4.2 Activity Classification
The first PECCS™ pillar captures the industrial activity of private companies, organised into classes and subclasses. Private companies operating in the same industrial activity face similar investment opportunities, mixes of tangible and intangible assets, exposure to systematic factors, regulatory environments, competitive forces, and employ related technologies in production. These overlaps make this a key pillar in the risk factors that affect a private company.
Prior academic work strongly supports the existence of a strong industry effect in valuations and consequently returns. For example, hot IPO (initial public offerings) and SEO (seasoned equity offerings) markets are characterised by large and numerous issuances, high valuation, and lower subsequent returns and are usually concentrated in industries (e.g., Helwege and Liang, 2004). Waves of mergers and acquisitions (M&A) propagate through industry links (Ahern and Harford, 2014). In addition, investment opportunities and financing policies are closely correlated among industry firms, resulting in industry momentum in returns (e.g., Moskowitz and Grinblatt, 1999). Consequently, dividing private companies by activity helps to capture the key systematic risk factors of private investments.
NACE Taxonomy
Any new proposed activity scheme needs to be comprehensive and reflect all of the kinds of businesses performed by private companies. Moreover, it should be simple and easy to adopt for market partcipants who are already exposed to numerous classification schemes. To satisfy these requirements of ease of use, familiarity, and interoperability, we evaluated the common schemes already available to investors, such as the SIC, NAICS, or NACE codes, and selected NACE to form the basis of the activity pillar.
NACE (or Nomenclature of Economic Activities) is the taxonomy of economic activities proposed by Eurostat, the statistical office of the European Communities. NACE has characteristics that are especially beneficial when applied to classifying a global universe of private companies in a multipillar framework:
Objective: NACE classification is not dependent on the type of ownership, legal, or organisational structures, the technology in production, or commercial viability of the activity. But rather NACE focuses on the economic activity, which takes place when resources such as capital goods, labour, manufacturing techniques or intermediary products are combined to produce specific goods or services.
Scope: NACE is compatible and builds on top of the United Nation’s International Standard Industrial Classification of All Economic Activities (or ISIC), thus making the scheme more relevant at classifying a global sample of companies.
Updates: NACE is more frequently updated when compared to other schemes such as SIC or NAICS codes. The latest version of NACE, the NACE Rev 2.1 is distributed in February 2023 (Eurostat. 2023), making it the most recent publicly available activity classification scheme. Also, the revisions are undertaken with significant feedback and participation from industry, ensuring that all evolving changes are reflected in the classification in a timely manner.
Granularity: NACE is extremely granular, which can be exploited to identify very similar companies. NACE is currently structured as four nested levels consisting of 22 sections at level 1, 87 divisions in level 2, 277 groups in level 3, and 651 classes in level 4. Each category in the framework is mutually exclusive (i.e., one activity can belong to only one category without overlaps) and exhaustive (i.e., all activities can be classified) and characterises the majority of the products and services produced by a company.
Thus, NACE provides the most representative, up-to-date, and relevant classification when considering a global opportunity set of private companies.
Approach
The first two levels of activities as classified by NACE Rev 2.1 which includes 22 sections at level 1 and 87 divisions in level 2, are adopted to constitute the activity pillar of PECCS™. A dual class system offers flexibility when applied to private companies as it allows both coarse and granular groupings.
NACE, however, does not take into consideration the extent of how populated (or not) each group could be. Such a consideration is important for a taxonomy for investors, as each subsegment should be investable and present enough choices for investors. With those principles in mind, a few of the level 1 sections are grouped into fewer classes based on economic similarity (e.g., return correlation, performance correlation) and business similarity (e.g., whether the business descriptions of companies in the two groups are similar). Below, the consolidated groups with the name of PECCS™ activity in the left and the corresponding NACE sections in the right, are described.
