Baillie Gifford Responsible Investing Breakfast

Your capital is at risk. 

The last five years have seen a sea change in attitudes towards responsible investment.

Assets under management in strategies classed as ‘sustainable’ have increased by 136 per cent since 2019, said Catherine Flockhart, Head of ESG at Baillie Gifford, in her welcoming remarks at the Haberdashers’ Hall, home of one of the venerable City livery companies.

“Responsible investment has become an increasingly important part of the investment conversation,” she continued. “However, the last couple of years have been tricky for responsible investors, with rising inflation and geopolitical tensions. Companies who invest for the future have been hit by unprecedentedly sharp rises in interest rates.”

Meanwhile, scientists are now warning that we are off course for the hoped-for smooth transition to limit global warming to 1.5 per cent by the end of the century. This is despite the international pledges made in 2015 at the UN’s COP21 Paris climate change conference.

But Flockhart said she remains optimistic, pointing to increasing evidence suggesting that companies prioritising social and environmental policies do outperform. She cited Hannah Ritche’s book, Not the End of the World, which encourages us to look up and see the important long-term trends (such as improvements in infant mortality, life expectancy or literacy) amid negative daily headlines. “Every country has made progress – not just the wealthiest.”

While not glossing over the complexities and challenges for sustainable investors, Flockhart said, “It is a long-term game, and the story is about the direction of travel.”

Engaging for change: a CEO’s perspective

Katherine Davidson, an Investment Manager on Baillie Gifford’s Sustainable Growth Team, interviewed Nicholas Anderson, the former chief executive of UK thermal energy company Spirax Group, who was speaking in a personal capacity.

When he became CEO in 2014, Davidson was the only investor who asked him about the company’s sustainability efforts. The company just got on doing what it felt was right without needing to discuss this aspect of its operations more widely.

By the time Anderson retired this January, he said things were very different. A pull factor from investors enabled the company to invest more resources in the sustainability work it wanted to do.

Asked whether interactions with shareholders can influence decision making, Anderson gave a definitive yes. “They all do, but it is important that all stakeholders – particularly investors – make their expectations clear. It is also important that companies listen.”

He also emphasised the need for companies seeking to attract long-term-minded shareholders to have a resilient business model. All investors, particularly ESG investors, need to resist the temptation to see things through a short-term lens, he stressed.

Davidson asked Anderson how best to approach emission-reduction targets when future dates, whether 2050 or even 2030, can seem so remote.

“When you start seeing what is involved, the investment, time and work that's required to achieve these goals, time will fly,” he answered. “Before you know it, you're up against those milestones. You must focus on what you can control and where you can have a more direct impact.”  

Investing for good outcomes

Many clients are looking for a contribution to a better world in non-financial terms, with positive environmental and good social outcomes. As the number of investment vehicles available mushrooms, despite growing global inequality and rising carbon emissions, Catherine Flockhart noted that she is often asked how Baillie Gifford managers define these outcomes.

She admitted that measuring broad outcomes is complex and difficult to trammel into a single measurement. Acknowledging that clients will hold different views of what makes a good non-financial outcome, Flockhart introduced a panel of Baillie Gifford investment managers and analysts who discussed their different approaches. 

Ed Whitten, Impact Director for the Positive Change Strategy looks for companies that will make more money the greater impact they deliver.

“These two things should really be aligned, but there is often an inherent complexity,” he observed. “Clients would like us to have perfect companies, but they don't really exist. There's always going to be a trade-off.”

For instance, with a healthcare company there will be a trade-off between affordable drug pricing and margins and profitability. Or in the case of Brazilian fintech Nubank, with over 100 million customers in Brazil, Mexico and Colombia in hitherto often inaccessible financial services, the question of fairness to customers needs to be considered against factors such as interest rates and profit margins. 

If investment managers can find companies where sustainability and investment strengths can reinforce each other, there is less likely to be a trade-off, agreed Bridget Harris, Investment Manager in the Private Companies Team.

“Several private companies are working on innovative solutions to very large problems. Quite often their priority is to commercialise their product, but we have a role to play in helping those companies think through the kinds of public companies they want to be.” For instance, the team may encourage companies to report carbon emissions and disclose more information than a private company would typically do.  

As the manager of the global real estate portfolios for Baillie Gifford’s Sustainable Income and Sustainable Multi Asset strategies, Jon Stewart has had the good fortune to find a natural alignment between the strategies’ financial and sustainability objectives, particularly in the realm of decarbonisation. As he points out, the built environment is either directly or indirectly responsible for about 30 to 40 per cent of greenhouse gas emissions. Only about 30 per cent of today’s London office space is estimated to be compliant with the UK government’s stringent regulations coming into effect in 2030.

Buildings that aren’t up to scratch will be left empty, and Stewart predicts that owners will not be able to enjoy steadily growing and compounding real income.

But this also represents an opportunity. Already tenants’ demand is polarised in favour of best in class, modern, highly sustainable and preferably net-zero-compliant spaces which command premium rents. As Stewart argues, “Sustainability is no longer a ‘nice to have’ or an add-on but an essential part of the property investment case.”

A recurring theme of the breakfast event was the importance of engaging with companies to improve governance, sustainability efforts and profitability. Davidson described a successful outcome from discussions with US biotech company Illumina over acquisition strategy. Following a shareholders’ vote, the chief executive and chair stood down and Baillie Gifford, one of the company’s largest shareholders, is now talking to the incoming management team and pushing for further improvements.

Meanwhile, in Chile, the fixed income team, as part of the Emerging Market Investors Alliance, requested and later secured a pre-budget report from the Ministry of Finance, improving transparency and feeding into the country’s credit agency ratings.  

Making climate scenarios work

The last part of the morning session involved a look into the future with Caroline Cook, Baillie Gifford’s Head of Climate. She warned, “In a world of uncertainties, one thing is certain: none of us individually will probably have the future that we expect, no matter how strong the force of our own personalities. This creates a particular problem for responsible investors as the world is complex and changing all the time.”

The transition to net zero is likely to be somewhere in the ‘messy middle’ between the worst hot-house scenario and a smooth Utopian progression, Cook explained. While some regulators now require scenario analysis around climate change, the risk is that it creates a false sense of security.

Quantitative models tend to be based on outdated economic thinking which assumes decisions are made on lowest cost assumptions. Cook suggested that these fail to allow enough room for the impact of climate change or new technologies.

Over the last year, Baillie Gifford has developed its own publicly available qualitative narratives in partnership with two collaborative groups of academics. These are publicly available, but within the firm, they are helping investors to see the opportunities and challenges facing individual companies, as well as raising exciting areas to research.

Scenarios with a full system view 

A successful transition to renewable energy, for instance, will almost certainly lead to cheaper energy prices. Indeed, there are likely to be all kinds of positives as we adapt to a world with less carbon, an aspect of the change often glossed over. While the challenges facing responsible investors are considerable, attendees left with a sense that these are not insurmountable and that responsible investors can play an important part in this.

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