Keesa Schreane [00:00:01] Welcome to the Refinitiv Sustainability Perspectives podcast, where our goal is to engage and inform our audience. From investors to asset managers and portfolio managers, to sustainability leaders and those involved in ESG and sustainable finance. This is Keesa Schreane.
Keesa Schreane [00:00:22] The growing interest in ESG and sustainable finance is creating a bit of confusion. A few challenges, for example, how do you use ESG data to make sustainable and profitable decisions? And is it enough to rely on off the shelf rating services. To shed light on this topic with us today is Andrew Cave, Head of Governance and Sustainability at Baillie Gifford, a UK based asset management company with three hundred and twenty four billion US dollars assets under management. So Andrew, what exactly leads to the limitations of ESG ratings? We talk about a bit of the confusion that people are talking about right now. How has the rating system changed over the last few years and what do you see really leading to this limitation that people are talking about around ESG ratings?
Andrew Cave [00:01:17] Well, first of all, thank you very much for having me along to speak to you today. So ESG ratings are very high interest to lots of people right now, and there's a number of reasons for that. The ESG industry is booming as more and more asset managers and asset owners and indeed ordinary investors get interested in long term sustainable investing and looking at a whole range of factors which might lead to performance issues over the long term or new opportunities for different companies. So there's a good reason why ratings services are very much in demand. And the thing about rating services for ESG is it's a very new industry. It's really quite nascent. It's been around about some 15, 20 years in earnest, but has ramped up massively in the last couple of years as more and more assets have come to be managed according to ESG criteria. And I think the first thing to say about ratings is how you use them really depends on what kind of investor you are, what kind of asset manager, what kind of capacity you have. So they are used in lots of different ways, but the core idea is that you can take a company and look at a range of different environmental, social, governance issues and stakeholder relations and reporting and you can come up with a system to score them in terms of their overall performance on ESG, and that those scores are then used to inform asset allocation decisions by portfolio managers. So that's the construct, and they can also be used in a more passive way where the scores automatically lead to different decisions around asset allocation. So there's a good reason, as I say, why ratings are much in the spotlight just now. I think the other thing I would say about ratings is they can only give you part of the answer. They inevitably rely on public disclosure of principally backward looking information, mostly taken from annual reports and company disclosures. So theyre a sort of snapshot in time and they tend to focus on risks and sort of things that might go wrong with companies and sort of exposures rather than thinking about what might go right and opportunities. So that's a sort of very quick introduction to ratings.
Keesa Schreane [00:03:27] So very good to note that, it's really interesting, a snapshot in time and it sounds like only one tool among many that responsible investors should use. And I'd love to get your thought on what exactly should responsible investors focus on? If we're looking at these ratings as one tool in a broader toolbox, what should they be focusing on to make these investment decisions? So, for example, is it all about risks? Should they be looking at long term growth potential? What is that bigger picture that these smaller components, such as ratings are made of and they should base their decisions on?
Andrew Cave [00:04:02] Yeah, it's a great question. Well, I think for us, I mean, we're a very long term active manager, so we carefully select a small number of holdings and put them into quite concentrated portfolios and then try and act as a sort of good owner of those companies for a number of years. So for us, we're really looking at everything we can about those companies. It's a very holistic way of investing. We try and understand as much detail and as much color about those companies as we possibly can before we buy in. And then we try and augment that once we've taken an ownership position through our engagement and our ongoing research on those companies to sort of build the sort of really comprehensive picture of these businesses. And we do very much try and focus on what might go right. We look at the opportunities that they're creating and we look at the societal needs these companies are addressing, and then think about if everything works for this company and the management team delivered on their promise, how will that benefit stakeholders? But also how will it benefit our underlying clients as investors? So I think it has to be realistic. If you just look at risks, you're just looking at best, I mean, I used the analogy of sports teams. If you just look at risks, it's a bit like rating a football team just based on its track record of giving away penalties and not on its goal scoring record. And, you know, we as an investor are very interested in goalscoring scoring and how interesting, innovative companies can transform entire sectors and indeed improve society.
Keesa Schreane [00:05:32] So looking at it from that perspective, the perspective of we are taking a holistic view and also we're looking at these various components to your point to to get to that goal. How should investors look at and approach, sustainable companies that are in sectors that are not considered very sustainable? You know when I look at YouTube, I've been seeing a lot of shell advertisements around their sustainable, you know, opportunities and things of that nature. I'm thinking, wow, that's really interesting, this oil company is talking about their response to sustainability, and that's an industry or sector that we may not necessarily always think of as being sustainable. So what is your thought about approaching sustainable companies that are in sectors that aren't considered or historically have considered very sustainable?
