BalancedStrategy

Investment managers

Governance and Sustainability Summary 2019

Balanced Stewardship Report 40502 0619.inddRef: 40502 ALL AR 0083

Risk FactorsThe views expressed in this article are those of Baillie Gifford 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 the third quarter of 2019 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Bonds issued by companies and governments may be adversely affected by changes in interest rates, expectations of inflation and a decline in the creditworthiness of the bond issuer. The issuers of bonds in which the fund invests may not be able to pay the bond income as promised or could fail to repay the capital amount.

The Balanced Fund has exposure to foreign currencies and changes in the rates of exchange will cause the value of any investment, and income from it, to fall as well as rise.

Potential for Profit and Loss

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

Stock Examples

Any stock examples and 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.

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.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this article are for illustrative purposes only.

Contents

Engagement Highlights

06

Beyond Equities

08

Proxy Voting

10

Carbon Footprint

11

ContentsHow We Think About Governance and Sustainability

02

A Balanced Approach

05

01

How We Think About Governance and Sustainability

At Baillie Gifford, we know our clients want us to achieve strong investment returns and we also believe that they care about the impact their capital can have on society and the environment. We take very seriously our role as stewards of our clients’ capital and therefore want our actions to reflect our shared values and concerns, as well as the broader responsibilities that come with managing significant sums of money.

How We Think About Governance and Sustainability

We believe there is strong alignment between good governance practices and achieving, over the long run, the best investment returns. Consideration of these issues is therefore embedded into our research and decision-making, as well as our active engagement with our clients’ underlying investments. These considerations are a key component of our long-term, active, and growth-focused approach to investment management.

We focus on in-house governance and sustainability research as we believe that this is where we can add value – by bringing a nuanced understanding of the performance of the companies we hold and, importantly, how they are looking to develop over time and the measures they have in place to achieve this. This is supplemented by an increased level of access to companies that comes with long-term holdings and our reputation as thoughtful, long-term investors that can support a level of engagement that is not possible by external research providers.

Length of Ownership (Years)

0

2

4

6

8

10

Representative Portfolio

Global Peers

Years

7.8

1.9

C.4x.

Source: Baillie Gifford & Co, 3 year average turnover as at 30 June 2019.

*eVestment’s Global All Cap Equity Investors universe is used as a representative sample.

At the same time, we believe that a positive and proactive approach to governance and sustainability can also be a competitive advantage for the companies in which we invest. Good governance can support better decision-making and capital allocation. Good social performance can create a more productive workforce. Good community relations can secure the social licence to operate. These relations can provide resilience in bad times, while positive environmental performance can lower operating costs and secure access to long-term natural resources.

02

03

04

Each of these investment teams has a named Governance and Sustainability analyst who supports our investors in their regular interactions with company boards and senior management as well as with proxy voting. Analysts from the Governance and Sustainability Team sit with our investment teams and regularly join them for meetings with company management and board members. In addition, analysts will arrange meetings directly with company representatives to discuss specific issues. It is through these interactions that we are able to understand the sustainability of individual companies’ long-term strategies. We are cognisant of the imperfect nature of the companies in which we invest, as well as the fact that actual investing requires patience and a constructive approach to help businesses become better from a governance and sustainability perspective. The Balanced Strategy’s focus is therefore on engagement rather than exclusion from portfolios.

Our focus on governance and sustainability starts in the research process where we consider the values and long-term motivations of management as well as corporate culture. This then extends to ongoing research and review as well as engaged voting (which is performed in-house). We believe that we invest in some of the best companies in the world and that as we engage with them, these businesses can only become better. However, the Balanced Strategy does not operate in isolation, with engagement often being the result of firm-wide collaboration.

On the next page, we have included several examples to demonstrate how our process translates into practice. This predominantly focuses on the strategy’s equity holdings, with further information on our approach to bonds and other asset classes being noted on page 8.

A Balanced Approach

A Balanced Approach

The Balanced Strategy combines the stock picking expertise of our five regional equity teams with our best ideas in government and corporate bonds as well as a tactical allocation to cash.

05

Engagement Highlights

UK

Republic of Ireland

TeslaTesla is changing the way we think about transport,

energy supply and distribution. In our view, its contribution to a lower-carbon economy far outweighs

the governance issues that have appeared in the media. Our conversations with the company have

continued to revolve around employees, health and safety, board make-up, merger & acquisition activity

and the controversial topic of Elon Musk’s remuneration. Our engagement meetings have one

goal – to ensure Tesla is positioned to continue with its positive contribution to the environment and society,

as well as to its shareholders. In 2018, for example, we met with Tesla’s head of environment, health and

safety at the company’s Fremont factory in order to develop our understanding of its policies and

practices. This provided assurance that these are consistent with our expectations of a responsible

operator.

