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.
ESG in our philosophy
Over Schiehallion's long-term horizon, we believe there is a convergence between what is good for a business and what is good for the world at large. The conventional wisdom, that there is tension between profitability and doing the right thing is based on short-term thinking. Over our investment horizon, we believe profitability depends not only on a company’s ability to serve customers well but also on its ability to do this without jeopardising its social licence to operate.
As such, we don’t break out consideration of a company’s role in the broader system from our core investment work, under ESG or any other rubric. For us, these considerations are core to long-term investing. It is the long-term nature of the growth ambition within our investment philosophy that causes us to pay special attention to the positive and/or negative externalities produced by a company’s operations. Over five-year-plus periods, these can have profound impacts on a company’s relationship with customers, regulators and staff. They can hugely help or hinder the growth of a business.
This is not about being a moral conscience for our clients. Rather, it is a vital part of practising the philosophy that we believe will grow the value of their capital over the long term.
ESG in our process
The Private Companies Team specialise in identifying high growth, late-stage private companies. We structure our research into potential investments by using a proprietary ‘10 Questions’ research framework. These questions aim to address issues such as the scale of the opportunity, the competitive edge and potential returns, whilst others focus specifically on ESG related topics.
Question Four (“How does the company’s culture help it achieve the leadership’s long-term business vision?”) asks about the stakeholders within a firm, the culture within the workplace, and whether it cultivates a healthy organisational mindset capable of delivering the mission. We have declined companies in the past based on negative behaviours toward staff as part of this question. Meanwhile, Question Five asks about external stakeholders (“Do the company’s customers like them?"). This question is geared towards ecosystem impact in terms of opportunities and potential strengths, not just uncovering risks.Question Six explores the E and S of ESG in greater depth (“How do environmental and social factors create opportunities and risks?").
Ultimately, this approach enables us to explore the inevitable grey areas. Companies, like economies, are complex ecosystems. Judging such a system as ‘good’ or ‘bad’ based on a single metric or factor strikes us as profoundly unwise. Factors must be weighed together. Consideration must be subjective and nuanced. The key data points are inherently qualitative. We would be doing our clients and our companies a disservice if we portrayed it as anything else.
ESG in Schiehallion specifically
All the portfolios created by the Private Companies Team reflect this philosophy and process. Of these, the Schiehallion Fund is the purest expression of the Private Companies Team’s beliefs.
In this fund, we hold a company called Allbirds. Allbirds is finding ways to make shoes and apparel from materials that allow them to dramatically reduce its carbon footprint. It is completely transparent about the carbon emitted in the making of each product, literally stamping this figure onto every shoe. Allbirds does this because of the beliefs of the founders – but also because this is integral to its product’s proposition, appeal and branding. The business is better and more differentiated as a result.
We also hold a financial technology company called Chime. Chime is winning millions of middle- and lower-income Americans over to its online bank accounts by treating customers better than traditional banks, and offering banking services that make it much easier for members to manage their financial lives. Chime does not grow despite the impact its products have on society – it grows because of it.
The fund also shows the benefits of avoiding single point-in-time ‘snapshots’ of a company’s societal impact. We fear that these will almost always exclude what is most important. This is true of financial data, competitive advantage, and market opportunity. It is also true of systemic impact. An example of this in action is our investment into Workrise (or RigUp, as it was known at the time of first investment). When we first invested, Workrise was removing friction in the employment market for skilled blue-collar workers within the oil and gas industry. In our view, the way it was helping these workers was clear societal good, while its intention to bring the model to bear on the renewable energy sector, with its chronic lack of skilled labour, was a smart business move to future-proof the company through a likely energy supply transition period. Not only would Workrise be able to connect workers with renewable asset operators, but it could also help retrain oil and gas workers to work on renewable assets.
A snapshot approach might have focused on the business’s association with a carbon intensive industry. Our qualitative, investor-led approach avoided this trap. Two years later, and Workrise has made incredible progress. In that time, renewables having grown from close to zero to nearly half of revenues, with the company now playing a key part in reducing the carbon intensity of the US economy.
If this is true of holdings, it is also true of the companies we did not invest in. The team has regularly declined – and we will continue to decline – opportunities to invest in companies that act in ways that jeopardise their social licence to operate. Looking back on both Uber in 2014 and WeWork in 2018, investment opportunities were declined based on concerns about how the companies were being run. An ‘ESG’ rubric might have seen these questions through the narrow lens of governance, but in reality, our concerns were fundamentally about the impact that governance was having on the probability of significant long-term upside.
