Mon, Sep 20, 2021
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Industry Updates

Flawed world financial metrics reported in paper presented at Yale University by Richmond Global Compass Fund

Tuesday, November 06, 2018
Opalesque Industry Update - A research paper presented at Yale University reports that the financial world's incumbent classification system, GICS, is inherently flawed, as it omits material sustainability factors.

At the other end of the spectrum, the SICS classification system created by the Sustainability Accounting Standards Board (SASB) is faulty in that it overemphasizes sustainability metrics in comparison to traditional financial metrics.

Richmond Global Compass Fund's Chief Investment Officer Decio Nascimento presented the paper entitled "Industry Classification and Environmental, Social and Governance (ESG) Standards" at Yale University's Initiative on Sustainable Finance Symposium 2018 on the State of ESG Disclosure Standards on November 2, 2018.

Richmond Global Compass concluded that integrating the two systems by overlaying SICS industry groups over those of GICS creates a more accurate classification system, one that significantly decreases the correlations between different sectors.

This result is impactful as it demonstrates that a reliance on either inferior system misrepresents certain risk factors within a manager's portfolio, and thus, could be a breach of fidicuary duty.

Richmond Global Compass presented conclusive empirical data from its study. First, the GICS and SICS classification systems were tested individually. Of note, Richmond Global Compass demonstrated that GICS fared better than SICS in classifying firms of similar characteristics together.

One explanation provided was that GICS is currently used to classify more than 95% of capital markets, reinforcing the feedback loop between the system and those managers deploying it.

The firm then took the study a step further and integrated the two systems by merging the 11 GICS sectors with the 10 SICS sectors to create a new classification system with 110 potential sectors - some sectors were null sets so the actual number of sectors was between 30 and 40.

Compass then tested this classification system in the same way it did GICS and SICS and the results were astounding: over various datasets, such as S&P500 small and large caps, S&P1500 small and large caps, and UK small and large caps, 95% of sectors saw improvements in their between-sector correlations.

In other words, companies that were classified into different sectors proved to be less related to one another in terms of their stock price movements. Furthermore, within the 95% of sectors that saw improvement, the average magnitude of these improvements were 51%.

Richmond Global Compass believes more work is to be done in this space, but the initial study's conclusions are promising. As Compass evolves its machine learning platform, the firm's knowledge on materiality will improve and an even stronger classification system can be developed that properly balances all financial and non-financial material metrics.

A manager utilizing a more optimal classification system will have a better understanding of the risks contained in his or her portfolio, which will prove especially important in times of turmoil. It is the belief of Richmond Global Compass that the markets will inevitably adopt a refined classification system that will drive the markets and world in a more sustinabile direction.

Link to the Paper

What do you think?

   Use "anonymous" as my name    |   Alert me via email on new comments   |   
Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing

 



  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. SPACs: The fall of the SPAC market has digital media companies in disagreement about best path forward, Cannae Holdings: SPAC bloodbath provides a good entry point, British car startup Cazoo raises $1bn from SPAC merger, Europe's incoming SPAC boom will create a demand for talent[more]

    The fall of the SPAC market has digital media companies in disagreement about best path forward From CNBC: The digital media industry has reached a strategic crossroads. Earlier this year, special purpose acquisition vehicles (SPACs) appeared to be the long-awaited savior of digital me

  2. Property: Real estate's new moneymaker is not design-driven, it's alternative, Two Sigma building quant tools to hunt real estate bargains[more]

    Real estate's new moneymaker is not design-driven, it's alternative From Forbes: There has been a recent shift of attention in the real estate market as to the types of investments which make the strongest returns. In the past, it's always been a combination of good design, prim

  3. PE/VC: Private equity GPs, LPs alike working on diversity and inclusion, Chinese regulator vows to crack down on private equity, venture capital funds, The VC playbook for portfolio companies: learning from the Covid-19 crisis[more]

    Private equity GPs, LPs alike working on diversity and inclusion From PIonline.com: Private equity general partners and limited partners are doing more to increase diversity in private markets, according to a report released Tuesday by the Institutional Limited Partners Association.

  4. PE/VC: Private equity continues to lead fund closings, Venture capital firms are fighting to throw money at cleantech[more]

    Private equity continues to lead fund closings From PIonline.com: Among private fund closings, private equity funds have led the pack starting in 2011, based on data collected by Pensions & Investments. During those years, private equity's share has ranged from 56% to 72% of the total

  5. PE/VC: Climate tech is hot, but VCs can't forget about water, Five top trusts to tap into the private equity boom[more]

    Climate tech is hot, but VCs can't forget about water From Crunch Base: "It is unequivocal that human influence has warmed the atmosphere, oceans, and land." These fiery words come from the latest landmark U.N. report detailing intensifying, universal climate change impacts. They cover