International All Cap Stewardship Process & Principles

When it comes to ESG, the investors at Baillie Gifford are true believers. There is a shared belief across the team that a company’s ESG practices can significantly impact the long-term performance of its stock. They also believe it is their fiduciary obligation as corporate shareholders to take proxy voting and corporate engagement seriously. Baillie Gifford has backed this mission with substantial research resources, including a team of over 20 ESG specialists as well as partnerships with academics and industry and regional experts. 

Beyond resources, we think Baillie Gifford’s ESG edge comes from traits that distinguish their firm as a whole – experience, patience and thoughtful bottom-up analysis. After more than a decade of conducting ESG research, Baillie Gifford fully appreciates the complexity involved in assessing a company’s ESG trajectory; they recognize that there are lots of grey areas and nuance. So they avoid shortcuts like simplistic checklists and third-party quantitative ratings, and instead put in the work necessary to develop a complete picture of a company’s ESG risks and/or opportunities. Their work also goes beyond analysis and into action. Baillie Gifford uses their position as a long-term shareholder to engage with company management to provide constructive feedback and encourage improvement. This Q&A provides insight into Baillie Gifford's ESG process, which we believe is second to none.

Baillie Gifford's Process

In order to explain how G&S issues are integrated into the International All Cap strategy, we spoke to Joe Faraday, who is the director responsible for leading Baillie Gifford's International Specialist Team, and has been a member of the International All Cap Portfolio Construction Group since 2007. Joe joined Baillie Gifford’s Graduate Scheme in 2002 and worked in our European, North America, Developed Asia, and Emerging Markets equity teams before transferring to the Clients Department in 2013.

Following an engineering scholarship with the Smallpeice Trust during his gap year, Joe graduated MEng in Chemical Engineering from the University of Cambridge in 2002 and gained an MBA from the University of Edinburgh in 2009. He is also a CFA Charterholder.

What do you mean by stewardship?

Stewardship has always been at the heart of what we do. We strive to invest in well-managed companies run by people who are doing the right thing for their shareholders. We are entrusted by our clients to manage their assets wisely, so we have a very important responsibility to pay close attention to the business practices and attitudes of the companies in which we invest on their behalf. This mindset is important element in our ongoing dialogue with company management teams.

How do you see this as distinct from ESG?

ESG focuses more specifically on the environmental, social, and governance aspects of each company’s activities. There are many ways of determining its scope, numerous definitions are involved, and the area is evolving quite rapidly. Nonetheless, there is considerable overlap with our long-standing belief in the importance of good stewardship: we expect the management of the companies in which we invest to consider these issues as part of their strategy, and we expect them to engage in discussion on these matters when we meet them.

Is this an ESG strategy?

This is not a strategy in which an ESG screen forms an explicit part of our investment process, and we do not attempt to separate out ESG issues and prioritise them over financial ones. Stewardship forms an integral part of our efforts in maximising long-term returns for clients, so rather than applying loosely-defined filters our priority is to find, research and select high-quality growth businesses that are being run in the interest of shareholders and other stakeholders by aligned management teams who are focused on the long term. We do believe that strong ESG credentials often underpin a company’s prospects of long-term corporate success, but it is important to look at the big picture, to think about each company individually rather than with reference to a single set of requirements, and to consider the extent to which management are bringing about improvements for the future. The International All Cap strategy firmly believes in the importance of environmental responsibility, the fair treatment of shareholders, and good governance.

For those of our clients who have specific ethical requirements, we offer tailored portfolios which can accommodate ethical exclusion screens.

So how do you integrate ESG considerations into the strategy?

A pre-buy note covering ESG matters is written by the strategy’s dedicated Governance and Sustainability (G&S) analyst. This forms an important input to the PCG debate around each stock being considered for inclusion in the portfolio. It is also important to note that we have an investment timeframe that is well aligned with ESG principles. The average holding period for stocks in our portfolios is around 10 years. Since we’re not just renting shares for the short term, it is very important for us and for our clients that the businesses in which we invest are good corporate citizens. Holding stocks for the long term means we have time to properly understand the issues that companies face. Furthermore, we have ample resources to bottom out these issues, with over 120 investment professionals focused on bottom-up company research, alongside a large team of G&S specialists who focus on ESG topics. All of this means that ESG considerations can be fully integrated into our research process. When taking new holdings, and reviewing existing positions, the portfolio managers benefit from insights and views from across the investment floor, from third parties, from time spent with management teams and site visits. For each stock the ESG challenges are weighed up relative to the unique context for each business and the implications for the long-term investment case. Thus the ESG aspects of our analysis are fully integrated into the process and do not form an entirely separate ‘overlay’.

