What Future Risk is Embedded in your Portfolio? Is Global Diversification Adding Benefit or New Unseen Risks?
Future risks that are not on the balance sheet – from human capital to customer satisfaction to carbon efficiency to board diversity – are knowable when you properly evaluate data on impact, sustainability, and ESG (environmental, social, governance) metrics.
To test which capital markets worldwide host publicly listed companies that disclose major risks, we mapped 45 international indexes across 38 countries and regions. The color-coded chart below provides a unique insight into which indexes have high coverage levels (color-coded in green, where the top score is 100%) and disclosure of future risks, including ESG risks – and which ones are opaque (color-coded in red), which could lead to more surprises for investors. We tracked coverage levels within these indexes across the years 2002, 2009 and 2015.
(Click to Enlarge)
Positive progress in coverage levels is underway in large company indexes based in Philippines in the Pacific Ocean region; Poland, Austria, Greece and Sweden in Europe; and Mexico and Chile in the Americas. As most companies in country indexes are large and mega caps, with some firms’ revenues exceeding country GDPs, stakeholders generally have a significant influence over these sprawling, multi-national enterprises. Yet, mid-caps do not necessarily get as much attention, and thusly, do not necessarily disclose as much information – even about meaningful risks. You can see these lesser disclosure ratios in Australia, Canada and UK indexes.Many country and regional indexes today have coverage levels at or near 100%. South Africa’s index, inclusive of mining and metals, has companies with high disclosure of material risks, so investors can properly assess human, social and environmental factors that link to financial risk and return potential. In Asia, high disclosure indexes are found in Hong Kong, Singapore, Taiwan, India, Malaysia, and Japan. Many Western European countries, as well as Canada and US in North America and Brazil in Latin America, bring high coverage levels in their indexes of larger firms.
Despite investor demand for globally diversified portfolios, several countries still host companies that have low disclosure. In Asia, this includes Thailand (a top economy in Southeast Asia), New Zealand (usually included in the Developed Market category), and Indonesia (the 4th most populous country in the world). In Europe, smaller countries like Ireland and Portugal (only half of the 20 companies on their indexes) and Netherlands (only one-third of the 122 companies in its index), lag in coverage levels; this can expose investors to new surprises. Argentinian firms in its index are quite opaque – only 1 of the 14 companies discloses ESG data about future risks.
TRANSPARENCY OF FUTURE RISKS BY FIRMS IN COUNTRY INDEXES
Source: HIP Investor analysis of country indexes
Expanding Coverage to Understand Future Risk
Improving ESG coverage is an essential first step in a long journey towards understanding the future risks that investors face in their portfolios. Increased levels of reporting on ESG issues is also an opportunity for corporations to mitigate future risks and pursue value-add opportunities, as we have outlined in previous featureson Equities.com.
The movement to increase reporting of impact, sustainability and ESG metrics continues with positive momentum. The Principles of Responsible Investment (PRI) Initiative, initiated by the United Nations and now spun out as an independent entity, has gained acceptance on a global scale. While the principles are voluntary, the PRI initiative has grown to a network of 1,325 signatories that represent $45 trillion in assets under management, starting at just 68 founding signatories representing $4 trillion in 2006.
In the past decade, governments and stock exchanges across the world have taken multiple initiativesto mandate or encourage increased levels of ESG reporting. Most notable recent measures include the 2014 European Parliament decision mandating ESG disclosure for around 6,000 large companies and groups across the EU. On the other hand, stock exchanges in emerging economies such as South Africa and Malaysia have been pioneers in requiring ESG disclosure in ongoing listing rules. The Sustainable Stock Exchange initiative now engages 24 exchanges globally, including NYSE and NASDAQ, but also Nigeria, Peru and Vietnam.
The task of ensuring standardization and high quality of ESG reporting has also been taken up by international organizations and collaborative movements. ESG reporting guidelines with widespread adoption include the UN Global Compact principles, the OECD Guidelines for Multinational Enterprisesand the Global Reporting Initiative. The adoption of these frameworks on an international scale as well as the collaboration by stakeholders from around the world to develop and improve these guidelines is testament to the progress made in recent times towards standardized ESG reporting.
Investors can use this information to make better future-looking decisions. And ratings firms – including MSCI, Sustainalytics, OEKOM, and HIP Investor -- bring insights, data, and expertise to interpret this impact and ESG metrics for investors, advisors and fund managers.
How much future risk is in your portfolio? Many risks are knowable yet ignored. Savvy investors collect, evaluate and integrate all information in their decision-making, and diversify globally where they can more clearly see future risks and opportunities.
How do you use impact, sustainability and ESG metrics in your portfolio? Share your commentary and suggestions in the comments section below.
Part 1 of 4 - Check back to Equities.com next week for part 2 in this series from HIP Investor.
By Hummayun Javed and R. Paul Herman
Hummayun Javed is an impact investment analyst, with a Masters in Global Policy Studies from the LBJ School at the University of Texas at Austin; R. Paul Herman is CEO, CIO and an investment adviser representative (Series 65) of HIP Investor Inc. and CEO of investment ratings firm HIP Investor Ratings LLC (More info at http://www.HIPinvestor.com)
The views expressed by registered representative and investment adviser R.Paul Herman of HIP Investor 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. 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 8,500 ratings to investors, advisors, indexes, fund managers and retirement plans, including 401(k)s.
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. To read our full disclosure, please go to: http://www.equities.com/disclaimer