Roland van den Brink: Impact investing, innovative exploitation of social risks

January 29, 2025

_{This article was originally written in Dutch. This is an English translation.}

Investor attention to social issues is increasing. A pioneering investment strategy that analyses the social risk of listed companies, thereby providing a responsible source of return, is the use of the S-Factor^TM score.

By Roland van den Brink, Founder TrigNum

Social responsibility is seen as a key driver of financial performance. Companies that proactively manage social risks perform better over time.¹ Recently, powerful applications have become available for relatively little money that can help assess documents, news releases, social media statements and quantitative data. This information can be used to make targeted investments in companies that succeed both socially and financially.

The most influential application is the so-called S-Factor Score, started in 2009. It exposes not only the social risks of a company, but of the entire supply chain around it. This includes issues such as working conditions, ethical business practices, human rights violations and the impact on local communities. The predictive insights help identify opportunities and risks before they become visible in financial figures and affect share prices. The AI-based methodology scans over 40,000 global stocks. Over the past 10 years, it has achieved almost 9% higher annual returns than the very broad MSCI All Country World Index on this basis.

The operation

In 2021, the then French listed Orpea SA operated over 1,100 nursing homes, assisted living facilities, post acute and rehabilitation hospitals and psychiatric hospitals. The company operated in more than 20 countries, including the Netherlands. On 26 January 2022, the bomb burst as journalist Victor Castanet revealed through thorough investigation that the company was abusing residents and employees.² The share price had already been falling slowly for a year and this publication dealt the final blow. In the end, only 2% of the €7 billion stock market value remained.

A year before, several reports had appeared on Facebook and Twitter about abuses at Orpea institutions, such as mediocre food and neglect of patients due to understaffing. This despite the relatively high nursing fee. By computerised analysis of these posts, the company's S-Factor score dropped from 55 to 20 (out of 100) in one month six months earlier. This major change was a strong indication to stop investing in this company.

Another example is the change in the daily S-Factor score of Alphabet, better known as Google. Figure 1 shows that there is usually little high-profile news and therefore little change in the monthly score. The right side of the chart shows that a positive change in the score one month later led to a better return than the S&P500 stock index. The outlier on the left suggests further investigation into material events, such as lawsuits or labour disputes. Using the S-Factor method, this stock achieved +1.8% extra performance in a year.

The S-Factor indices

The key question is always: does it work? Well, the approach described was used to find the 100 best US companies in six areas: Health & Safety, Human Rights, Ethics, Labour Rights, Diversity & Inclusion and Supply Chain. With this, public indices were compiled in each area.³ Compared to the whole market, it turns out that for each S-Factor index, risk (measured in volatility) is lower and returns are higher. This can be seen in Figure 2 using the high Sharpe ratio.

Too good to be true?

There are two reasons why it works. There are many studies that show that traditional balance sheets only provide information on a part of the stock market value, often only a third.⁴ Intangible assets are more important today and it is precisely this value that has a relationship with the best ESG practices. The behaviour of portfolio managers also plays a role. Alex Edmans, Tom Gosling and Dirk Jenter recently asked over 500 managers about how they deal with ESG factors.⁵ What emerged? The anticipated financial return was clearly more important than issues such as working conditions, ethical business practices, human rights violations and impact on local communities. As long as that is the case, it is not surprising that alternative selection is successful.

The application

There are two ways to convert observations into an investment portfolio. The first approach is to invest only in socially capable companies (the ‘long only’ approach). Portfolios based on this selection proved robust even in turbulent times like the Covid period. However, the disadvantage of the long-only approach may be that the portfolio obtained inherently carries other risks, such as a high concentration towards a specific sector. In Anglo-Saxon countries, we therefore see that a market-neutral application in the form of a hedge fund is often chosen. Combined with going short in certain stocks and using derivatives such as index futures, a portfolio is created that has little correlation with the stock market.

A notable side effect

In certain states of America, public institutions, such as pension funds, cannot communicate approaches such as ‘ESG-conscious’ and ‘impact investing’. As for many issues, there is a way out. One can invest in funds that use S-Factor without going into the background. Because of the high returns, or rather the positive alpha, there are no objections. In short, several US institutions and family offices are in practice investing more impactfully than many statistics portray us.

Investment plan 2025

About €50,000 billion is currently invested in ESG strategies. However, there is growing doubt about their impact because the data used often amount to rough estimates. The ‘S’ in ESG, if any, is based on anecdotal data. In short, institutional investors, especially pension funds, face the risk of ‘the emperor with no clothes’. The innovative S-Factor approach analyses millions of sources, combining social responsibility with financial opportunities. Companies that value transparency, fair working conditions and ethical sourcing practices benefit from this approach. This aligns with broader European standards and values around social justice, sustainability and long-term value creation. Through advanced technology and a targeted focus on social risk, this strategy allows investors to achieve both social and financial returns. Because the global equity market is large, it fits any institutional portfolio. A starting point could be the 2025 investment plan.

1 MSCI ESG research ‘Social Risks and Opportunities for Corporates: Long-Term Performance in Global Equity Markets’, augustus 2024.
2 https://www.epsu.org/article/new-epsu-report-chronicles-downfall-profit-care-giant-orpea
3 S-Factor-indices: https://indexone.io/indices en selecteer bij Issuer ’S-Factor’. Zie ook https://thesfactor.co/analytics.
4 Prof. Baruch Lev, Universiteit van New York.
5 Research paper ‘Sustainable Investing: Evidence From the Field, September 2024