Baille Gifford's global head of ESG highlights how sophistication is increasing in an evolving space
Looking at the state of ESG funds in Canada compared to adoption in Europe, advocates for the investment strategy could appear somewhat disheartened. Around six per cent of all Canadian managed funds are labelled as ESG. In Europe, around 48 per cent of assets under management are in sustainable funds, in a roughly equivalent labelling system to ESG. Catherine Flockhart, however, believes that the quantity of assets and funds is only one part of the picture.
Flockhart is the head of ESG at Baillie Gifford. While she notes that Europe continues to lead in this space, she highlights the level of sophistication and adoption of ESG strategies by Canadian institutions. As asset managers and plan sponsors look to increase ESG allocations, she argues that the state of the Canadian market can be assessed on a quality metric, as much or more than a quantity metric.
“More ESG doesn't necessarily mean better quality, more sophisticated, or the right thing,” Flockhart says. “ESG is a hugely broad term that covers a massive array of approaches, and there is a debate going on whether ESG is in conflict with returns. There are a bunch of studies out there that show that good ESG credentials strengthen a company’s likelihood of delivering good returns, others show it weakens them.
“Generally speaking if you’re taking a blunt exclusionary approach to an investment universe, it’s hard to make the argument that’s going to be returns enhancing…When you factor in a consideration of environmental and social issues a company faces, how it’s governed, in an active investment management style I do believe that can be returns enhancing.”
That idea of ‘quality’ ESG, Flockhart explains, amounts to using all the tools in your toolkit. ESG credentials form one component in a broader assessment of a company. Using ESG criteria can reveal risks or opportunities a company is exposed to that a traditional financial analysis may not show.
Flockhart explains that this kind of ESG approach fits best within a long-term, active, growth-focused equity style. Within five to ten-year time horizons she believes that ESG integration can result in outperformance, even if that doesn’t immediately show itself when looking quarterly. She also believes that as this sort of quality ESG strategy proves its value over time, there will be less of a push for constant justification.
One of the trends Flockhart notes within ESG adoption, in Canada and around the world, is a need for near-constant information flows, justifying strategies and displaying how metrics are being applied. As managers taking this more nuanced approach to ESG integration are able to show longer track records of returns, there may be a drop in that level of reporting which may actually serve to provide greater clarity, with fewer reports making sure plan sponsors can see the forest from the trees.
The outperformance Flockhart expects will come from this sort of nuanced ESG integration can also be attributed to risk offsets. She sees the risk of companies being caught flatfooted if they don’t adequately develop a climate strategy. They could be made obsolete by changing circumstances or swift regulatory action. She also sees opportunities that ESG highlights, such as the greening of electricity grids. She says that asset managers like Baillie Gifford are using ESG metrics to relentlessly assess risk and generate alpha through these assessments.
“There is a danger that we think of ESG as this rarefied acronym that doesn't mean anything. And it's when we do that that I think it starts to become a distraction rather than helpful,” Flockhart says. “But if we think about this as a heterogeneous topic and about a series of tools that can help us better understand the investments in our portfolios, or the managers managing those for us and the opportunities and risks that they face, then this is merely equipping ourselves better to do our jobs better."