Andrew Cave [00:06:26] Thanks, that's a great question. I think the first thing to say is that the sustainability challenge and the sort of low carbon transition that is part of that applies to all sectors. So you know what we need improvements right across the economy, and that very much includes the sort of big industrial sectors with traditionally larger impacts. I would say for us as an asset manager, we're more drawn to the more disruptive New York companies with innovative, disruptive technology. So, you know, Tesla is a classic holding for us, but also a range of other tech companies and biotech stocks and communications companies like Zoom who are bringing people together in a very different way, in a low carbon way, and those kind of business models are very attractive to our style of long term growth investing. But I would say there's an ongoing debate within responsible investment, and it's a worthy debate about, you know, the different types of responsible investing that are required because it's not just a case of having ultra clean funds of highly ethical low carbon companies. There is a need too for responsible investing to address some of the big impact sectors. So I think, for example, there's a very important case for responsible investment funds to continue to hold the very best mining companies. Mining is absolutely essential to all sorts of other enabling sectors and technology. So if you think about the low carbon transition and the need for batteries and battery storage and electric vehicles, we very much need mined products. So it's very important to have very responsibly run mining companies and that's the sort of sector where we would actually encourage seeing sector leaders emerge with data to back up that story. So I think responsible investing is a whole spectrum of approaches. There's no single right way, and actually, we're going to need lots of different approaches to move the economy forward to a more sustainable footing.
Keesa Schreane [00:08:23] So continuing with that mining example, I love it, how would you, Andrew, recommend that an investor gauge that ongoing process? So we talked about snapshot, looking at a moment in time versus continual review, is it a function of continuously engaging with your ESG ratings? What is it that investors should continue to do to ensure that they get a full picture of how a company is evolving and becoming, as you say, a better steward no matter what industry or sector they're in?
Andrew Cave [00:08:57] So I think the first thing we talk about is data. So there is a great need for better, more consistent data across companies. And I'm actually a former chief sustainability officer from from the corporate side. So I was involved in corporate disclosure and reporting for many years, and when I started out in that journey, getting on for 20 years ago, the data was completely bespoke to each company. Each company had its own idea about what data it thought was important with respect to sustainability. And it's taken years to get some convergence across those indicators and that's a really important process because it gives comparability and comparability drives up standards across sectors. So there is definitely a need for good comparative data. But I think the step beyond that is, once you've got data, you have to really think about how a company can achieve an ambition. So we really look for companies that have visionary leadership that can see a very different way of a sector or a company working or a very different product and then they can map out a pathway to get to that product and then execute against that. And that's the kind of vision you're starting to see come through things like impact reporting, which is more realistic and more forward looking and has a very clear sense of what a company's impact is, but also what its impact could be if it's able to deliver on its technological promise. So it is a much more complicated thing than just a sort of backward look at, you know, environmental footprint for a business. When you think about impact, you go right up and down the value chain and you think about use of product by other parties. So even when those carbon emissions aren't owned by you as a company, it's the product being used by the consumer. The most responsible companies think completely about that end to end value chain and all the different ecological footprint across it. So that's the sort of leadership we're looking for and you can only really get a sense of that, I think from engaging directly with companies and speaking directly to management teams to get a sense that ambition.
Keesa Schreane [00:11:09] So it's so much broader than just the the industry and historically, what we've seen and thought about the industry really has to do with the type of leadership in many cases. And so you mentioned visionary leadership is something that you look for in your work and your article, 'We need to talk about ESG ratings' you say that companies are often ranked less on their actual performance and impact and more on the exam technique, will they present themselves to the outside world and what are they picking the right reporting boxes? And I'm wondering about that in context of the conversation that we just had about leadership. Could you speak more about how companies are actually ranked, whether it is perception versus the actual doing?
Andrew Cave [00:11:55] Sure, well, there's a big challenge here for ratings agencies and indeed anyone looking externally at companies and trying to ascertain how well they're doing on an issue. And you're forced to look at the public disclosure and see what's on their sites and what's in the reports and what you do find that you tend to find the bigger, more mature corporations that have been around the block more tend to have quite polished reporting, and they tend to have the right policies in place in their web sites, and, you know, a sort of centralized team overseeing their approach to sustainability and a whole range of other sort of attributes which all sort of signal that the company is taking an issue seriously. But I think what we've found in practice is that that doesn't necessarily count for much. I mean, some of the biggest scandals we've seen in ESG in the last decade have been from companies that were seen as leaders in their sector and had very sophisticated reporting policies. And the policies alone tell you little about the culture, and that's where you have to sort of look a bit deeper. And, you know, you get that from engaging directly with management teams. But you look at all the other signals and clues about a company. You look at customer testimonials on YouTube or you look at Glassdoor employees scoring and you look at all the different signals about what does the culture tell you in practice, because I think that's very much more important to properly sustainable outcomes in terms of business. So, yeah, I think it's a it's a challenge built in to the model for rating services that are sort of somewhat reliant on publicly disclosed benchmark data. But I don't see a way around it in the short term other than I think for investors that have the capacity and are serious, you have to do your homework and try and look much deeper than just what's publicly available.
