Why the disconnect? Most equity investing today is quantitatively driven. Rather than the traditional view of investors who read annual reports, meet with management, and make informed judgments about a company’s culture, leadership and strategy based on first-hand experience, the overwhelming amount of money today is managed by an algorithm or at least by a quantitatively driven process. Investors also like to compare companies over time and across sectors—and tend to be skeptical about companies’ varying metrics– so there is a real need for consistently calculable and widely applicable metrics. Even the most sophisticated sustainability reports are hard to incorporate into such a process.
So, what data can companies share that is both reflective of their businesses and useful for investors to make long-term investment decisions? While the industry and regulators come together around the most appropriate frameworks, we believe we can advance the conversation with metrics that meet the following criteria:
- Quantitative: Not frameworks, ratings or judgments, but raw numbers that investors can incorporate into their own decision-making processes
- Investor decision-relevant: Material to long-term investors
- Consistent: Uniformly defined and consistently calculated
- Widely applicable: pertinent across countries, sectors and contexts
- Assurable: Auditor assurance is necessary over time to build credibility and reliance on new metrics.
Of course, companies could disclose additional information, and these metrics are not the only things an investor might want to know. But we need to start somewhere, and the metrics that follow are a place to start.
Long-Term Financial and Organizational Metrics
In order to be relevant to most investors, long-term or sustainability metrics need to be disclosed in a consistent matter that is assurable by auditors.
Long-term investors recognize that business practices not reflected in standard financial reporting still affect their return, and incorporating sustainability principles into investing is increasing dramatically. As investor demand grows, myriad efforts are underway to measure and disclose corporate sustainability. There are 600 environmental, social, and governance (ESG) frameworks in use today, and companies release detailed ESG data in sustainability reports, each with its own non-standard format. At the same time, investment processes are becoming increasingly computer-driven. There is a clear need for long-term financial and organizational metrics targeted at quantitative investors.
Rather than developing yet another framework, FCLTGlobal has worked closely with sustainability experts and other business and policy leaders to identify a series of metrics that we believe would streamline and enhance the incorporation of the key long-term value drivers in investment processes.
We identified these metrics with several goals in mind – first, to provide investors with information that is not already available in the machine-readable versions of regulatory filings. These metrics would supplement Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) financials.
The second goal is to give investors insight into granular year-over-year changes in financial and operating practices and outcomes. Therefore, the metrics have continuous ranges rather than being yes-no questions, such as management attestations, which are considered separately.
The third goal is to recognize that investors build distinct investment processes based on their investment beliefs and client priorities. These metrics are not judgments or ratings, but rather information in the form of raw numbers. Investors can incorporate the metrics as they see fit.
Lastly, FCLTGlobal aims to put forward a simple starting point with a clear recognition of the need to evolve over time.
To be relevant to investors using quantitative methods, long-term financial and organizational metrics must satisfy several criteria referenced above, which have been vetted by FCLTGlobal Members and other global experts. These criteria narrow the list of potential metrics substantially to a common baseline targeted at investors. We recognize that there are many other stakeholders and reasons for disclosure. Companies may naturally choose to provide additional disclosures, beyond these baseline long-term financial and organizational metrics.
While not a framework, our list of long-term financial and organizational metrics can be grouped into six distinct groups, based on Member and other expert opinions: Talent, Governance, Innovation, Capital Allocation, Environmental Footprint, and Payments to Governments.
The majority of the metrics are supported by academic research and expert opinion, in addition to being compatible with 22 current frameworks (as shown above) that sustainability experts, global business leaders, and policymakers have spent years developing, including: 3M, the Climate Disclosure Project, the Climate Disclosure Standards Board, the Coalition for Inclusive Capitalism (EPIC), Corporate Reporting Dialogue, Datamaran, EY, the Global Reporting Initiative (GRI), Greenhouse Gas Protocol, Her Majesty’s Government, the Impact Management Project, the International Integrated Reporting Council (IIRC), the International Organization for Standardization, Nasdaq, One Planet Summit Sovereign Wealth Funds Working Group, Principles for Responsible Investment, Social Accountability International, Sustainability Accounting Standards Board (SASB), Task Force on Climate-related Financial Disclosures (TCFD), the European Union (EU), the United Nations (UN), and the US. Securities and Exchange Commission (SEC)
There are a number of important metrics that are challenging to uniformly calculate and assure, but that FCLTGlobal would like to acknowledge and incorporate over time:
- Additional dimensions of leadership and board diversity, including racial, ethnic, and/or cognitive diversity
- Revenue from product lines that were added in the past 5 years
- Customer retention
- Employee engagement
- Cybersecurity (protection of personally identifiable information).
Managerial attestations would also provide value in addition to the metrics outlined above. First, a management attestation of no compulsory or child labor (though a binary metric) would address a key investor concern. Norms-based screens such as this are a common form of ESG screening – such an attestation would align with the work of UNPRI, UN Global Compact, UN SDGs, and European Directive on Disclosure of Non-Financial and Diversity Information. Second, a yes-no question on whether there has been a qualified audit in the past 5 years would indicate the presence of any significant governance issues. Third, a yes-no question on whether a company reports TCFD metrics and targets would help investors separate commitment to sustainability from greenwashing.
Over time, FCLTGlobal plans to collaborate with other initiatives to drive convergence and adoption, and to further define methodologies. We hope that this work will make a new and valuable contribution to quantitative investment processes and corporate reporting around the world. And we hope to hear additional views on the metrics and methodologies as we continue to explore this important aspect of long-term investing.