More broadly, in a market where the ability to access great investment opportunities for our clients is inherently tied to our reputation as investors that founders are proud to associate with, we take special care to avoid tarnishing our reputation by acting in a way more likely to repel than attract the best businesses. We have had multiple opportunities to invest in leading-edge facial recognition companies but has continued to opt not to. This is due to concerns about how authoritarian governments are using these products to limit the basic rights and freedoms of their subjects.
ESG factors that are particular to private markets
There are three ways that ‘ESG’ considerations play out differently in private markets compared to public markets.
First, the vast majority of the capital we deploy is done so as primary capital investments. The money we invest in companies does not go to another investor from whom we are buying shares, but rather directly onto a company balance sheet to help them invest in their growth. We believe this magnifies the implications of the capital we deploy – for better or for worse. While public market prices may have a knock-on impact on a company’s cost of capital from other sources, our investments directly enable companies doing good or ill to do it more. If this is a difference of degree, it is a meaningful one.
Second, we are much more likely to find mission-driven businesses, for whom doing the right thing is one of their competitive strengths – in terms of product, but also regarding recruitment and retention. There are not many tobacco, firearms or mining companies in the late-stage private ecosystem! Indeed, while many of the companies that have entered public markets in the past decade claim a mission-driven mentality, in private companies such an approach is almost ubiquitous. The cautionary note is that ubiquity is not the same as authenticity. Every company we meet claims some kind of ‘ESG’ pedigree. While for some it may be a true motive, for others it may be a more cynical attempt to tick boxes on ‘ESG’ checklists or give prospective investors warm and fuzzy feelings.
Third, as private investors, we often have a different kind of relationship with holdings – and with it, a different kind of influence on them. While our public market colleagues build deep relationships of trust with company management teams over time, in the private markets it is the building of these relationships that marks the start of our investment interaction. Indeed, our access to investments is often predicated on the building of such relationships. Whilst this increases the danger of bias, it also provides a platform for conversation and influence around how a company treats its stakeholders. When we invest, we do so through a set of bespoke legal agreements, creating a new class of equity with its own governance rights. At the point of investment, we therefore have a say in the ongoing governance of the business. On occasion, we have used this to help companies right misalignments that have crept into their capitalisation tables. We have also sometimes taken board observer seats, giving us a greater informal influence at the board level. Finally, when it comes to the public listing of our private holdings, we regularly are engaged and engage on topics, such as dual-class share structures, board construction and the maintenance of long-term thinking in the face of short-term public market pressures.
Where to from here?
These unique factors in private company investing, together with our deeply held belief that companies can only be understood as complex systems sitting within larger complex systems, means that we do not believe that governance, social or environmental questions can be helpfully extracted from our core research process – either to be codified in the form of a checklist or to be covered by a specialist. These are fundamental questions of investment analysis, rooted in the unique circumstance of each investment. It would make no more sense to segregate them from the core of our work than it would to ask analysts to defer to third-party opinions on a company’s competitive advantage, market size or potential for generating substantial returns on invested capital.
We have a series of upcoming projects to strengthen how we engage with ESG questions. The Baillie Gifford ESG Team is preparing to run a ’Stewardship Risk Report’ on the Schiehallion portfolio in Q1 2022. It aims to compile in one document the set of stewardship issues investors on the team are considering about each holding. This will be supplemented with additional suggestions from the ESG Team’s climate, governance and social justice specialists as to where we have blind spots. Separately, Bridget Harris is leading a project with the core team to make sure all investors are continuing to develop their mental models for thinking about ESG factors. There are also a couple of ongoing workstreams creating documents and technical infrastructure to help us provide governance advice around the listing moment to companies in a more scalable way over 2022. All these projects represent natural evolutions in how we engage with our companies, with the ultimate aim remaining to build a portfolio of global investment opportunities that can yield terrific long-term returns to our end clients.
Peter Singlehurst and Robert Natzler
March 2022
Risk factors
The views expressed in this communication are those of Peter Singlehurst and Robert Natzler 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 March 2022 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Private Company assets may be more difficult to buy or sell, so changes in their prices may be greater. There is no guarantee that private companies will become publicly traded companies in the future.
All investment strategies have the potential for profit and loss.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority. Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs and an authorised Alternative Investment Fund Manager and Company Secretary of investment trusts.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is current and sourced from Baillie Gifford & Co unless otherwise stated.
Stock Examples
Any stock examples, or images, used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us.
Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
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