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Sustainable investors are too reactive, say Baillie Gifford’s Davidson

22 May 2023

Selling a controversial company is unconstructive, according to the fund manager.

By Tom Aylott,

Reporter, Trustnet

Markets can be overly reactive when a company goes through a controversy and ethical investors are often too quick to sell out of a holding when it comes under fire, according to Katherine Davison, manager of the Baillie Gifford Global Sustainable Growth fund.

“We expect bad things and controversies to happen across the portfolio – it is just a question of how management handle them,” Davidson added.

“I don’t think its helpful either for the company or our clients to have that knee-jerk sell response because you'll usually have taken quite a big hit on the share price anyway and you can have a more powerful impact by working with a company.”

This echoes the rhetoric from Baillie Gifford’s Kirsty Gibson earlier today, who said vulnerable companies have a place in a portfolio.

Davidson said this is particularly the case with environmental, social and governance (ESG) stocks, where ratings agencies make snap judgements by condemning a controversial company, which is unconstructive when it comes to encouraging improvement.

“I don't really care whether it gets downgraded by MSCI or if it's controversial to own in a sustainable portfolio. It's more important for us to understand why a controversy has arisen and how a company is handling it,” she said.

“It’s one of the reasons I get frustrated with things like the Morningstar Global Sustainalytics, because they put a huge amount of weight on a controversy. Sometimes bad things happen to good companies and it is how they handle them that can actually reinforce your perception.”

This view of rating agencies being irrational was reinforced by Aela Cozic, sustainable investing analyst at Fidelity, who said that her firm had to develop its own ranking system after encountering problems with conventional regulators.

“We asked our analysts to provide trajectory with their ESG ratings because it’s really important to look at not only what the company has done, but what it is planning to do going forward,” she said.

“That's one of the reasons why we launched our own ESG rating, because we often found that external agencies are quite backward looking.”

Like Davidson, Cozic said that it was much more proactive to maintain a position in a controversial company where you influence its practises.

However, engagement can only go so far if a company fails to make improvements, in which case divestment becomes the only option.

Cozic said: “We give them a specific timeframe and if we don't see any improvement materialise during that period, we would have to sell. There have been several examples of that happening over the years.

“Investors have more of an impact on companies through engagement rather than divestment, so that would really be a last resort for us.”

Davidson also uses Baillie Gifford’s own metrics to find a set of stocks that meet their sustainable criteria and any decisions beyond that come purely from an investment perspective.

“I think it's really important to separate that [sustainability scores] from the investment decisions. In my view, it’s not really appropriate for sustainability analysts to be making portfolio construction decisions,” she said.

“We consider the sustainable bit as creating our investable universe and then Toby and I think just about risk reward.”

All companies, no matter how ESG-friendly they are considered to be by ratings agencies, are bound to make mistakes and expecting otherwise would be naïve, according to Davidson.

“We are very aware that there is no such thing as the perfect company and our engagement is very much our mechanism to iron out the kinks in any company that we look at,” she said.

Finding where to draw that line can be tricky, according to Davidson, who was conflicted by the fund’s top holding in Tesla when she joined Baillie Gifford from Schroders last year.

“I have never held Tesla before and I actually got a bit of stick from my old colleagues for going to a strategy where Tesla was a large holding,” she said.

After weighing the options, Davidson found advantages to holding the electric vehicle manufacturer in her ESG fund, but not without cutting exposure by more than half.

The controversial stock has been polarising to investors and its shares have reflected this, booming during Covid but crashing last year.

Share price of Tesla over 5yrs

Source: Google Finance

She did consider divesting after Elon Musk’s contentious purchase of Twitter, but Davidson was reassured when Tesla chairwoman Robyn Denholm told her that Musk was likely to install a CEO at Twitter soon.

“I think we might have [sold out of Tesla] if it had happened three years ago, but nowadays – as much as there is the Elon halo effect around it – it's a manufacturing business that’s chugging along on its own steam,” Davidson added.

“At this point, I wouldn't say we’re happy, but we are prepared to continue holding and monitoring that, especially on having spoken to the chairwoman.”

Davidson and her co-manager, Toby Ross, rank a company’s sustainability on the positive impact it creates by its products and practises. Tesla got the top score for product, but only a one on practices.

Davidson also turned some heads by buying Starbucks when she joined the fund last year, a company that has come under scrutiny for its actions against workers’ unions.

“It certainly does not leap out as a sustainable stock but the investment case is really clear and positive,” she said.

Share price of Starbucks over 5yrs

Source: Google Finance

Although Starbucks founder Howard Schultz was interrogated by a senate committee for potentially breaking labour laws in March, Davidson said that the company ranked highly on practices.

It encouraged ethical farming through its Coffee and Farmer Equity (C.A.F.E.) policy, which has now been adopted across the industry, creating a positive impact throughout the sector.

Davidson also voted in favour of a shareholder proposal at the latest AGM to commission an assessment of Starbucks’ worker rights and approach to unionisation.

Alasdair McHugh, an investment specialist on the fund, explained: “We've made it pretty clear to them that it is a concern for us and now that the shareholder resolution passed, we will see some output from that.

“We're not at all making the case that it is making a difference to society through its products – it's definitely doing it through its practices though.”

Starbucks is under pressure to amend its approach to unions, which may not have been the case if investors based their decisions on ESG ratings.

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