This is Part Three of our series on the value of forward thinking, impact investing. You can find Part One here and Part Two here.
Is a capital market efficient when company resources go toward lobbying for political benefit?
An index based on human, environmental and social factors says, “no,” which in part explains the difference in position between Texas Instruments Incorporated (TXN) and Wells Fargo & Co (WFC) in the two indexes above. According to self-reported lobbying expense data, Texas Instruments spends about a half a percent of sales toward lobbying, whereas Wells Fargo declines to report on lobbying expense. Third party sources, such as OpenSecrets.org, can help impact investors with further quantitative fundamental, or “quant-amental” data where needed. In 2014, OpenSecrets shows Wells Fargo spent $6.4 million on lobbying, while Texas Instruments spent $1.7 million. Those figures do not include political action campaigns (PACs,) non-profit structures, and other funnels of political money. OpenSecrets.org reports these too, and Texas Instruments also channels less money than Wells Fargo on this type of political spending.
Similar to the metrics of employee pay and CEO compensation discussed above, lobbying signals a company investment away from innovation and toward regulatory protection or maintaining a status quo. When companies are extractive or focused on short-term results, fundamental indexes can weight them lower because the long-term view is not overall value for stakeholders but short-term quarterly financial return, which can become “extractive” versus “innovative”.
To further assure long-term perspective, fundamental indexes can include evidence of innovation (and avoiding extractive practices) by assessing third party certifications. In the same way a recommendation from a trusted friend increases confidence in a product, credible outside certifications increase the level of trust in a company’s products, services, processes, operations, and general practices. Texas Instruments leads many companies in its environmental management process commitments and occupational health and safety, holding certifications from ISO, Eco-Management Audit Scheme (EMAS) and Employee Health and Safety (OHSAS) Wells Fargo reported no third party certifications. All ten of the top companies in the HIP 100 Index have at least an ISO 14000 certification.
Index Weighting
The focus so far has been rankings and drawing out the new fundamentals—human, social, and environmental quantitative factors—where ranks are strongly disparate. It is worth noting another feature of market cap weighted indexes is the “super”-mega-cap companies can have significant influence on the performance of the index. One or two companies could influence 5-10% of the index, as seen in the following table showing weights as of 12/31/2014:
Source: S&P, HIP Investor
The top ten components of the S&P 100 make up 30% of the index versus the top ten components of the HIP 100 making up about 13% of the total index weight. The range of weights among the S&P 100 components is 0.13% to 5.82% at the highest. The weights of the HIP 100 Index components range from 0.57% to 1.37%. In this way, the HIP 100 Index and other fundamental indexes are more like another type of index – the equal-weight index – and could be considered an equal-weight index enhanced for social, environmental and human impact factors. Some firms are branding their ESG indexes as “smart beta.”
Looking at industry breakdown shows this, too, with a more even distribution among industries than the S&P 100 sector weights. The table shown here uses Thomson Reuters Business Classifications, so it may look different from the GICS sector classification chart on the www.SPindices.com website.
Source: Reuters, S&P, HIP Investor
Performance
Finally, what can happen in terms of performance when weighting for these new fundamentals—societal and environmental factors—versus market-cap weighting?
Fundamental-weight and equal-weight indexes of the S&P 100 firms have outperformed over one, three and five year periods ending 12/31/2014. Fundamental weights focus on the strongest companies who create value from people (human capital), natural resources (environmental capital) and stakeholders (social capital). These are factors of production, taught in foundational economics. Yet the common view of investors is that these are costs to be minimized, rather than assets to be productive and tended to. Intelligent investors see this value and can position their portfolios to capture it, which the “efficient markets” of market-cap weighted indexes ignore, despite being knowable, public information.
Through 12/31/2014
HIP 100 Index
S&P 100 Index
S&P 100 Equal Weight Index
Weighting Style:
Impact Factors
Market Value
Equal Weight
1 Year (2014)
+15.61%
+12.74%
+14.40%
3 Year (2012 – 2014)
+21.91%
+19.49%
+21.93%
5 Year (2010 – 2014)
+15.95%
+14.64%
+16.41%
Source: Morningstar, HIP Investor
HIP 100 Index performance calculation through 12/31/2014; inception date July 30, 2009. S&P 100 Index and S&P 100 Equal Weight Index performance through 12/31/2014 from Morningstar. Figures beyond one year are annualized. HIP 100 Index figures are unaudited. Indexes are NOT investable. Please read all the disclosures and disclaimers at the bottom of this post, and on the HIP Investor site.
Conclusion: Intelligent Investors Evaluate All Factors that Drive Value Creation
Though market-cap index investment strategies can track the market, higher performance in factor-based index investment strategies suggests investors can more closely find investment opportunities through in-depth analysis of quantifiable factors, also called the “new fundamentals.”
Intelligent, savvy investors who analyze and embed intangible value in their estimated valuations can more closely link to the underlying drivers of value creation and risk reduction. A rigorous, data-driven analysis and methodology for measuring these intangibles – which also include human, societal and environmental impact factors – and how they affect a weighted basket of companies can lead to stronger portfolios with potential higher long-term value creation and lesser risk.
Are you integrating these new fundamental factors into your portfolios? Add your commentary and suggestions in the comments section below.
Shilpa Andalkar is Senior Vice President and an investment adviser representative (Series 65) of HIP Investor Inc. and HIP Investor Ratings LLC (More info at http://www.HIPinvestor.com)
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.
HIP INVESTOR’S DISCLOSURES AND DISCLAIMERS The views expressed by registered representatives and investment advisers R.Paul Herman and Shilpa Andalkar are for informational and educational purposes only, and are not investment recommendations or an offer of securities. This post should not be construed as a solicitation or offer to sell investment advisory services except where HIP Investor, Inc. is registered or where an exemption or exclusion from such registration exists. Performance of the HIP 100 Index is gross of any fees and includes reinvested dividends and stock splits. Indexes are not investable. Any investable fund would have advisory, management and trading fees. This is not an offer of securities. Past performance is not indicative of future results. HIP Investor Inc. is an investment adviser registered in the states of California, Washington and Illinois, with clients nationwide, and also operates and licenses indexes. HIP Investor Ratings LLC is an independent limited-liability company, providing ratings to investors, advisors, indexes, fund managers and retirement plans, including 401(k)s.
Liked What You Read? Join Equities.com as a contributor and get eyeballs on your content FOR FREE