Engagement and the power of relationships: it’s about time

Do companies really listen to their shareholders? As a charity, is your voice heard?

When it comes to charities investing, aside from generating returns, we know it’s a priority to encourage good business practices, allocate funds sensibly and transparently, and ensure that company values align with your mission.

So, these are important questions. And not only that, they’re questions that should be answered with a long-term mindset.

Indeed, being seen to invest in companies over an extended time is an essential ingredient for successful engagement, allowing your charity to open doors and influence companies for the better.

A long-term approach to investing is therefore highly compatible with charities, and crucial for engaging with businesses on key issues which take time to solve.

Meanwhile, we’d argue that a lack of patience with companies doesn’t always result in the best outcome.

An accelerating world

From the mid-seventies onwards, one observable trend is that stock markets have become increasingly short term.

Data shows that the average holding period of shares on the New York Stock Exchange, is now well below one year after a long and steady decline. It seems the attention span of investors is waning.

Investors have become obsessed with daily moves and quarterly results, and if you listen to many companies’ results presentations, you might notice that the majority of questions to management focus on either the most recent or upcoming quarter.

This is the ‘Uber-isation’ of investment: ride a stock for a few months and move on to the next one. It’s not actual investing, it’s mostly trading.

For comparison, Baillie Gifford’s average holding period is between six and nine years – significantly longer than the market average.

That trend of short-termism is also apparent in the tenure of company chief executives (CEOs), where we can see a steady decline over the past decade.

More than 50 per cent of CEOs now have fewer than five years of tenure. From both the investors’ side, and from the companies’ side, it feels like the world is accelerating.

The risks of rushing

Why should it matter that the pace of investment is increasing? We believe it can lead to bad decision making.

As a CEO, for example, you may be tempted to delay spending on the future of your company, leaving the consequences for your successor.

The change of CEO at Toyota last year is telling. New CEO Kōji Satō did not waste time in accelerating the company’s transition to electric vehicle (EV) production following criticism over his predecessor’s apparent hesitance to adapt.

Toyota is not alone – many of the European carmakers have been dragging their feet for a long time, delaying investments in EVs. Now they find themselves playing catch-up with Chinese automakers, which have gained vast experience in just a few years.

As an investor, a focus on the short term makes you more susceptible to behavioural bias. For example, you may sell out of a company because its share price was punished in a quarter where it did not meet its consensus earnings forecast.

For portfolio managers, a short investment horizon is often linked to incentives. Many are judged on three-year performance, which introduces a strong incentive to align closely with the benchmark.

Put simply, many managers will not take a career risk by deviating too much from the benchmark because they’re worried it might lead to a short-term performance slump. But by 'hugging' the benchmark, these managers also reduce the likelihood of outperforming it after fees.  

Why does engagement matter?

Evidently there are risks for companies and investors stemming from a short time horizon. But what do they have to do with engagement?

Engagement is a key component of stewarding a client’s capital. It ensures alignment of interests between companies and shareholders, which in turn means it should also benefit wider stakeholders.

Some vocal politicians and officials, for example in the US deem environmental, social and governance (ESG) considerations burdensome and criticise them citing a perceived conflict with fiduciary duty.

But we would argue it is absolutely part of our fiduciary duty to account for ESG in an investment case. One just needs to look at new EU regulations introducing a carbon tax at the border to realise that the ‘theoretical’ cost of emissions and disregarding environmental concerns is soon to become very real.

Why does time matter for engagement?

If you are a long-term investor, time naturally removes the tension between investing today for an uncertain payoff in the future.

Here’s a concrete example: during the pandemic, Nestlé found efficiencies in its business to the tune of about CHF3bn (~US$3.3bn). If you held the shares for a year, you’d be incentivised to ask the company to let those efficiencies boost the profits and dividend for that year.

If you were mindful of the company’s future success, however, you’d be incentivised to push it to reinvest those savings to future-proof the business.

For example, Nestlé needs to start acting now on its use of plastic packaging, which will become a growing issue that takes time to address. In our recent engagements with the company, this is what we pressed for instead of a slightly higher dividend.

Your managers should put your interests ahead of theirs. Pushing a company to underinvest so results look better may boost the share price for a few quarters, but it will be detrimental in the long term.

The second advantage of having a long investment horizon is that it helps build better relationships with companies. In turn, this leads to improved access, making us better investors over time because we can compound our knowledge of a business.

Relationships also give us more influence on decisions.

Thus, it’s critical to invest in like-minded managers and boards: those that take a similarly long view and do not take decisions to boost short-term profits. This is why we like companies still led by their founders or where a foundation is a majority shareholder.

Case study: Albemarle

Albemarle is a good example where long-term engagement has been successful. The company has its main operations in Chile and Australia and mines a commodity essential for the energy transition: lithium.

Lithium extraction is a bit like salt extraction. Underground brine is extracted, and the water is left to evaporate before the residue is processed into lithium. It’s an emissions-intensive operation.

Baillie Gifford's Responsible Global Equity Income (RGEI) Fund first invested in the company in 2017 and encouraged it from the start to lead its industry on sustainable mining. In 2020, the fund managers asked Albemarle to consider third-party auditing of its operations, believing it could enhance competitive advantage in terms of supply chain transparency.

Two-and-a-half years later, Albemarle became the first lithium miner to be certified by the Initiative for Responsible Mining Assurance (IRMA).

Why does that matter? Because its clients can now claim to source from a certified mine. Ford was the first of Albemarle’s clients to announce a supply agreement specifically from IRMA-certified mines. And it probably paid a premium for a commodity product.

As you can see, this took time. It was only worth doing because we’re invested for the long term.

Other examples of our successful engagements range from encouraging logistics operator UPS to reduce emissions by electrifying its delivery fleet, to persuading Danish pharmaceutical company Novo Nordisk to increase access to its treatments in low-income countries.

Our investors often consult experts during this process to promote an informed dialogue. For example, in the case of UPS we consulted NGO and logistics industry thinktank Smart Freight Center. 

Time well spent?

As well as championing the benefits of extended engagement, it’s also important to explain what we don’t look for – that being quick fixes, ‘one-size-fits-all’ approaches or the ‘perfect’ company. We know that every business faces different issues, so we tailor our engagement accordingly.

Our managers are allowed to take a long-term view thanks to a supportive, like-minded organisation and, more importantly, thanks to you, supportive clients who share that long-term approach.

The fundamental question is, does tension exist between financial returns and making companies better? And our answer? Not if you have a long investment horizon.

This is relevant for you as a charity because, like us, charities are focused on the long term. Our values align. Time allows us to measure outcomes and see real value emerge.

Finally, time gives you the opportunity to have a greater impact on company activity, helping you to nudge operations in a direction that will benefit all stakeholders.

Engagement takes time, but it is time well spent.

Read more valuable insights on our company engagements in the Responsible Global Equity Income Stewardship Report.

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