Kering: The luxury goods and apparel group demonstrates some of the contradictions that can occur when thinking about ESG issues. The investment case is based on the rise of the global consumer. Yet the supply chain is complex to manage and the environmental impact of the production process from raw materials to finished apparel requires careful management and oversight. Kering has established a dedicated sustainability team to work with each brand and has increased its disclosures significantly in recent years. But we recognise that engagement and monitoring are required to maintain confidence that Kering is meeting our ESG expectations.

All members of the PCG have an awareness of material ESG factors including remuneration, board diversity labour practices, health and safety expectations, climate change and other social and environmental challenges. The discussion and debate within the team and with the investment teams is an important part of the analysis process, as is the specialist input provided by the strategy’s dedicated G&S analyst.

Recruit: The recent purchase of this online platform company best known for its Indeed and Glassdoor employment-related services provides a good illustration of the way in which ESG topics are debated at the pre-buy stage. The initial ESG research report highlighted the societal opportunity for the company to improve economic chances and the quality of life of its customers. The PCG debated how the company securely manages its tens of millions of customers’ private data. After further research and discussion, we reached the conclusion that the company is managing this ESG risk effectively.

Gavin Grant is a Governance and Sustainability specialist who spends 50 per cent of his time working directly with the International All Cap team. He participates in company meetings, PCG discussions, and pre-buy conversations. Having a G&S specialist embedded within the team provides a different perspective on this topic and gives the team a direct link into the wider governance team.

Have you sold any companies based on ESG concerns?

Yes. On occasion, we have sold a holding based on ESG concerns. It has also happened that we have declined to invest in a company for these reasons. However, given the relatively concentrated number of companies in which we invest for our clients, the importance that we place on stewardship, and the high bar that we set for inclusion, it is rare for us to have to sell a stock purely on ESG grounds. Our perspective as long-term owners of companies means that we want to help them to overcome their challenges rather than to sell and walk away when challenges arise. Examples of sales on ESG grounds include those where there have been significant deteriorations in governance. These can involve notable management departures, a significant change in our view of the quality and culture, and concerns over the strength of supply chains, manufacturing processes, and business edge.

What ESG qualities do you look for in a company?

We don’t believe in a one-size-fits-all approach because quantitative metrics of ESG considerations are often unreliable and unsatisfactory. We are open minded as to the most appropriate way to govern and manage a company and are pragmatic about the significant differences in what is expected and the options available to companies. For example, we don’t have a fixed view on how a company’s board of directors should look. Effective boards can and do take many forms, and some of those which are least effective conform to the full range of widely accepted corporate governance norms. For this reason, we are sceptical of overly prescriptive policies and checklists when analysing, engaging and voting on corporate governance issues. Just as our investment research is bottom-up, we prefer to take a case-by-case view on governance, focusing on what works in practice. There is, perhaps, more common agreement on sustainability qualities. We will gravitate towards companies that treat their stakeholders fairly and have a strategy to address the growing challenge of climate change.

Do you outsource ESG activities to a separate team?

No, the PCG takes full responsibility for all ESG activities and outcomes. Where there is a contentious issue the portfolio manager will collaborate with a Governance and Sustainability specialist in company meetings, in primary research, and in relation to challenging votes. Of course, we also benefit from a wide range of external inputs, from colleagues in different teams to trusted external information sources, but this is part of our fundamental research process.

Are there any pre-buy checks on ESG issues?

Yes, the portfolio managers and our G&S analyst will carefully research all companies prior to initial purchase and will consider any relevant ESG issues as part of this process. One of our advantages is that we have the time and resource to tailor our work based on the company in question. We do not use a prescriptive pre-buy checklist because each company is different, and we believe that open-ended questions are a more appropriate way to identify the key issues in each investment case. However, our dedicated G&S analyst completes a more detailed independent analysis of each potential holding’s governance structure and practices as well as the societal and environmental impacts and benefits. This analysis forms part of the discussion papers for our decision-making stock meetings and is an important input to the discussion and debate for each stock.

Do you use screens to filter out companies on ESG grounds?

We have a firmwide policy the prohibits investment in controversial weapons such as landmines, cluster munitions, nuclear weapons, chemical weapons, white phosphorus and depleted uranium, and some clients ask us to comply with their own ESG rules by avoiding certain industries. However, beyond this we prefer to let our portfolio managers form their own view on what represents a good investment on ESG grounds. The strategy has developed a separate Responsible International All Cap portfolio for clients who wish to apply additional ethical exclusions, such as tobacco, alcohol, gambling and certain high impact fossil fuels.

How do engagement and voting factor into your process?

