight and its three advisors, Mellon Capital, Mercer, and Imprint.
Over a ten-month period, the partners faced numerous challenges, including confusion about roles and responsibilities, incomplete data from third-party providers, and the iterative process of arriving at an executable investment model with a clear thesis. The partners, through persistence and working collaboratively, finalized the Carbon Efficiency strategy that would provide broad equity exposure cost-effectively while assessing, recognizing, and supporting strong climate performance. This would be achieved by using a combination of rewards, penalties, and screening for climate-related behaviors and proxy voting in support of shareholder resolutions and other corporate initiatives related to climate risk, performance, and disclosure.
The Carbon Efficiency Strategy is designed to provide broad, equity exposure while seeking to minimize investments in companies with high carbon emissions. The strategy helps investors manage climate change related risk by focusing on carbon emissions as the key risk indicator. To address the most negative impact, coal companies are excluded from the portfolio. Utilizing a reward and penalty system, the model assesses a company’s environmental performance within its peer sector, seeking to reduce the carbon intensity exposure of the strategy by over 50% while minimizing tracking error to less than 0.50% relative to the benchmark2. Additionally, the strategy incorporates an engagement approach through integrated proxy voting policies, signatory initiatives, and direct conversation. Such a strategy would potentially enable investors to send a strong signal of climate-change-related action and engagement while maintaining a beta investment profile and managing climate-related investment risk.
The Seven Core Characteristics of Deliberate Leaders: All of the partners who created the Carbon Efficiency Strategy consistently displayed the seven core characteristics (the 7 C’s) to be deliberate leaders:
For MCM and BNY Mellon, the CES is a new product placed in a dynamic and expanding market, proof that the Social Finance approach is an actionable strategy. It also means new skills and abilities in ESG and Social Finance for the team and greater depth of experience working with nontraditional partners and communicating with clients about the future of responsible investing. While the final story about the impact of the CES is not yet known, the partners have already begun to benefit from what they have learned about collaboration, managing team conflicts, navigating internal resistance to change, exploring ways to blend financial and social returns, and mapping out a process for taking a new idea and shaping it into a market-ready product. The partners can now begin to ponder “what’s next?”
1 Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA or the BNY Mellon funds.
2 This strategy can be applied to any broad equity benchmark.
Mellon Capital Management Corporation (“Mellon Capital”) is an investment adviser registered with the Securities and Exchange Commission (“SEC”) under the Investment Advisers Act of 1940. Mellon Capital is a wholly-owned subsidiary of The Bank of New York Mellon Corporation (“BNY Mellon”). The firm is defined as Mellon Capital and includes assets managed as dual officers of The Bank of New York Mellon and as dual employees of The Dreyfus Corporation. Mellon Capital Management and its abbreviated form Mellon Capital are service marks of Mellon Capital Management Corporation.
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Chairman, President and Chief Executive Officer of Mellon Capital