Ryanair Ryanair is the largest European low-cost airline. Despite it

having the youngest, most efficient fleet in the industry, the company is one of the larger contributors to the representative

portfolio’s carbon footprint (see details on page 12). In part, this is attributable to the very nature of the industry. However, we

have been encouraged by Ryanair’s efforts in this area and the company’s commitment to further reduce its environmental

impact. Recently, Ryanair became the first EU airline to report monthly CO2 emissions, noting that it delivers the lowest CO2

per passenger/km in the EU airline industry.

Another key topic of our engagement with the company has been in respect of stakeholders. Whilst we admire the social

and economic benefits that Ryanair has brought to European countries through lower cost air travel, we have for some time

been disappointed by its attitudes toward important stakeholders, including shareholders, employees and trade

unions. Our recent engagements have mostly revolved around improving shareholder access to management and, in

particular, the board. We have also engaged on the outcomes of negotiations with pilot and crew unions. We welcome the

efforts to improve relations with employees and will continue to monitor the evolution of these issues.

USA

Bonds / Credit AcceptanceCredit Acceptance Corporation is an auto finance company which provides car loans and other related financial products. We met with the treasurer of Credit Acceptance during 2018 following the surprise announcement of the president / COO retiring with no successor plans in place. With the chairman having also left under a cloud in 2017, we had concerns around the ongoing governance of the company. Our engagement was unable to provide us with the confidence needed to sustain a holding in the company’s bonds and therefore our views on its weak governance, combined with credit discipline concerns, meant that we sold the bond.

CemexCemex is one of the largest cement companies in the

world. Although Mexico-based, we like the international presence of this business and, in particular, its US

operations. However, Cemex’s board composition hasn’t reflected the global nature of this company. Until

recently, the board was all male, Mexican and from Monterrey, and in both 2017 and 2018, we opposed the

election of Directors to reflect these concerns. While there is further to go, and engagement is ongoing, we supported the bundled director proposal at the most

recent AGM in March 2019. The result of this saw Cemex appoint its first experienced female Board member.

CEMEX is the largest contributor to the representative portfolio’s carbon footprint (see details on page 12).

Ultimately, the bulk of CEMEX’s business is manufacturing cement, the very nature of which is highly

carbon intensive and we do not believe it is an outlier within the industry. However, we have engaged with management to discuss how improvements can be made to sustainability targets, including increasing alternative fuels usage and furthering clean energy efforts. Therefore, while this will remain a carbon-

intensive business, management are making efforts to undertake carbon reduction initiatives.

Mexico

Engagement Highlights 06

Sweden

Just Eat Just Eat is a leading portal for takeaway food in several countries including the UK, Canada, Australia and Brazil. The core business is profitable, benefiting from low capital requirements and a strong network effect, i.e. the more outlets listed on its sites the more consumers it will attract. This year we engaged with chairman Mike Evans following the unexpected departure of the company’s CEO. We discussed the background to this change, the appointment of Peter Duffy as interim CEO and the succession process. Later, we met Mr Duffy and CFO Paul Harrison to discuss strategy and progress. We also participated in a lengthy consultation on executive remuneration. In Q1, 2019, an activist investor with a small shareholding continued to agitate for changes to strategy, personnel and executive pay. As this sort of activity can be a distraction for any board operating in a competitive industry, we have engaged further with the chairman to monitor the situation, the ongoing implementation of strategy and board development. In July 2019 it was announced that the board had agreed an all-share merger with Takeaway.com, an online food delivery business based in the Netherlands. As patient and long-term investors we are engaging with both the chairman and the CFO of Just Eat to discuss the merits and terms of the proposal to ensure that we reach a considered voting decision on the merger.

Japan

Atlas CopcoAtlas Copco is an industrial company manufacturing tools and equipment and has been held by Baillie Gifford on behalf of clients for over 35 years. We have great confidence in Atlas Copco’s consideration and understanding of sustainability within its operations, as well as its position within its clients’ supply chains, which provides a platform for superior and sustainable growth. One key competitive advantage is the energy efficiency of its industrial machines, whose lower energy consumption gives substantial cost savings for customers. The topic of the long-run impact of reduced energy consumption on the business was discussed with the management during 2018. It is encouraging to see that their thinking in this area continues to evolve.

CyberAgentCyberAgent benefits from the widespread shift to internet advertising, online gaming and social media. We like the company’s dynamic, entrepreneurial culture and believe that it has the potential to emerge as a major force in the Japanese internet landscape. However, CyberAgent does not have an independent board of directors. We have had numerous conversations with the company encouraging inclusion of independent representation to bring outside perspective to this interesting business. We opposed the election of three directors at the company’s AGM both in 2017 and 2018. Engagement is ongoing.

07

Fixed Income: Corporate Bonds

Alongside a company’s long-term competitive position and capital structure, governance and sustainability factors are considered as a key component in assessing a bond issuer’s fundamental financial resilience. As well as providing warning signs of upcoming issues, governance and sustainability factors can also signal improvements in a company’s general investment attractiveness.

