ESG data: filling in the gaps in disruptors’ scores
Long Term Global Growth is addressing shortcomings in the ESG metrics currently available about its holdings’ environmental and social impacts and governance structures.
The value of an investment, and any income from it, can fall as well as rise and investors may not get back the amount invested.
Given the meteoric rise of ESG-influenced investing, you’d be forgiven for thinking there was enough relevant data to guide decisions. But this is far from the truth. Despite decades of research into corporate responsibility, growing interest in sustainable finance, and an entire industry devoted to churning out ESG data, there are still significant gaps in our knowledge.
We know very little about the environmental impacts products and services have over their full lifecycles, and even less about their social aspects. Increasing numbers of companies are publishing ESG progress reports, but the quality, comparability and coverage of their data are underwhelming. Estimated figures are still commonplace, even for very large companies. In some industries and some parts of the world, robust data is almost non-existent. Unsurprisingly the ratings agencies often give companies divergent ESG scores, as can be seen by how far some of the dots stray from the line on this graph. This indicates the divergence between scores given by two of the ratings agencies to the same companies. And it raises questions about how meaningful their conclusions are.
Rather than shrug off this challenge on the basis that it’s just too difficult, we are encouraging our holdings to make their disclosures more comprehensive and comparable. Where appropriate, Baillie Gifford is also working with third-party providers so we can receive better data. We hope this will not only complement our own research but also be a useful resource for our clients.
One example of this involves collating data for our LTGG TCFD1-aligned report, plus our SFDR2-aligned Principal Adverse Impacts publication, which we expect to release in early 2022.
What follows is a snapshot of the LTGG portfolio based on the limited ESG indicators available to us today. We treat them as an output of the process rather than an input. So while we can use the data to test our convictions, it’s no replacement for the much deeper stock-level analysis and engagements carried out over LTGG’s investment process.
The metrics date to 30 June 2021 or those most recently reported, and are considered correct at time of publication. They were collected via the Factset platform from MSCI, Sustainalytics, ISS and BoardEx.
1. Task Force on Climate-Related Financial Disclosures
2. Sustainable Finance Disclosure Regulation
Selected holdings – ESG scores
What is this indicator? The percentage of our portfolio’s board members that meet MSCI’s criteria for being independent, weighted according to the sizes of our holdings.
What the data tells us: The vast majority of LTGG company board members are considered independent. This suggests most holdings appreciate the external skills and experience that independent board members can provide as their businesses scale and mature.
What we think: Data on four holdings, together accounting for nearly 8 per cent of the LTGG portfolio does not feature in the MSCI database. Also, some holdings have many more independent board members as a proportion of their boards than others. This ranges from 33 per cent at Tesla to 82 per cent at BeiGene. This statistic does not account for different governance structures in different regions. For example, Dutch payments company Adyen’s 100 per cent independent supervisory board skews the result. Furthermore, it doesn’t recognise that innovative disrupters in our portfolio are very often at an earlier stage of maturity than index incumbents. As a result, their board memberships rarely comply with ‘best practice’ and are still evolving. Finally, it provides no insight into board dynamics, board effectiveness or how challenging or collegiate the board is. All these factors influence how much we trust management and the board to take a long-term view to look after clients’ interests as minority shareholders.
Our approach therefore remains based on our 10 Question Stock Research Framework and ongoing engagements with management and board members.
Board gender diversity
What is this indicator? The portfolio weighted average percentage of board members who are female.
What the data tells us: Just over a quarter of LTGG companies’ board members are female, indicating that progress is still needed to increase gender diversity. What we think: As usual, the average figures mask significant differences at stock level. More than 60 per cent of Kering’s board members are female and Amazon’s figure is 40 per cent, but there are no female board members at all at Pinduoduo, Meituan or NIO. Being a backward-looking snapshot in time, the data does not reflect efforts to improve, nor does it inform us about ethnicity, national origin, knowledge and experience or educational background – all of which are as important as gender for genuine board diversity. As a starting point, we expect boards to have made reasonable progress towards both gender and ethnic diversity, or to have at least set out a clear roadmap as to how they will achieve this. If the composition of the board or its subcommittees is very different from these expectations, then we aim to engage with the companies in the first instance. We may later consider additional voting action if appropriate. Of note is that following a recent conversation we had with NIO, its board appointed a female member; we are supporting Pinduoduo’s selection process as it interviews female board candidates; and Meituan is similarly taking steps to select potential female members. Beyond the board, we expect our holdings to take steps to understand, disclose and, where necessary, improve diversity in their workforces. Relatedly, we are also seeking better data on gender pay gaps, employee turnover and collective bargaining.
What is this indicator? A ‘founder-led firm’ is a company whose founder serves as CEO and/or chair or retains significant influence. A ‘widely held’ company has no identified shareholder or shareholder group holding greater than 10 per cent of the voting rights.
What the data tells us: Across LTGG’s holdings, 82 per cent are founder-led. That’s much higher than the index-wide figure of 23 per cent. Only 6 per cent of LTGG holdings are considered ‘widely held’. This is an extraordinary observation, illustrating how differently we think about governance structures and corporate ownership.
