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GSAM Perspectives

Right Tools, Right Time: The Rise of Impact Investing

Rick Scott, Vice President of Finance and Compliance at the McKnight Foundation, discusses his views on environmental, social and governance (ESG) and impact investing with GSAM.

Rick Scott is the Vice President of Finance and Compliance at The McKnight Foundation. Previously, he was CFO of The Guthrie Theater and CFO of a human service agency. Prior to that, he spent thirteen years working in the computer industry. He has served on the boards of Foundation Financial Officers Group, the Minnesota Council on Foundations, the Minnesota Charities Review Council, PFund, and Northern Clay Center, as well as the committees of the Council on Foundations, Project 515 and the Headwaters Foundation. Scott also serves on the advisory committees for Pantheon Capital, Commonfund Capital and BNY Mellon Asset Management.


Introduction

In 2013, The McKnight Foundation’s Board of Directors allocated 10% of its $2bn portfolio to an impact investing program. The goal is to identify investment opportunities from public markets to direct investing that align with the mission of the foundation while generating reasonable financial return. In particular, McKnight is seeking investments that will accelerate a transition to a low-carbon economy, help ensure a clean and resilient Mississippi River, and contribute to a thriving and sustainable region. Since the impact program’s inception, the Investment Committee has designated an additional $100mn for a carbon efficiency strategy.

How has your thinking about ESG and impact investing evolved since you began employing the strategy?

Our thinking has evolved considerably, as our learning has granted us new perspectives on our approach to the broader portfolio. While McKnight started with 10% of our endowment dedicated to impact investing, we see value in using an ESG mindset in approaching both our dedicated impact investments as well as the entire portfolio. We have found more levers for advancing our grant-making goals as we look at our position as an ESG- and impact-conscious institutional investor with a $2bn endowment.

We see power in our role as: (i) an asset owner who can dictate how our capital is allocated, (ii) a customer of financial services with the capacity to request new approaches or products, (iii) a shareholder who can vote proxies and request better ESG transparency from companies; and (iv) a peer investor who can work with other institutional investors for a better regulatory framework at the SEC, or collaborate with other foundations on deals. So while our endeavor may have started with a keen focus on a subset of our endowment, this approach has seeped into our overall investment thinking.

How do you think about the divide between investing and philanthropy?

I do not necessarily see a divide; I see them as complementary and not mutually exclusive or at odds with each other. Investing allows us to engage in philanthropy with the assumptions that we are a foundation in perpetuity and that we want to maintain the purchasing power of our endowment. There can be a natural tension that develops within certain foundation structures, such as when independent investment offices sit in a separate silo from the program functions, however, that is not the case at McKnight. Here, we have long collaborated across all functions within the Foundation, even well before we formally began our impact investing program.

Our Investment Committee members are typically trustees as well as investment professionals, and they are very knowledgeable about our program goals. Our strategic framework states that “Our overarching goal is to optimize the use of all Foundation resources to contribute to building and strengthening socially, economically and environmentally sustainable communities.” This includes mobilizing our investments.

What are your board’s key considerations for ESG and impact investing, and what opportunities and challenges do you see?

One key consideration is that we achieve a triple bottom-line for financial, programmatic and learning return. The learning return that has come out of the impact investing program is distinctive in part because we are committed to transparency and sharing lessons learned, both positive and negative, with our foundation peers. It’s learning by doing. Some institutions never get past the theory and conceptualization phase. Rather than suffer from paralysis by analysis, we implement, then adapt and make adjustments to our practice as necessary. We bring real-life impact investments to our Investment Committee, which clarifies our tolerance for illiquidity, risk, uncertain performance and types of high-value impact. We then incorporate what we have learned from each impact investment idea back into our program work, adding value to our core grant-making strategies, which loop back to our impact investing work.

In addition, we have built a program with significant flexibility in terms of tools and types of investments, varying risk/return characteristics, and the impact we want to achieve. This gives us options for matching the right tool to the task, as the sector has historically lacked tested tools developed for benchmarking or evaluation of impact.

There is a lot of hype in this sector, so impact investing must be approached with healthy skepticism and discernment. Care must be taken to sort through the noise and avoid greenwashing, whereby companies spend more time touting their ESG efforts than actually addressing the issues.

