Across the market segments we serve, decision-makers are looking for more holistic ways to study and mitigate issuer risk. Mainstream investment managers and insurers increasingly recognize that ESG and accounting-related risk metrics represent important – if not the most urgently needed – additions to the arsenal of any decision-maker mindful of the frequency and complex causes of adverse events stemming from variables typically overlooked in classical economic theories and approaches to risk modeling. Considered in aggregate, this research reinforces the following points:
- The basic character of global capital markets has changed dramatically. Volatility has increased as has the frequency of anomalous events that defy the predictive power of classical economic theories, including Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis.
- The theoretical underpinnings of modern finance need to expand. By now, it is evident that much of the value destruction over the past decade resulted from operational and financial variables inadequately reflected in prevailing approaches to risk modeling and investing.
- Investment managers and insurers can significantly reduce their exposure to unanticipated and mis-priced risks by incorporating governance, ESG, forensic accounting and other non-traditional risk metrics into stock screening and selection, portfolio risk assessment and, for active managers, day-to-day dialog with portfolio companies.
The ongoing research at GMI Ratings extends and reinforces these conclusions based on our proprietary models and extensive historical data. For example:
- AGR Impact on Performance – Every month, we release the latest results of our rolling 10-year study comparing the equity performance of companies with top-decile and bottom-decile AGR ratings. AGR is GMI Ratings’ proprietary measure of the investment risk reflecting a broad spectrum of accounting irregularities and weaknesses in corporate governance statistically associated with an elevated risk of anomalous events likely to cause significant drops in equity value. This study consistently shows that a portfolio of companies with top-decile AGR ratings would have significantly outperformed the lowest-decile portfolio.
- Litigation Risk Model – Approximately every six months, we report on the performance of our Litigation Risk Model in accurately identifying public companies at risk of class-action lawsuits. We consistently find that a majority of companies facing Federal class action lawsuits were ranked in the lowest 20% of our risk ratings distribution a year before the lawsuit was filed.
- Company-specific Case Studies — Recent history offers many examples of corporate crash-and-burn stories foreshadowed by ESG metrics more clearly than in traditional measures of issuer investment risk. We periodically publish “Rating Foresight” reports with detailed case studies that illustrate the predictive value of ESG ratings.