Quantifying the real alpha found via social change

Bonnie-Lyn de Bartok has seen the impact of social-focused investing with her own eyes and these days is spreading the word of a new source of alpha as the founder and CEO of The S Factor Co.

And while the “S” Factor in ESG is often overlooked, she has made a career of focusing on what is likely becoming the most impactful element of our world today.

Bonnie-Lyn de Bartok (provided)

S Factor currently covers approximately 10,000 companies — the bulk of global publicly listed equities — with a minimum of six years historical data. The data allows the user to drill-down into standardized, norms-based social risks and impacts across a company’s operations and throughout its supply chain, according to de Bartok.

Now through the confluence of technology, larger data sets and greater interest in ESG on the part of investment firms, her work has picked up even more as de Bartok now is taking the knowledge she’s gleaned from 20-plus years advising heads of state, financial institutions, mining and oil and gas companies as well as NGOs to offer a unique set of social screens.

She has won several entrepreneurial and technology awards, having now worked across 59 countries, evolving and establishing exceptional teams and several proprietary ESG data measurement products including the MSPI (2010) and the S-Factor Solution (2016). Her company has developed a proprietary algorithm and index that measures corporate social management against international standards, public sentiment and financial performance.

Barreto: Thank you for agreeing to share your insights with Alternatives Watch readers at this time of change on the topic of ESG.

de Bartok: Thank you for having me, Susan.

Barreto: Please tell us how you became interested in social impact measurement and investments.

de Bartok: After two decades of social impact fieldwork in dozens of countries, including some of the world’s most impoverished, I could not for the life of me understand how a company’s stock was soaring, while I stood there knee-deep in the red dirt of Africa, staring at the devastated landscape, watching migrant workers toil in an oppressive, humiliating, regime-operated mine site — knowing the boys back on Bay Street who owned the land, operation and mine permit were celebrating their hard-earned rise in stock price.

So long as there is demand, there will be supply, seemingly at any cost. Tragic is the history of the world that believes profit must come at the expense of people. Today, the impact investment industry has gone to great effort and expense to bend the mnemonics to include the value of carbon reduction over the cost of actual lives affected or lost in a “net-benefit” theory.

After two decades of watching market profit at the peril of others, I knew I needed to take this on.

Barreto: What kind of alpha exists in the social or ‘S’ category of ESG investing, and how can investors build a portfolio with social impact in mind? Does it have to be a standalone portfolio, for instance?

de Bartok: My theory, since publishing The World’s First Social Index in 2010, which correlates social management and financial returns, which I later elaborated on in my February 2020 TEDx talk, is that we know environmental damage is manmade. However, if you screen using social indices first, you will bottleneck any further damage. The most devastating industries are the worst performers in social management. Ultimately, its substantial social risk-adjusted returns equals alpha. Without this S screen, alpha is left sitting on the table.  

Barreto: Can you offer us an example of what this alpha looks like?

de Bartok: Using a predictive model based on social factor (SF) signals in a regression analysis we have found results in 207% excess return.

We constructed a recent example (or test case) long/short portfolio consisting of six companies across two industries based on the predictive factor derived from Monthly SF scores. A running back test over the past five years, rebalancing every five months, yields a 2.071 annual alpha, compared with a negative alpha using a naive non-predictive factor — 53 times higher in absolute terms: more than 10% cumulative returns, versus 20% loss in the naive cases. 

The results completely dispel the myth that investors need to sacrifice returns for ESG. Alpha is in the S. Not head count D&I, but rather our method for S — which equals operational level S with a 360-degree societal impact view of S — this includes signals related to compliance for labour and human rights issues, as well as health and safety and diversity and equity — but deep dive on the labour and human rights.

Barreto: A standard comment I hear is that ESG measures are not standardized and can be the pride of particular firms that have evolved specialized proprietary models for investor reporting, like Bridges Fund Management, for example. Others talk about the UN PRI and/or the GIIN IRIS+ frameworks as the closest we have to standard methods for measuring impact in an investment portfolio or at the company level. What would you say about the standardization of ESG metrics?

de Bartok: We have mapped the social indices of over 45 frameworks, both policy and reporting resulting in a set of standardized definitions for over 1,200 indicators.

