Catastrophic investors losses, such as those at Enron and Parmalat, are often driven by unethical management practices. Detecting such behavior within firms is difficult since, almost by definition, these practices are not disclosed and are usually not obvious. The Total Corporate Responsibility (TCR) approach is intended to overcome this difficulty and identify firms that are most likely to be involved in unethical internal behavior. It does this by analyzing the more easily measured external behavior of firms. Companies engaged in unethical external practices are much more likely to be involved in unethical internal practices, such as falsifying accounting numbers. For example, if Enron's efforts to inappropriately influence regulators through excessive campaign contributions had been analyzed, investors would have been alerted to the likely presence of additional unethical behavior.
Total Corporate Responsibility Funds [TCR]TCR provides a strong indicator of management quality and ethical performance by comprehensively analyzing the integrity and ethics of external corporate activities. For example, a firm that demonstrates high levels of integrity and responsibility in areas including corporate governance, human capital, product safety, environmental performance and stakeholder relations is much less likely to be involved in unethical business practices. Conversely, firms that perform poorly in these areas relative to peers are much more likely to generate catastrophic investor losses due to the presence of difficult-to-identify unethical behavior.
Fund Construction. Best-in-class TCR ratings will be produced by Innovest Strategic Value Advisors. Innovest is the largest firm in the world comprehensively analyzing corporate responsibility performance. TCR ratings can be used as a source of risk reduction and alpha generation on many different types of investment products. For example, a TCR enhanced index product with a low tracking error could be developed based on the MSCI World Index. This would be appealing to risk averse investors.
Risk Reduction. Scandals such as Enron, Tyco and Parmalat have eroded investor confidence in the capital markets. To protect investors and restore confidence, asset managers must do a better job of identifying internal ethics problems. TCR provides the most reliable means to date of identifying such problems. This approach would be appealing to investors who have incurred large ethics-driven losses in recent years and are now seeking a way to avoid such losses in the future.
Beyond ethics, TCR analyzes external performance issues, such as those noted above, that are highly financially relevant. For example, failure to consider the ability to attract and retain a high quality workforce, the likelihood of environmental and product safety disasters, and the presence or absence of sound corporate governance greatly increases investor risk. Asset managers that do not to consider these issues when making investment decisions imprudently increase investor risk exposure. Using the TCR approach ensures prudent consideration of these financially relevant issues.
Alpha Generation. Nearly all financial analysts would agree that management quality is the primary driver of stock market returns. However, management quality is difficult to measure since it is intangible. As a result, this most important driver of stock market returns is often not addressed, or at least not adequately addressed, when making investment decisions. While management quality cannot be measured directly, evidence that good management is in place can be measured. Probably the best way to do this is to measure performance on the most complex challenge facing management. Success in a highly complex area strongly implies management has the ability to excel in other areas and thereby earn superior returns.
The external performance issues analyzed in the TCR model pose the most complex challenge to management because there are high levels of technical, regulatory and market uncertainty as well as many stakeholders and complex issues to address. In addition, TCR analyzes efforts to block or promote system changes that hold firms more responsible. For example, a strong indicator of internal ethical performance is how firms interact with government and regulators. Firms asking to be held less or not responsible for negative impacts on society (ie: Enron lobbying and campaign finance activities) strongly indicates that other unethical practices are present. By analyzing the most complex challenges facing management, TCR provides the most accurate indicator of management quality and stock market potential available.
Maximizing Sustainability Performance. For investors interested in environmental and social issues, TCR ratings can be used to construct the most innovative and effective socially-responsible investing (SRI) products available. Declining environmental and social conditions around the world indicate humanity is grossly unsustainable. A primary driver of humanity's unsustainable state is economic and political systems that fail to hold firms fully responsible for negative impacts on society. Despite strong efforts on the part of many firms to improve environmental and social performance, no firm is close to being sustainable. Attempts to fully mitigate impacts in the current economic system would put a firm out of business since costs would become too high relative to peers. Essentially all other SRI products focus on environmental and social issues. TCR analyzes these plus system change issues. By addressing the fundamental driver of unsustainability (system flaws), TCR does more to promote sustainability than any other SRI product.
Contact Information:
Frank Dixon, Managing Director
Innovest: Strategic Value Advisors
Four Times Square, 3rd Fl.
New York, NY 10036
646-237-0220
Fx: 212 421 9663
www.innovestgroup.comCopyright � 2004 Frank Dixon