Social premium on the rise: Federated Hermes

Listed companies with good or improving performance on social factors can outperform companies with poor performance by up to 17 basis points, according to research from Federated Hermes.

Federated Hermes' data methodology has shown that outperformance on social factors such as employee health and safety has actually increased during the COVID-19 pandemic and is up from 15 basis points per month in 2018, when Federated Hermes last examined its research.

What we're saying hers that companies that rank in the bottom 10% have underperformed the top 10% company in the benchmark by 17 basis points on average per month, purely on social grounds," said Lewis Grant, senior global equities portfolio manager at Federated Hermes.

According to Federated Hermes, research into companies' performance and their investment return has found that the financial qualities that mattered during the coronavirus-induced market crash in March of 2020 were strong balance sheets and operational efficiency. Social factors also proved important to companies.

The findings are sector and region neutral, and are based off of Federated Hermes' proprietary research methodology for ESG ranking, which has been in operation since 2014, Grant noted.

"What we find is that governance is actually being rewarded and that the companies that get it wrong tend to underperform," he said. "That phenomenon has grown since 2014, and this again is based on data from a lot of different sources, so this isn't backward looking and thus only possible to pick out with hindsight," Grant said.

Federated Hermes says social metrics have become increasingly important for hyper-growth names and companies with more social awareness than their peers have tended to outperform. The exception to this trend was in March 2020 during the extreme stock market volatility that accompanied the early frenzied days of the pandemic. In that case, the key consideration was companies' access to cash, while characteristics such as good governance were considered 'nice-to-have'.

Federated Hermes' diversified global equities team uses social metrics as one factor that feeds into the stock selection process. In addition to using third-part data on ESG information, Federated Hermes also has an internal research team to augment those sources.

"Third party data can be fantastic in terms of broad coverage, but we find that they may only update companies once or twice a year," Grant said. "If you're trying to measure change, it could be 11 months out of date, and if you're looking at change, the previous data could be 12 months older than that."

Keeping track of data such as fatality rates, long term injury rates and other metrics are not an exact view of corporate culture, but measuring those data points over time does feed into a view on corporate culture, he noted.

"Does a company have an appropriate health and safety process, do they have a human rights policy," Grant said. "Third party providers will track that, but does it look like it's just ticking the boxes? To assess that, you look at the reality - what is that fatality rate? Then you compare to peers. Then you look at if the company has social controversies and you assess it against how the company has changed over time to see if it's improving."

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