Keesa Schreane [00:13:45] And does one pillar present more substantial challenges than the other?, We have the E and the S and the G, so the environmental aspects, the social aspect, as well as the governance aspect. And right now at this stage, all of them are ultra important. Do you think that one right now or in the future as we head into 2021, that one will have a lot more impact or even present more of a challenge than the others?
Andrew Cave [00:14:13] ESG is such an unusual, imperfect construct. It's a sort of three pillars of actually overlapping concepts, because environmental is also about human too. You know when climate change undermines your ability to make a living, it's very much a social impact. And governance has a bearing on environmental and social performance behaviors, governance is actually key so you would make a case for in governance at the top and then E and S in ESG is sort of subparts of that. So it's a very imperfect construct. But I think when you look at the different pillars, E you're getting convergence on environmental issues. So you're beginning to get a consensus emerging across key economies and indeed across companies and society about where we need to head on different ecological impacts. So a dramatic reduction in carbon over the next couple of decades is really beyond doubt across most economies now. It's much less so for S. When you think about issues like labor rights and human rights, use of data and responsible AI and algorithms, there's very little consensus even within societies. So I wrote a piece earlier this year called 'The S in ESG is difficult' because there's no single right answer and the views are very culturally relative and vary across different stakeholders and time. So I think what we think about technology now is very different from what we thought even 15 years ago. So S is very fluid and I would say governance, governance there is more alignment, but you get some very different views on good governance. Governance, I should say, is not an end in itself, it's much more about the way to get good outcomes with respect to running a business. And it's about a culture of appropriate oversight and stakeholder relations and lots of other things. So we have got a new view of governance, which is different from many asset managers. We tend to be more favorable to certain governance quirks and sort of less dogmatic on exactly how you run a company, there's no single right way for us. We're much more interested in, you know, teams of management that we can trust and a way of aligning with strategic investors or management that is long term and value creating. So that's a long way of saying that there's actually no easy rules across ES and G. You are getting some more convergence, but radically different views within that. So all that's a way of saying that it's very difficult to turn those pillars into numbers and then to aggregate those numbers and to come up with something meaningful and scientific and useful, we just don't think you can do, which is why we have a much more bottom up approach to understanding companies and looking at them holistically rather than trying to reduce things down to a sort of single or maybe three data points.
Keesa Schreane [00:17:12] And let's talk about, finally, that approach, specifically in terms of Baillie Gifford's ESG investing philosophy. How does the firm balance between portfolio and maximizing returns for investors with ESG principles? Are there certain sectors and industries that Baillie Gifford does not invest in? Is there reason behind that?
Andrew Cave [00:17:32] So we have many different funds and we have the full spectrum of funds available to our clients from ethically restricted models through to Paris aligned models that we now have available. We also have a large number of different funds which are unconstrained but which have a difference of regional or subregional sexual bias or, you know, different kinds of offerings which are of interest right across the market. What I would say there, the interesting thing is, although we do have ethically restricted funds, there's been significant divergence between those funds and our mainstream funds in recent years. And that's really coming out of our style of investing and where we see growth coming from the global economy over the next couple of decades. So even in the absence of any restrictive policy, a lot of our funds have steadily reduced their holdings in sectors like defense or tobacco, where we have almost no holdings whatsoever any more down to a tiny percentage or indeed even oil and gas production where we we just don't see those growth opportunities coming in the coming decades. So it's a really interesting picture that certainly within our business, all of our funds are tracking towards more sustainable investing, whether they're sustainable investment funds or not, the direction of travel is very clear.
Keesa Schreane [00:18:55] And I would add to that from a Refinitiv perspective, Refinitiv's proprietary ESG scoring methodology focuses on a transparent and yet objective assessment of disclose company data. And as we talked about earlier, their approach enables companies to disclose data, use disclose data to drive scoring and more disclosures around common metrics in a given industry that lead to confidence in the data. So confidence by those who use it to really make the right decisions.
Keesa Schreane [00:19:25] So, Andrew, really appreciate that tremendous information about this being a new industry, but really understanding that things are wrapping up and how we use ratings depends on our role. We look at a range of stakeholder issues and ratings are a key part of that, but just a part in that there is a holistic picture to be had as it relates to investing. Your thoughts about needing more consistent data, as well as the importance of visionary leadership, and leaders who can see sectors in a different way that can really help us see beyond traditionally the way we've seen a specific sector, but to really see what the sector can do to become more sustainable. Andrew, thank you so much for your time.
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