Another opportunity presented itself this past summer when Goldman Sachs Asset Management acquired Imprint Capital Advisors (“Imprint”), our impact consultant. Imprint has experience with many of the issues we face and diligently guided our staff and board through our process of developing an impact investing program. With the acquisition, we see an opportunity to tap resources beyond Imprint’s specialized knowledge.

What are the key principles to your investment philosophy and portfolio construction approach in this space?

Like most impact investors, we demand both high-impact investment and strong performance, which drives a higher standard in the industry. We don’t see a binary “either/or” situation when it comes to achieving financial and social returns. It’s “both/and.” We work under the principle that we do not need to sacrifice return or assume outsized risk to achieve impact. There are certainly times we will knowingly make a higher-risk investment for greater impact. The guiding principle is to develop enough tools so we can choose the right one to get both the financial return and the ESG impact we want.

What are the risks unique to ESG and impact investing?

There are many risks to ESG and impact investing, but we should be mindful that traditional investing is risky too. Endowments with a mission face headline risk as well as the risk of their investments undermining the work they are striving to do year in and year out. With a shift to impact investing, however, you can cast your net too widely and risk losing focus on your core values by trying to incorporate every social or environmental challenge. As with traditional investing, risks can be minimized with credible data, independent analysis and diversity in the portfolio.

First, the tools for benchmarking and performance evaluation need to improve greatly. The emerging tools are new and creative, which can be both a strength and a weakness. There are many organizations—from consultants like Imprint to investor groups like the Global Impact Investor Network (GIIN)—discussing and debating which measurements would be most meaningful. Companies need to enhance their reporting on material ESG risks. Using thoughtful rubrics, such as the Sustainability Accounting Standards Board (SASB), investors will have increasingly consistent, comparable data for analysis and investment decision-making.

Second, the lexicon in this space is problematic. There is an alphabet soup of acronyms and newly minted terms that are used loosely and with great variation in definitions. As the field matures, we hope and expect we’ll soon be able to speak a universal language.

Additionally, given that this is still a niche investment area, a range of other factors are currently lacking; however, this will likely improve over time as more fund managers enter this arena. Transparency is one area in particular where improvement is needed in order to provide more clarity into how investment managers consider and incorporate ESG factors. 

How do you anticipate ESG and impact investing to evolve over the next three to five years? Do you predict any new issues?

ESG and impact investing is the way of the future. Financial service firms will become increasingly sophisticated about the widespread materiality of ESG trends and practices. Today, many financial services firm still view ESG as a separate product class, but in the future this will change. In the past 12 months, we have seen at least three of our long-time fund managers introduce new product offerings in this space, going from zero to something. It won’t be long before investors have many more choices, and increased competition, leading to lower fees and transaction costs, which in turn translates to greater competition to source and broker the best deals.

Generally speaking, I see the alignment of investments as moving up the tree from lower-hanging fruit to opportunities that might be more esoteric, challenging to define, and harder to reach. In five years, for example, we may begin to see an impact-related trigger in private equity management fees, whereby a fund manager has to achieve specific ESG outcomes in order for certain fees to kick in.

Specific to our priority areas, we anticipate a broader scope in the clean energy space. There’s a lot of excitement and innovation related to renewable energy, storage, and distributed generation. We expect investors who are moving away from coal to begin thinking more about reinvesting in communities where the economy has historically relied on fossil.

Another evolution we see is in the agricultural sector, such as goods and services farmers use to reduce pesticide use. There’s been dramatic growth in natural foods and organic inputs, but we are also interested in who is serving conventional farmers and helping them to reduce expensive inputs and improve their impact on water quality. We expect growing opportunities in agricultural data management, soil augmentation, permanent crops and more.

Overview: ESG and Impact Investing

In an ultra-connected world where transparency is the norm, investors have begun to appreciate that compartmentalizing their values and investment decisions is no longer practical. 

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Beyond Screening: The Evolution of Impact Investing

Taylor Jordan, Former Co-Founder of Imprint Capital, discusses the evolution of impact investing with Hugh Lawson, Global Head, ESG Investing Efforts, Goldman Sachs Asset Management.

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John Goldstein, Former Co-Founder of Imprint Capital, discusses how an effective ESG program calls for a focus on key metrics with Hugh Lawson, Global Head, ESG Investing Efforts, Goldman Sachs Asset Management.