Fixed Income: Sovereign Bonds

When we consider investing in a country’s bonds we examine key governance and sustainability factors to help assess associated risks, the country’s broad direction of travel and whether our provision of capital is likely to aid its progression. We believe that if a country is governed effectively, its people are respected, and its natural assets are managed responsibly, there is a greater chance it will enjoy sustainable growth and development and be in a better position to repay bond debt investment, or finance infrastructure projects.

Cash and Derivative Exposures*

Governance and sustainability analysis is not applicable for cash or derivative exposures.

Beyond Equities

Beyond Equities

We believe governance and sustainability factors are applicable and important in fixed income and we therefore take these issues into account as part of our investment process.

*The strategy (including the Managed Fund) may invest in derivatives such as currency forwards, futures and interest rate swaps, for investment purposes as well as for efficient portfolio management. This only applies to portfolios with exposure to fixed income – equity portfolios are long-only.

08

09

Proxy Voting

We believe that active ownership of our clients’ equity holdings is just as important as selecting the right investments. Proxy voting at company meetings is one of the key components of our stewardship activities. It allows us, where necessary, to influence or challenge the management teams of the companies we invest in for our clients. The Baillie Gifford Governance and Sustainability team has primary responsibility for coordinating proxy voting across all of the firm’s holdings, working closely with our investors on this.

Proxy Voting

Proxy Voting Statistics

For: 92.7%

Against: 5.5%

Abstain: 1.4%

Topic Remuneration Capital Allocation

Company Bank Rakyat Indonesia Shimano

Country Indonesia Japan

When May 2019 AGM March 2019 AGM

Why We opposed the remuneration for the board as independent directors receive incentive-based pay which we believe could compromise their objectivity.

We opposed the low dividend payment as we believe the company’s capital strategy could be more efficient.

Examples of Why We Oppose

Supporting Shareholder Resolutions

Facebook, United States, May 2019 AGM

We supported a shareholder proposal requesting the company produce enhanced disclosure on gender pay disparities across the business. This resolution didn’t pass, with 90% voting against the proposal.

Source: Baillie Gifford & Co. Based on a representative portfolio as at 30 June 2019. Totals may not sum up due to rounding.

10

The Balanced Strategy’s Carbon Footprint

Relative carbon footprint and carbon intensityThe relative carbon footprint is the total carbon emissions of the representative portfolio per million GBP invested. It therefore tells us what the carbon footprint would be if we invested £1 million in the fund versus £1 million in a benchmark index. The carbon intensity is the total carbon emissions per million GBP of revenue generated; this allows comparison with a benchmark index as a measure of the efficiency of the representative portfolio with regard to emissions per unit of financial output.

Carbon Footprint

Carbon footprint (tCO2e/GBP million invested)

248.7

157.0

87.9

167.7

MSCI All Country World IndexRepresentative Portfolio

Carbon intensity (tCO2e/GBP million revenue)

The carbon footprint of the representative portfolio has been calculated using ISS-Ethix Climate Solutions carbon footprinting tool embedded within the yourSRI platform. The following metrics have been calculated and compared against the MSCI All Country World Index benchmark. All refer to scope 1 and 2 emissions only. Scope 1 emissions are those deriving directly from company activities (i.e. stack emissions and fuel use); scope 2 emissions arise indirectly as a result of electricity use. Emissions within these scopes are reasonably under the control of the company and can be expected to be calculated by all companies.

Both measures highlight that the representative portfolio is significantly less carbon intensive than the MSCI All Countries World Index. This reflects the nature of the businesses that we are most excited about. Many are capital light, innovative companies such as Amazon and Tencent. And, while there are some stocks in industries such as oil and gas, the strategy typically has few holdings in these areas. This is entirely a result of our bottom-up stock selection process.

11

The Balanced Strategy’s Carbon Footprint

Largest Contributors to the Carbon Footprint of the Representative Portfolio (Function of Holding Size and Emissions)

Norilsk Nickel 3.5Petrobras 7.2

Enquest 6.6

Rio Tinto 4.9

Ryanair 4.9

Others 33.6 Cemex 27.5

DSV 7.4

Royal Dutch Shell 4.6

Using the carbon footprint – largest contributorsThe companies contributing the most to the carbon footprint of the representative portfolio are identified in the chart below. We monitor carbon intensity as well as the attitudes of management towards the long-term sustainability of the businesses in which we invest on behalf of our clients. Please refer to page 6 for further information on Cemex and Ryanair.

This data is provided on a ‘best endeavours’ basis using the available market information, which includes estimated data and unverified company disclosure, so it is therefore open to challenge. It also uses the methodology of one provider (yourSRI), which may vary from other databases.

12

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