Voting and engagement are part of the same stewardship process of working with companies to help them succeed. Our starting point is to understand what the management team are trying to achieve, and to support them in making good decisions. Where there is an ESG issue to address we work patiently with companies through ongoing dialogue, whether that be remuneration, board structures, or employee welfare. These meetings are a collaboration between portfolio managers and our Governance and Sustainability specialists. In many cases these engagements are motivated by upcoming AGMs, and we regularly help companies to shape their policies before the resolution goes to a vote. Where clients permit, we vote all our own proxies and form our own opinion on each resolution. Likewise, we actively engage with companies to learn about the challenges that they are facing and to help them improve.

Do you raise ESG issues in your meetings with company management?

Yes. In fact, ESG issues are also increasingly an agenda item raised by management themselves. Frequently encountered areas are corporate governance and sustainable business practices. We are also finding that climate change preparedness is an increasingly common topic of discussion.

How do you monitor existing holdings in relation to ESG compliance?

The process of monitoring ESG factors is largely embedded in portfolio construction rather than being entirely separate. We incorporate new information published by companies, for example in annual reports, sustainability reports and regulatory filings, and we follow third party research and information sources for ESG- related information. This information is filtered back into team stock discussions and investor analysis throughout the year. We also use our meetings with company management and board members to further our understanding of their approach to ESG issues, and to engage on these. This work goes on week-by-week during the year and is part of the portfolio building and monitoring process. On a more formal quarterly timetable, our Governance and Sustainability analyst runs a check on all holdings against a screen for any identified breaches of ethical norms. This additional check ensures that we are aware of issues which may not have arisen during other more traditional analysis.

Baillie Gifford's Stewardship Principles

At Baillie Gifford, we have a responsibility to behave as supportive and constructively engaged long- term investors. We invest in companies at different stages in their evolution, across vastly different industries and geographies, and we celebrate their uniqueness. Consequently, we are wary of prescriptive policies and rules, believing that these often run counter to thoughtful and beneficial corporate stewardship. Our approach favours a small number of simple principles which help shape our interactions with companies.

Prioritisation of long-term value creation 

We encourage company management and their boards to be ambitious and focus their investments on long-term value creation. We understand that it is easy for businesses to be influenced by short-sighted demands for profit maximisation, but believe these often lead to sub-optimal long-term outcomes. We regard it as our responsibility to steer businesses away from destructive financial engineering towards activities that create genuine economic value over the long run. We are happy that our value will often be in supporting management when others don’t. 

A constructive and purposeful board 

We believe that boards play a key role in supporting corporate success and representing the interests of minority shareholders. There is no fixed formula, but it is our expectation that boards have the resources, cognitive diversity and information they need to fulfil these responsibilities. We believe that a board works best when there is strong independent representation able to assist, advise and constructively test the thinking of management. 

Long-term focused remuneration with stretching targets 

We look for remuneration policies which are simple and transparent, and which reward superior strategic and operational endeavour. We believe incentive schemes can be important in driving behaviour, and we encourage policies which create alignment with genuine long-term shareholders. We are accepting of significant pay-outs to executives if these are commensurate with outstanding long-run value creation, but plans should not reward mediocre outcomes. We think that performance hurdles should be skewed towards long-term results and that remuneration plans should be subject to shareholder approval. 

Fair treatment of stakeholders 

We believe it is in the long-term interests of companies to maintain strong relationships with all stakeholders, treating employees, customers, suppliers, governments and regulators in a fair and transparent manner. We do not believe in one-size-fits-all governance and we recognise that different shareholder structures are appropriate for different businesses. However, regardless of structure, companies must always respect the rights of all equity owners. 

Sustainable business practices

We look for companies to act as responsible corporate citizens, working within the spirit and not just the letter of the laws and regulations that govern them. We believe that corporate success will only be sustained if the long-run impact of a business on society and the environment is taken into account. Management and boards should therefore understand and regularly review this aspect of their activities, disclosing such information publicly alongside plans for ongoing improvement. We take our responsibilities seriously. We will encourage a focus on the building of lasting competitive advantage, and we will enthusiastically support those with a thoughtful approach, using voting to support our five core principles. At a time when the word ‘activism’ is synonymous with those targeting short-term gains, we want to reclaim the term for the long-term growth investor.

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Legal Notices & Disclosures 

All charts and data are for illustrative purposes only. Views expressed herein are those of Baillie Gifford and may not be reflective of their current opinions or future actions, are subject to change without prior notice, and should not be considered investment advice. The information provided in this presentation is for informational purposes only. 

The information provided in this article should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, and countries mentioned may change at any time and may not represent current or future investments. 

Harbor has engaged Baillie Gifford as a subadviser to one or more Harbor sponsored products.

*Redistributed with Baillie Gifford's permission Investing entails risks and there can be no assurance that any investment will achieve profits or avoid incurring losses.