Sustainable Investing: Seeing the wood for the trees.

March 2022

Key points

For sustainability, it is important for investors to see both the bigger picture and intricacies at a company level. The US Equity Team’s investment approach does both.

All investment strategies have the potential for profit and loss, capital is at risk. Past performance is not a guide to future returns.

How many trees are in this picture? Impossible to say, but you could estimate the typical number of trees in a given area and make some educated guesses about how far and wide the picture extends. 10 thousand? 100 thousand? 10 million?

Or is the right answer ‘they are all part of one’? Underground, the roots of these trees are intertwined, and messages, water and nutrition are being shared among them. Above ground, trees communicate with airborne chemicals, co-opt the fauna into carrying their seed and, as they shed their leaves and die, prepare the ground for future generations. Trees do not keep all the sugars they make – but instead share those sugars with others via a complex network of fungi, microbes and fauna. Is this a reflection of the sort of desperate war waged in nature, or of something more akin to a web of trades in some vast exchange?

The importance of thinking in systems is becoming increasingly apparent to us as investors. The productiveness of ancient woodland far exceeds that of manmade plantations because while we can plot out spacings and ratios, we can’t replicate the complex web of interactions among trees and the life that accumulates around it. Companies too rarely thrive in isolation. Their interaction with employees and customers, competitors and suppliers, regulators and investors all influence their development. We must broaden our thinking on each company to stand a chance of seeing both the woods and the trees.

Our research process has evolved to give these considerations more weight. At the start of every research report, we ask, ‘What might the world look like if this company is successful?’

We ask this because we believe that companies with the potential to deliver returns that are many multiples of their current share price will have to provide more value to society than they capture for themselves. A company such as Tesla that is shifting the entire auto industry towards electric vehicles. Or Watsco which is driving up standards in the heating, ventilation and air conditioning (HVAC) world and fitting monitoring technology across the installed base. Or Datadog which is giving its customers new insights into IT environments through its range of real-time tools. Being on the right side of this equation makes businesses more robust and durable. These are the kind of sustainable businesses we want to invest in.

We continually monitor the investment sustainability of every company in the strategy. This work is designed to make us more effective owners of rapidly evolving businesses. To define our thinking, we write social contribution hypotheses for each holding. These explore the extent to which a company’s position is underpinned by the value it delivers and sets out the key positive and negative implications of corporate success. We also produce Climate Unlocks – assessments of each company’s key exposures and opportunities regarding climate change and carbon emissions. In most cases this work generates as many questions as answers. We welcome this as an opportunity to engage with companies and improve our understanding of each of them.

Emissions will be relevant to the way that every business operates on a 5–10-year view. That’s why we have separated this out into a defined analysis for every holding. We believe that we are at the early stages of an energy transition and, as investors in structural change, we should look for opportunities to invest in businesses on the right side of this shift. In the current portfolio, some less obvious businesses are already building competitive advantages on emissions and acting as leverage points, such as Wayfair as its influence reaches into the furniture supply chain and Shopify which is enabling its merchants to showcase their green credentials to customers.

These behaviours are significant and seriously underappreciated. Innovative businesses can change patterns of emissions production. Conventional emissions monitoring sees only what such companies produce, raising questions as to what gaps there are in system-wide changes to emissions.

There is no null hypothesis to test the effect each company has, and any attempts to do it in isolation run into issues with boundary setting and double counting. But it is important, and we must do more than shrug our shoulders if we want to justify why box ticking is not the right way to monitor businesses. What have Zoom’s video conferences and Twilio-enabled automated communications replaced, and how does that compare to their server footprint? Is Peloton’s network of bikes in homes different to the footprint of a conventional gym where people travel to use communal equipment? We do not yet have all the answers, and may never do, but in their pursuit we are engaging with academics and our colleagues in a search for a more systemic view of emissions. There is a tangle of roots to pick our way through.

As a starting point we will report against the metrics listed at the end of this article on an annual basis from 2022 and based on the Net Zero Asset Managers initiative (NZAMI). Our assumption is that climate change can be addressed by a shift to a lower carbon economy and that net zero by 2050 is a sensible baseline level of ambition to set our expectations against.

Companies at least disclosing their emissions and communicating emissions plans will be a helpful place to start useful discussions from. At present only a minority of our holdings report their emissions and we are pushing for a step change here. Referring companies to Baillie Gifford’s NZAMI commitment should help those conversations and we plan to engage with all the strategy’s holdings on emissions by the end of Q2 2022. This ought to move us closer to understanding companies’ attitudes to emissions and climate change and to assess the adaptability and resilience of each approach.

In summary, we are recognising more of what is around us as parts of complex, often unstable, systems. We can become better long-term investors by broadening our thinking on how companies interact with the world, and we must continue improving. Recent examples of our efforts include a reframing of the first question in our research and the separation of social and climate summaries for monitoring our holdings. We believe that carbon emissions will be a feature of society that every company will have to engage with and companies that plan ahead will be better off than those which fail to consider them. Some companies will build businesses on structural changes in energy production, storage, and usage and these may present us with tremendous investment opportunities. When we peer into the corporate forest, we look most keenly for giant redwoods.

Kirsty Gibson’s excellent piece, Asymmetry of Influence, sets out the purpose and philosophy of our engagement with companies in more detail. Please speak to your Baillie Gifford contacts if you would like to discuss this directly with us.

NZAMI reporting
1.  90 per cent of holdings to disclose scope one and two emissions by end 2023.
2.  90 per cent of holdings to disclose scope one to three emissions by end 2024. 
3.  65 per cent of holdings to have emissions targets by end 2025. 
4.  90 per cent of holdings to have emissions targets by end 2030. 
5.  Benchmark the portfolio against progress towards net zero by 2050, based on carbon intensity.
6.  Expand the benchmarking to include scope three emissions, targeting end 2024. 
Monitoring and reporting
7.  Engage with all holdings by end of Q2 2022.
8.  Identify holdings which fail to disclose/set targets and set a formal engagement process.
9.  Report progress against our framework annually. 

Important information and risk factors

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