Natural resources: Includes 1) Agriculture, forestry and fishing, and 2) Mining and quarrying
Utilities: Includes 1) Electricity, gas, steam and air conditioning supply, and 2) Water supply, sewerage, waste management and remediation activities
Real estate and construction: Includes 1) Construction and 2) Real estate
Hospitality and entertainment: Includes 1) Accommodation and food service activities, 2) Publishing and broadcasting, and 3) Arts, entertainment, and recreation
Professional and admin services: Includes Professional, scientific, and technical, 2) Admin and support services, and 3) Other services
Education and public: Includes 1) Public admin, defence, and social security and 2) Education
Other than these groupings at level 1 NACE Rev 2.1 sections, households and extraterrestrial activities are excluded from PECCS™ activity pillars as these activities are less investable in private markets.
Furthermore, as NACE Rev 2.1 is a flexible and principle based framework, the derived activity pillar of PECCS™, is also seamlessly mappable to other industry schemes, allowing users to integrate PECCS™ into their current workflows.
For example, the classification of infrastructure companies, which forms a growing and increasingly important part of private companies, can be performed on the basis of TICCS®, which is mappable to NACE, and hence with PECCS™. The TICCS® is the predominant industry classification standard for infrastructure companies, developed by EDHEC Infra and Private Assets, and adopted by a majority of infrastructure asset owners and fund managers (learn more about TICCS®).
PECCS™ Industrial Classification
Under PECCS™, each private company is assigned to its class and subclass based on the closest match of its key business activity with the definitions of these classes and subclasses. In total, PECCS™ divides key business activities into:
12 activity classes
67 activity subclasses
The table below shows the detailed definitions of each class in PECCS™, their original names in NACE Rev 2.1, and their definitions.
Table: Activity definitions | |||
---|---|---|---|
Code | Activity Class | NACE Rev 2.1 Section | Definition |
AC01 | Education and public | 1. Education | Companies that are involved in activities relating to education, public administration, defense, and compulsory social security. |
AC02 | Financials | Financial And Insurance Activities | Companies that are involved in financial service activities, insurance and reinsurance activities, and similar auxiliary activities. |
AC03 | Health | Human Health And Social Work Activities | Companies that are involved in healthcare-related activities, residential care activities, and social work activities without provision of accommodation. |
AC04 | Hospitality and entertainment | 1. Accommodation And Food Service | Companies that are involved in accommodation and food service activities, publishing, broadcasting, content production and distribution, and those in arts, sports, and recreation activities. |
AC05 | Information and communication | Telecommunication, Computer Programming, Consulting, Computing Infrastructure And Other Information Service Activities | Companies that are involved in telecommunication, computer programming, consulting, computing infrastructure, and other information service activities. |
AC06 | Manufacturing | Manufacturing | Companies that are involved in manufacturing activities, including repaid and maintenance activities. |
AC07 | Natural resources | 1. Agriculture, Forestry And Fishing | Companies that are involved in agriculture, forestry, fishing, mining, and quarrying-related activities. |
AC08 | Professional and other services | 1. Professional, Scientific And Technical Activities | Companies that are involved in professional, scientific, and technical activities, those involved in administrative and support services, and other services offered to consumers. |
AC09 | Real estate and construction | 1. Construction | Companies that are involved in real estate activities and in construction activities. |
AC10 | Retail | Wholesale And Retail Trade | Companies that are involved in wholesale and retail trade. |
AC11 | Transportation | Transportation And Storage | Companies that are involved in transportation and storage-related activities, including all modes of transportation and warehousing. |
AC12 | Utilities | 1. Electricity, Gas, Steam And Air Conditioning Supply | Companies that are involved in electricity generation and supply, supply of steam, air conditioning, and water, and those that provide sewerage, waste management, and remediation services. |
The following table lists the PECCS™ subclasses which assume the same name as the level 2 in NACE Rev 2.1, to avoid confusion.