What we think: We believe it often takes influential and visionary leadership, backed by aligned and patient shareholders, for a company to spearhead disruptive change while remaining focused on its long-term mission. It’s therefore unsurprising to us that most LTGG holdings are founder-led and very few are considered ‘widely held’. We are sceptical of overly prescriptive policies and checklists when considering what effective leadership should look like, preferring instead to take a case-by-case view. However, the data doesn’t tell us about the founder’s other business activities, the depth of the management team around the founder, or attitudes towards shareholder rights and other stakeholders. Our focus is therefore on our fundamental research and ongoing company engagement to determine what works in practice for each company and how that impacts innovation and corporate culture.
Responsible business conduct
What is this indicator? Sustainalytics assesses companies’ compliance with the principles of the UN Global Compact (UNGC). This provides a proxy for a company’s social performance and exposure to corporate controversies.
What the data tells us: The data suggests that the vast majority – nearly 90 per cent – of LTGG holdings are deemed to be compliant. This indicates that most members of our portfolio conduct themselves responsibly in regard to society and the planet.
What we think: Sustainalytics’ lack of information about some holdings affected our overall score. None of LTGG’s holdings were deemed to be ‘non-compliant’; however, some didn’t ‘pass’ as the agency didn’t hold the relevant data. In any case, we view UNGC compliance as the bare minimum required of our holdings. We expect all our holdings to respect internationally accepted human rights and labour rights throughout their business operations and value chains. We are seeking better data and disclosures about companies’ approaches to taxation, supply chain due diligence, pay rates and labour rights.
Data on responsible business conduct can help us reflect on a company’s behaviour, but it can’t replace the deeper insights derived from our own fundamental analysis. We use our 10 Question Stock Research Framework to dig into aspects of corporate character. When we believe a firm’s conduct falls significantly below expectations, we engage with management in the first instance. Then we may consider appropriate voting action or an investment decision. For example, we have spoken to Amazon on multiple occasions about labour conditions, Tencent about its relationship with China’s government, and Facebook about data privacy and broader societal issues. That Sustainalytics features these same three companies on its UNGC ‘watchlist’ only serves to confirm why we’re already engaged.
Source: Baillie Gifford & Co and yoursri.com. Data for a representative LTGG portfolio. Benchmark: MSCI ACWI. As at 30 June 2021.
What is this indicator? The relative carbon footprint is the total carbon emissions of the portfolio per million US dollars invested relative to the MSCI ACWI benchmark. The carbon intensity is the total carbon emissions per million US dollars of revenue generated – this allows a comparison to be made with the benchmark to measure the portfolio’s efficiency with regard to emissions per unit of financial output. The weighted average carbon intensity metric considers portfolio exposure to carbon-intensive companies.
What the data tells us: The carbon footprint, carbon intensity and weighted average carbon intensity of the LTGG portfolio are many multiples lower than those of the index. This suggests that LTGG companies are well positioned to adapt and thrive in a carbon-constrained world.
What we think: These metrics only refer to scope 1 and 2 emissions. Scope 1 emissions derive directly from a company’s activities, including stack emissions and fuel use. Scope 2 emissions arise indirectly because of the use of electricity and similar resources generated externally. Many companies in the portfolio don’t report scope 1 and 2 emissions. And scope 3 emissions aren’t reflected at all. These are emissions resulting from activities involving assets that are neither owned nor controlled by the company but still indirectly impact its value chain, such as those that arise from the distribution and use of its products after they have been sold. The concept of ‘avoided emissions’ – such as from using video conferencing to reduce business travel – is also absent from this analysis. Moreover, the underlying data can be subject to a range of calculation approaches, assumptions and exclusions, which makes comparability between companies challenging.
When presented in absolute terms, the data is also heavily influenced by the size and profile of the company. For example, more than a quarter of the portfolio’s scope 1 and 2 carbon emissions are estimated to come from Tesla, yet the electric car maker is a significant enabler of the transition to a low-carbon economy. Caution is therefore needed. Furthermore, climate change is not solely about carbon emissions. This data tells us nothing about biodiversity impacts and water use, for example.
While we believe climate change will present our portfolio with more opportunities than risks, we are far from complacent. There are many areas where we can improve our data and analysis. We are engaging with each LTGG holding about scope 1, 2 and 3 emissions reporting. In due course, we expect the companies to establish clear goals to achieve net zero emissions by 2050 at the latest. We also are working with carbon-footprinting expert Professor Mike Berners-Lee to identify data gaps and other limitations in several of our holdings, and he plans to help us develop better scope 3 estimates. We are also seeking better data on biodiversity and water intensity.
The value of an investment, and any income from it, can fall as well as rise and investors may not get back the amount invested. Past performance is not a guide to future returns.
This article was produced and approved in January 2022 and has not been updated subsequently. It represents views held at the time of recording and may not reflect current thinking.
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