At the end of the day, the criteria they are each asking for does have a “norm.” It is possible to standardize the criteria, we have done it. It is political agendas that are in the way in terms of “membership” and “affiliation” by fee for approval that is creating the chaos. Not the criteria. Rather than create an entire new framework that nobody needs, we are applying vast amounts of performance data to the ones that already exist and seem to be widely accepted. We have the largest number of social norms-based screens across the entire ESG universe.

Barreto: After social justice issues came into clearer focus in 2020, how have you seen investor sentiment change with respect to social impact investment and ESG measurement for funds in other sectors beyond impact?

de Bartok: If you are referring to the #BLM movement, clearly it has driven D&I issues to the forefront of all considerations. D&I, beyond gender includes skills, race, ethnicity, class and educational attainment, parity and equity.

What it should mean, according to regulatory frameworks, is that investors should be screening for things like anti-discrimination policies, inclusive policies, freedom of association and collective barging in decision making authority, transparency on related incident tracking and grievance mechanisms, proof of diverse equity stakeholders and pay parity across social segmentations representative of the populations and workforce where companies operate.

We want ratios in middle and upper management as well as boards, and supply chain management. Instead, what we see, is a splash of color in ad campaigns, not reflective of the genetic make-up or performance of companies — yet.

Perhaps this is the first wave of the inclusive process and we’ll be tracking performance against new public commitments companies are making and working towards. But D&I does not equal S. It’s more than that, and we have history on more than that.

Barreto: What are some commonly overlooked considerations for alternative asset management firms in other sectors such as private equity, credit and infrastructure, as they look to beef up their ESG reporting capabilities in the face of increased investor demand?

de Bartok: Across the board in all asset classes, is the misunderstanding of social criteria and how to measure it. Most products equate D&I or some health and safety for employees to equal the totality of the social metric equation; or worse, some believe that managing public perceptions with media controls and PR as equal to checking the social box. These are not operational efficiency metrics. They belong to a larger equation of risk mitigating signals that result in monitoring over 1,200 indices. These signals both positive and negative give investors the “edge” they need to better inform decisions, before they become controversies or yesterday’s news. The ROI is in mitigating lost time or reputational costs.

Barreto: What industry initiatives do you appreciate most in this context and why?

de Bartok: If I had to pick something current and relevant to your audience in the alternative or private financial world it would be promotion of female built fintech products. It’s almost non-existent. Almost every fintech product and algorithm in the world which calculates what is valuable has been built by adult males. This perpetuates systemic bias in outcomes. What I prefer to focus on are global initiatives such as the global transparency initiative, the Modern Slavery Act in the U.K. and recent enforcement action at the SEC investigating ESG products to ensure they do what they say and SFDR for calling for a reclassification of funds as people often and interchangeably use the terms impact and ESG in the same sentence, yet they are completely different, as well recent supply chain embargoes both in the US and Europe suspected for forced labor practices — all of these recent events should send waves of signals to investors on how their assets may be comprised in the very near future.

Barreto: What are the greatest challenges with respect to ESG reporting as it stands today?

de Bartok: The data the market needs for social, remains largely inaccessible in a usable format. It remains “unstructured” buried in bits and pieces of reports and documents and not formatted to rules of measurement or norms-screens, i.e., record of a fatality buried in the fine print of an MD&A report, or worse multiple class action lawsuits against a company related to a social issue which have NOT been disclosed by the company to its shareholders (public or private) at all — sourced externally. Structuring vast amounts of unstructured information in accordance with the norms-screening rules has been a huge undertaking.

It is our mission to fulfill this material social data gap in the ESG equation, way beyond D&I issues.

S-Factor aggregates, but also originates our own data by structuring from unstructured sources; the content is in accordance with global social regulations. Think Modern Slavery Act enforcement — monitoring companies’ behaviors in operations and supply chains is as predictable as weather patterns. Therein lies the alpha.

Barreto: Thanks for taking the time Bonnie-Lyn!

de Bartok: My pleasure, Susan.

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