Table: Activity Subclasses | |||
Subclass Code | AC Class | NACE Rev 2.1 Section | AC Subclass (NACE Rev 2.1 Division) |
AC01001 | Education and public | 1. Education | Education |
AC01002 | Education and public | 1. Education | Public administration and defence; compulsory social security |
AC02001 | Financials | Financial And Insurance Activities | Activities auxiliary to financial services and insurance activities |
AC02002 | Financials | Financial And Insurance Activities | Financial service activities, except insurance and pension funding |
AC02003 | Financials | Financial And Insurance Activities | Insurance, reinsurance and pension funding, except compulsory social security |
AC03001 | Health | Human Health And Social Work Activities | Human health activities |
AC03002 | Health | Human Health And Social Work Activities | Residential care activities |
AC04001 | Hospitality and entertainment | 1. Accommodation And Food Service | Accommodation |
AC04002 | Hospitality and entertainment | 1. Accommodation And Food Service | Food and beverage service activities |
AC04003 | Hospitality and entertainment | 1. Accommodation And Food Service | Gambling and betting activities |
AC04004 | Hospitality and entertainment | 1. Accommodation And Food Service | Motion picture, video and television programme production, sound recording and music publishing activities |
AC04005 | Hospitality and entertainment | 1. Accommodation And Food Service | Programming, broadcasting, news agency and other content distribution activities |
AC04006 | Hospitality and entertainment | 1. Accommodation And Food Service | Publishing activities |
AC04007 | Hospitality and entertainment | 1. Accommodation And Food Service | Sports activities and amusement and recreation activities |
AC05001 | Information and communication | Telecommunication, Computer Programming, Consulting, Computing Infrastructure And Other Information Service Activities | Computer programming, consultancy and related activities |
AC05002 | Information and communication | Telecommunication, Computer Programming, Consulting, Computing Infrastructure And Other Information Service Activities | Computing infrastructure, data processing, hosting and other information service activities |
AC05003 | Information and communication | Telecommunication, Computer Programming, Consulting, Computing Infrastructure And Other Information Service Activities | Telecommunication |
AC06001 | Manufacturing | Manufacturing | Manufacture of basic pharmaceutical products and pharmaceutical preparations |
AC06002 | Manufacturing | Manufacturing | Manufacture of beverages |
AC06003 | Manufacturing | Manufacturing | Manufacture of chemicals and chemical products |
AC06004 | Manufacturing | Manufacturing | Manufacture of coke and refined petroleum products |
AC06005 | Manufacturing | Manufacturing | Manufacture of computer, electronic and optical products |
AC06006 | Manufacturing | Manufacturing | Manufacture of electrical equipment |
AC06007 | Manufacturing | Manufacturing | Manufacture of fabricated metal products, except machinery and equipment |
AC06008 | Manufacturing | Manufacturing | Manufacture of food products |
AC06009 | Manufacturing | Manufacturing | Manufacture of furniture |
AC06010 | Manufacturing | Manufacturing | Manufacture of leather and related products of other materials |
AC06011 | Manufacturing | Manufacturing | Manufacture of machinery and equipment n.e.c. |
AC06012 | Manufacturing | Manufacturing | Manufacture of motor vehicles, trailers and semi-trailers |
AC06013 | Manufacturing | Manufacturing | Manufacture of other non-metallic mineral products |
AC06014 | Manufacturing | Manufacturing | Manufacture of paper and paper products |
AC06015 | Manufacturing | Manufacturing | Manufacture of rubber and plastic products |
AC06016 | Manufacturing | Manufacturing | Manufacture of textiles |
AC06017 | Manufacturing | Manufacturing | Manufacture of wearing apparel |
AC06018 | Manufacturing | Manufacturing | Manufacture of wood and of products of wood and cork, except furniture; manufacture of articles of straw and plaiting materials |
AC06019 | Manufacturing | Manufacturing | Other manufacturing |
