Exercise Caution: A New S&P Index

At first glance, the announcement was an impressive one. At the swanky Word Economic Forum in the Swiss resort town of Davos last week, the Canada Pension Plan Investment Board joined Standard & Poor’s in announcing the creation of the new S&P Long-Term Value Creation Global Index.

Standard & Poor’s, of course, is the global provider of financial information that maintains a corporate mission of providing “data and research … (that is) independent, transparent and cost effective.” Presumably, S&P achieves its mission by utilizing its own expert professional staff to create clearly defined financial metrics without undue influence from — or overt reliance on — asset management and investment advisory firms.

In fact, that’s exactly what S&P is claiming to do with its new Long-Term Value Creation Global Index, comprised of 246 companies that purportedly “have the potential to create long-term value based on sustainability criteria and financial quality.” S&P continues:

The S&P LTVC Global Index is constructed by combining qualitative and quantitative measures into a single metric to determine the potential for long-term value addition. The Economic Dimension Scores provided by RobecoSAM are included in the qualitative assessment to gauge corporate governance effectiveness.  The quantitative assessment consists of drivers of long-term investment returns – Return on Equity, Balance Sheet Accruals ratio and leverage ratio.

Okay … but what is RobecoSAM? And are those investment metrics expertly and transparently designed to focus on long term value creation? In addition, doesn’t more than one balance sheet accrual ratio actually exist? And more than one leverage ratio as well?

Apparently, RobecoSAM is an asset management company. And one can find those investment metrics in elementary primers of standard accounting financial statements. And yes, there are many accrual and leverage ratios in active use by financial specialists.

In other words, S&P’s new Global Index of Long Term Value Creation simply takes a set of qualitative metrics that is computed by a single asset management company, and combines it with a set of generic and undefined financial metrics. Although S&P’s press release appears to imply that its qualitative assessment function encompasses other activities, it doesn’t specifically describe any additional work.

To be sure, the Canadian Pension Plan Investment Board should be commended for attempting to promote a long term value perspective in the financial industry. And S&P should certainly be encouraged to continue its mission of developing expert metrics that are “independent, transparent, and cost effective.”

Nevertheless, when the qualitative component of an S&P index emphasizes the metrics of a single asset management firm, it doesn’t bode well for the firm’s mission of independence. And when an index provides no detailed description of its investment metrics or its other qualitative assessment activities, it doesn’t bode well for the firm’s mission of transparency.

One could argue, of course, that such effortless approaches to constructing indices may help S&P achieve its mission of cost effectiveness. Nevertheless, given these other concerns, financial investors might wish to exercise a bit of caution while reviewing the S&P Long-Term Value Creation Global Index.