Extra-financial coverage broadens
Extra-financial issues (EFIs), especially environmental issues, are receiving broader and more sophisticated research coverage, according to the seventh semi-annual Enhanced Analytics Initiative (EAI) evaluation.
EAI chairman Peter Scales (pictured above) puts this down to increasing external pressure and the recognition by a growing number of financial institutions of a link between EFIs and investment performance. “There is demand for the research in order to make good investment decisions and there is regulatory and governance pressure on the funds to be more active and demanding,” says Scales.
Malcolm Gray, portfolio manager for socially responsible investments at Investec Asset Management, says: “The significant shift in capital ownership over recent decades has also highlighted a need for better analysis. It is now in the hands of trustees who have realised that in order to fulfil their fiduciary responsibilities on behalf of their members, a more thorough consideration of extra-financial factors is required given the impact these factors potentially have on the long-term sustainability of their funds.”
Research into corporate governance is also improving, according to the results of the evaluation, which was called ‘Beyond the Low-Hanging Fruit’.
The EAI reports a greater willingness to cover long-term horizons and deal with related uncertainties, which it hopes will be assessed more systematically in the future by means of sensitivity, scenario or other types of analyses.
However, despite improvements, a better integration of EFI research into standard company financial analysis, as laid out in the EIA’s evaluation criteria last year, remains a challenge.
Although the initiative has witnessed analysts venturing increasingly into new sectors, such as the physical impacts of climate change, under-researched areas still exist.
“We have seen a distinct improvement in both the quality of research and the quantity and breadth, with it moving out of its comfort zone of European utility or climate change space into new areas,” says Gordon Hagart, senior consultant at Swiss-based evaluation consultancy onValues. “We see some corporate governance research in emerging markets and analysis of the insurance industry, which is very positive.”
“However, coverage of social factors - such as human capital management, labour and stakeholder-related issues - as well as coverage of the banking sector remains underdeveloped,” Hagart notes.
“Mergers and acquisitions is another growth area for research, as current coverage only amounts up to 1-2%,” adds Scales.
Gray notes that emerging markets coverage is still Asian-based, with only limited exposure to Russia and eastern Europe, while Africa, South America and the Middle East remain poorly covered.
“It is a case of slowly following the money as the big funds have started to allocate to these frontier markets,” says Gray. “And the challenge now lies with the sell-side community to start covering these areas as well.”
Scales believes client demand is driving this type of research. “Some providers wish they had researched some areas, such as lending, better. They may be able to generally predict volatility but to foresee something like last year’s sub-prime crisis is very difficult. The focus was on the money markets rather than the investment process.”
“As a short-term phenomenon, volatility often drops out of the process,” Gray notes. “From a fund manager’s perspective there is a degree of short- to medium-term cyclicality and the interest in emerging markets and climate change may to some extent increase or decrease relative to market volatility in each cycle. A bear market could potentially affect resource allocation within the sell side too. But as the cycle unfolds greater resources will be allocated to areas that a lot of the clients are focusing on.”
He adds: “Some of the research we are looking for requires innovation. In order to affect the discount rate or obtain a risk premium, we need to convert and challenge a lot of the sell side.”
The member initiative, which now collectively owns or manages €2.1trn of assets, evaluated CA Cheuvreux, Citigroup, Credit Suisse, Deutsche Bank, JPMorgan, Oddo Securities and UBS as best research providers of extra-financial issues between May and October 2007 from a total of 26 research providers and 158 reports, thereby making them eligible for EAI member commission.