Baillie Gifford joins the Net Zero Asset Managers Initiative.

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The COP26 climate change conference is beginning in Glasgow. We hope this event acts as a further catalyst to some of the deep societal, technological and economic shifts necessary within the global response to the climate emergency. In our view, the financial community has a huge responsibility and a huge opportunity. It must not only support legacy business models to adapt to a net zero economy but even more importantly back innovation, bravely and patiently, in the face of the crisis. We are excited to be joining the Net Zero Asset Managers Initiative (NZAMI) to add to our efforts to build momentum in this regard.

Any such venture is only as worthwhile as the participants make it. We see the NZAMI collaboration as a means to learn from and share with our industry, our clients and the companies in which we invest as we strive to accelerate the transition to a thriving low-carbon world.

Our portfolios demonstrate Baillie Gifford’s long history of thinking about and investing in companies supporting the energy transition. But we doubt we’re doing enough, and we can certainly see that the world is not doing enough. Climate-related issues are increasingly central to the task of delivering strong long-term returns for our clients. So we believe that this step, among others we’re taking, reinforces that objective.

Over the next few years, the climate-related regulatory and policy environment will be turbulent. There will be good data and bad data. Some will construct effective frameworks but others counter-productive algorithms. Against this backdrop, our purpose and philosophy need to remain clear. In the words that follow, we set out some of our ambitions. We will continue to update and build upon these thoughts in the months and years ahead.

What is the Global Climate Crisis?

The root of the crisis lies firmly in the failure of markets to properly price the cost of pollution, as well as that of other environmental damage. This, alongside the political dominance of the incumbents, caused a failure in our collective imagination. We believed for too long that only a fossil-based and highly centralised energy system could drive successful development. 

Changes to the natural world are now accelerating at a faster pace than we can cognitively recognise, let alone adapt to. They threaten to rob us of the rich biodiversity and sheer majesty of nature that are important to us in so many ways. And they risk triggering catastrophic physical feedback loops from which there is no return.

The physical effects – including extreme weather, rising sea levels and extinctions – are clear and present, with worse expected. In the short to medium term, they threaten yet greater social division between those who can insulate themselves from the repercussions, and those that cannot. In the long term, the adverse impacts will affect us all unless we fundamentally shift the nature of our energy systems.

The worst the financial sector could do now is respond to the climate crisis by repeating the mistakes that got us here.

Risks of a new market failure lie in the siren calls of metrics and their associated algorithms. They tempt our industry to use backward-looking or window-dressed data as a substitute for analysis and judgement.

And we need our imagination. The energy transition is not a one-dimensional substitution of renewables for fossil fuels, or electric vehicles for ones with internal combustion engines. Rather, it is part of a wider resource and developmental narrative that requires deep transformations to be made across our societies. We must be creative and relentlessly ambitious – like many of the great companies we own and seek out – in the investments we make to support this.

This is where asset managers can have the most material influence. There’s a huge opportunity to be grasped in thoughtfully allocating capital to support the transitions ahead.

What is Baillie Gifford’s Role?

We mustn’t be complacent, but we believe that Baillie Gifford’s investment philosophy starts at the right place. We are resolutely long term and look for companies that will grow for many years to come. That means we must think about sustainability rigorously and in its broadest sense.

We construct concentrated portfolios of companies that we know well, from the bottom up, with managements that we seek to understand and appreciate. Our track record shows that we are prepared to back the apparently unconventional and wait patiently for success. Just as we believe that generally only a small number of companies deliver outstanding returns, so we suspect a small group of innovators and industry leaders will prove to have an outsized influence on a timely energy transition.

This belief applies not only to our activities in the secondary markets, in which stocks and bonds are traded between investors, but also to our primary investments, where we can put new capital into private companies. In recent years, we have spent increasing amounts of time and effort enabling our clients to access these unlisted opportunities.

That sounds all for the good, but we need to challenge ourselves to work harder with our clients and with the companies that we hold on their behalf. The urgency of the climate crisis demands it, as do the magnitude of potential changes in asset prices, the competitive landscape and consumer attitudes.

We can be more disciplined and conscious about making sure our portfolios are truly climate-fit. We can look harder for those rare opportunities to invest in truly transformational technologies and business models that just might solve the problems at hand. Even if the energy transition takes longer than we all hope, we expect these characteristics to prove strong drivers of growth and competitive edge.

We recognise that different investment firms will have different roles to play. Passive, universal owners – who tend to track a specific index or market rather than pick individual stocks – must engage to try to manage the downside. They can ask all companies to improve disclosure and to share management’s thinking about the business impact of different climate scenarios. This will benefit the whole market and encourage us to be more ambitious in pressing our own holdings to do the same.

But what we don’t want is to mirror the index fund reliance on metrics. Nor would we want to see extensive use of narrow exclusion-based approaches in the construction of our portfolios.

Indeed, we will continue to push back on the inappropriate use of data. We have spent much time over the last 12 months pointing out the weakness of using estimated scope 3 (indirect) emissions data to assemble baskets of stocks, supposedly best aligned to deliver our low-carbon future.

Scope 3 has a vital part to play in company strategy and in deep investment analysis, but such blunt use indiscriminately across all sectors is not yet appropriate. We have enormous respect for those working at the cutting edge of estimation and scenario modelling, but little for those who pretend that it can already do what it can’t.

