Indexing Sustainable Performance; Building Financial Portfolios and Indexes Using TBL Methodology

Paper Published: March 31, 2009 – This Summary – September 10, 2009

To download a copy, please register at http://www.crdanalytics.com/register.php

Overview:

With the 2008-2009 financial meltdown and subsequent global recession affecting investors in virtually all capital markets, the quest for reliable means of evaluating a public company’s staying power over the long-term – or even a company’s survival capacities – is becoming an important consideration for asset owners and asset managers, financial analysts, financial intermediaries, and especially fiduciaries.

Regardless of the ability to determine a company’s worth, in terms of Sustainability and Corporate Responsibility, it is equally important to determine how this will factor in investors’ decision-making.  While vital statistics of corporate accountability, responsibility, transparency and social performance are often assumed to be immeasurable, investors continue to seek reliable, comparable and standardized methodologies to guide their decision-making. 

Fortunately a quantifiable and comparable SPV or Sustainable Performance Value is available for any public company that discloses its financial, environmental, and social data to their investors. 

Using their SmartViewTM Technology Platform, CRD is able to distill from large and complex data sets, comprehensive and relevant financial and ESG performance-driven information.

SmartView ™ screening algorithms consider technical criteria, fundamentals, geographic considerations, environmental factors, corporate governance record and practices, and policies and actions on social issues.  The SmartView forced-ranking algorithms include analysis, modeling and mapping, leading to benchmarks, scores, weights and rankings.  Using this platform, CRD delivers index-ready products, best-in-class rankings, force-ranked portfolio tools, and optimized resources for ESG investment.

 

Comments from the Paper about the SRI Journey to Mainstream Investing

The first generation of “Socially Responsible Investing” (SRI) was based on processes and investment policies that screened out investments. For example, the exclusion of tobacco companies from investment portfolios.

The second generation was the evolution of SRI decision-making to consider ESG performance a factor, which was fundamentally qualitative in nature. ESG factors were considered in terms of risk and return and the direct impact on shareholder value. 

The third generation considers many more factors in building optimal portfolios to include top performing companies using both quantitative and qualitative metrics. The trend is to use a global standard for benchmarking and to measure a company’s stock performance based on a series of investment criteria relative to their peer groups.  Critical drivers included expanded adoption of the United Nations Principles for Responsible Investment (PRI) that requires signatories to incorporate extra-financial (ESG/Sustainability) research into their investment analysis.

The fourth generation is the Triple Bottom Line approach:  This is a derivative of the quantitative-based analysis which began with consideration of ESG performance.  The CRD model uses a forced-ranking algorithm that screens a set of companies using multiple financial, environmental and social performance metrics across all sectors using best-in-class derived benchmarks. This approach accommodates both passive and active investors and addresses voids in the first three generations of SRI:

• Lack of quality in extra-financial audited information.
• The need for global standards and guidelines for reporting across all industries.
• Guidance for developing legislation and regulations for corporate reporting.
• Addresses investors’ need for hybrid financial portfolios.
• Provides empirical research with risk-return analysis to demonstrate the out-performance of sustainability-based investment portfolios (not “SRI” or “ethical” investing).
• Generates sustainability investment products similar to traditional growth and value investment products.

A review of 52 research studies with more than 33,800 individual observations concluded that corporations operating in socially- and environmentally-responsible ways were positively correlated with better financial performance.

The importance of corporate transparency and disclosure is underscored by the expanding commitment of global and domestic companies to the United Nations-sponsored Global Reporting Initiative (GRI).  This is a voluntary disclosure initiative, which originated in the Boston-based Ceres organization, and has become the world’s standard for corporate performance disclosure on sustainability practices.  More than 1,500 companies and organizations have signed on to the GRI. 

The United States corporate sector is considered to be under-represented when compared to the European Union and other industrialized and developed nations.  A company not participating in the GRI initiative is not included in the CRD 50 index.

The GRI’s Sustainability Reporting Framework is underpinned by Sustainability Reporting Guidelines (the “G-3”), which are universal standards used to report sustainability performance.  (There are also sector supplements such as electric utilities and telecommunications).  Key factors in reporting are community indicators, human rights indicators; content and materiality; management approach; performance indicators.  There are protocols behind each indicator.

 

Definitions:

The Performance Metric, a quant value (based on a ratio, percentage or weighted quotient, across all market sectors and capitalizations).

The Metric Score, a computed grade (zero to 4) based on placement within the entire range of a portfolio’s quartile markets.

The Dimensional KPI, the sum of each metric score with assigned weighting with the financial, environmental, social and governance performance ranges (zero to maximum of 100).

Sustainable Performance Value (SPV) is the weighted arithmetic mean of all dimension KPIs (values range from zero to 100).

Sustainable Performance Momentum (Velocity * Critical Mass) is the absolute change in SPV over a time period weighted by the relative market cap at the first period.

The critical outcome is the identification of companies for investment portfolios (or indexed products) better positioned to produce risk-adjusted long-term investment value.

TBL:  The Triple Bottom Line methodology measures, compares and scores public companies based on financial, environmental and social performance metrics.  Combining this approach with best-in-class portfolio optimization produces indexes with the highest performance across all industries and market sectors regardless of their carbon intensity, a critical factor such as “carbon tax and trade” is being discussed and implemented in major industrial economies.

The CRD Global Sustainability 50 is an index approved for trading by NASDAQ OMX in June 2009.  The component companies are the 50 most sustainable global issuers as determined using the CRD SmartView methodology.  The index tends to outperform on the long-term horizons such well-known and widely-used indexes as the Dow Jones Industrials, the S&P 500, and the MSCI EAFE.   The Global Sustainable 50 is actively managed, rebalanced quarterly and represents 70% US-headquartered and 30% Europe-based companies.  Critical factors in the consideration for inclusion are transparency and disclosure under the GRI initiative (as of 10 September 2009).

The CRD Global Sustainability Index and the SmartView methodology are described in depth in the CRD White Paper.

To download a copy, please register at http://www.crdanalytics.com/register.php

 

* * * * * * * *