AC06020 | Manufacturing | Manufacturing | Repair, maintenance and installation of machinery and equipment |
AC07001 | Natural resources | 1. Agriculture, Forestry And Fishing | Crop and animal production, hunting and related service activities |
AC07002 | Natural resources | 1. Agriculture, Forestry And Fishing | Extraction of crude petroleum and natural gas |
AC07003 | Natural resources | 1. Agriculture, Forestry And Fishing | Fishing and aquaculture |
AC07004 | Natural resources | 1. Agriculture, Forestry And Fishing | Forestry and logging |
AC07005 | Natural resources | 1. Agriculture, Forestry And Fishing | Mining of coal and lignite |
AC07006 | Natural resources | 1. Agriculture, Forestry And Fishing | Mining of metal ores |
AC07007 | Natural resources | 1. Agriculture, Forestry And Fishing | Mining support service activities |
AC07008 | Natural resources | 1. Agriculture, Forestry And Fishing | Other mining and quarrying |
AC08001 | Professional and other services | 1. Professional, Scientific And Technical Activities | Activities of head offices and management consultancy |
AC08002 | Professional and other services | 1. Professional, Scientific And Technical Activities | Activities of membership organisations |
AC08003 | Professional and other services | 1. Professional, Scientific And Technical Activities | Employment activities |
AC08004 | Professional and other services | 1. Professional, Scientific And Technical Activities | Investigation and security activities |
AC08005 | Professional and other services | 1. Professional, Scientific And Technical Activities | Legal and accounting activities |
AC08006 | Professional and other services | 1. Professional, Scientific And Technical Activities | Office administrative, office support and other business support activities |
AC08007 | Professional and other services | 1. Professional, Scientific And Technical Activities | Other professional, scientific and technical activities |
AC08008 | Professional and other services | 1. Professional, Scientific And Technical Activities | Personal service activities |
AC08009 | Professional and other services | 1. Professional, Scientific And Technical Activities | Rental and leasing activities |
AC08010 | Professional and other services | 1. Professional, Scientific And Technical Activities | Repair and maintenance of computers, personal and household goods, and motor vehicles and motorcycles |
AC09001 | Real estate and construction | 1. Construction | Construction of residential and non-residential buildings |
AC09002 | Real estate and construction | 1. Construction | Real estate activities |
AC10001 | Retail | Wholesale And Retail Trade | Retail trade |
AC10002 | Retail | Wholesale And Retail Trade | Wholesale trade |
AC11001 | Transportation | Transportation And Storage | Air transport |
AC11002 | Transportation | Transportation And Storage | Land transport and transport via pipelines |
AC11003 | Transportation | Transportation And Storage | Postal and courier activities |
AC11004 | Transportation | Transportation And Storage | Warehousing, storage and support activities for transportation |
AC11005 | Transportation | Transportation And Storage | Water transport |
AC12001 | Utilities | 1. Electricity, Gas, Steam And Air Conditioning Supply | Electricity, gas, steam and air conditioning supply |
AC12002 | Utilities | 1. Electricity, Gas, Steam And Air Conditioning Supply | Waste collection, recovery and disposal activities |
AC12003 | Utilities | 1. Electricity, Gas, Steam And Air Conditioning Supply | Water collection, treatment and supply |
Helwege, J., & Liang, N. (2004). Initial public offerings in hot and cold markets. The Journal of Financial and Quantitative Analysis, 39(3), 541-569. Cambridge University Press. https://www.jstor.org/stable/30031871
Ahern, K. R., & Harford, J. (2014). The importance of industry links in merger waves. The Journal of Finance, 69(2), 527-576. https://doi.org/10.1111/jofi.12122
Moskowitz, T. J., & Grinblatt, M. (1999). Do industries explain momentum? The Journal of Finance, 54(4), 1249-1290. Wiley. https://www.jstor.org/stable/798005
Eurostat. (2023). NACE Rev. 2.1 classification is now official. Eurostat News. https://ec.europa.eu/eurostat/web/products-eurostat-news/w/wdn-20230210-1