Where we really hope to contribute is through our capacity to spend time with companies. To be aware of climate risk, and then to build on that knowledge to put capital to work on the opportunities that can address the challenge. To support those companies that have the greatest potential to show climate leadership within their respective domains.

Our investment approach should lend itself to finding and supporting transformational innovators. They will not only bring new products and business models to market but encourage others to follow and thus drive their accelerated adoption. Tesla already demonstrates this in the car industry, but other sectors – from food to recycling – beckon.

We also see a large opportunity to back ‘adaptation leaders’. These are companies pushing the boundaries to make their essential processes and products fit for a low-carbon future. They will gain a competitive edge but can also support change at pace across their sectors.

Companies with systemic influence represent a third cohort of focus. These will often be carbon-light companies that are absent from the risk narrative’s radar. But they can play a very material role in nudging their customers to become pro-climate.

Netflix, for example, has described this to us as its ‘handprint’. Examples include its funding for David Attenborough’s Our Planet programmes about humanity’s impact on other species, and its Seaspiracy documentary about marine biodiversity. These are actions which delight customers and cement the brand, but also deliver critical climate momentum.

This potential makes it far more important that Netflix and other carbon-light holdings – such as Facebook, Delivery Hero or Pinterest – maximise this influence rather than just focusing, for example, on 100 per cent solar power for their data centres. This is also important, but, somewhat like ‘house-keeping’ by comparison.

In each of these areas, our search for positive climate contributions will have to be guided by a raft of qualitative judgements. There isn’t a single predetermined path to a successful energy transition, so we need to stay flexible and imaginative.

Which brings us to NZAMI

The initiative’s stated aim is for investment managers to “work in partnership with asset owner clients on decarbonisation goals, consistent with an ambition to reach net zero emissions by 2050 or sooner across all assets under management”.1

While the collaboration has a basic framework, it is purposely methodology agnostic. It requires that assets being managed for net zero alignment:

• set interim decarbonisation goals for 2030
• prioritise real economy impacts
• engage actively
• report transparently

Exactly how those aims are achieved is somewhat up to individual managers to approach relative to their own strengths – subject to appropriate challenge by NZAMI, by regulators and, of course, by their respective clients.

At Baillie Gifford, we hope we bring a sharper focus to identifying the most impactful climate opportunities and engagements. We can share our long-term perspective, the context we gain from our deep relationships with companies in both private and public markets and the insights we acquire via our wide range of academic partnerships.

We‘d really like to lift our industry’s gaze from downside risk to upside opportunity: encouraging the provision of long-term, patient capital to support the truly game-changing solutions that this deep transformation requires. Increments are not going to be enough.

Alongside NZAMI, and building on many of our recent conversations with our holdings, we will also focus on the benefits of well-established companies taking the lead in reducing emissions from existing and future assets. The management teams of many of the companies that we respect the most are now setting science-based targets for their businesses. They are doing this to gain an early competitive edge and to prepare for rising carbon prices in the years to come.

The relatively small number of companies that we tend to hold in our portfolios will shape our approach to the NZAMI decarbonisation goals. We don’t need to rely on top-down emissions pathways to drive stock selection but can build our commitments bottom-up.

This means encouraging and owning increasing numbers of companies that are themselves increasingly aligned in their actions – each making their own distinctive contribution as they take their own ‘fair share’ of the climate challenge.

For some, it might even be possible to achieve net zero carbon emissions by 2025. But for others making real physical products that could transform tough sectors, their company-level emissions might actually need to rise through the decade before eventually falling back.

This fundamental approach will mean that we care a great deal about future potential, about concepts like lifecycle ‘avoided emissions’ and about company-level accuracy and verification in the disclosures and targets they provide.

We’ll have to put our shoulder to the wheel as companies, regulators and policy makers figure out thorny topics like effective carbon pricing, climate-clear accounts and crediting the potential for material climate solutions.

What we all know is that it’s not acceptable that access to capital markets be determined by backward-looking data, poor estimates or inflated targets. There’s too much at stake.

The growing NZAMI tent enables us to make our contribution. A narrow organisation driven by current metrics and prescription most probably wouldn’t, and we’re grateful for the vision of the founding partners in setting this philosophy.

In terms of next steps, we’ve been busy this year exploring approaches for net zero alignment across our mandates. We’ve also been listening to companies, academics, society and – especially – to the clients whose money we manage.

For some of our largest funds, positive climate alignment should be an intrinsic part of their philosophy, given that long-term sustainable growth and innovation are core. So explicit portfolio alignment would not mean a change of approach. But for some others, the orientation is not quite so clear cut, and we will be working with asset owners and on variant structures as an interim step. While there is real urgency to the climate challenge, we will take the time to determine the right approach for each of our investment strategies and their clients, and we will provide specific detail in the coming months.

Meanwhile, expect us to up our game on climate-related reporting – but, as ever, expect as much narrative as data as we seek to peek into the world ahead. There will always be volatile changes to technology, policy, data and verification. But philosophy must be enduring. And our goal is to cut emissions, not to create an inward-looking net-zero-alignment industry.

1 We also acknowledge that the scope for asset managers to invest for net zero and to meet the commitments set forth above depends on the mandates agreed with clients and clients’ and managers’ regulatory environments. These commitments are made in the expectation that governments will follow through on their own commitments to ensure the objectives of the Paris Agreement are met, including increasing the ambition of their Nationally Determined Contributions, and in the context of our legal duties to clients and unless otherwise prohibited by applicable law.

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The views expressed in this article are those of the writer(s) and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in October 2021 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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