(London): Investors are not getting the information they need to make sound, long-term decisions because sell-side research fails to consider material non-financial drivers of company performance like environmental, social and governance (ESG) factors, according to a survey of 342 sell-side analysts by Aviva Investors.
Research has a significant impact on investor and company behaviour, but much of the current analysis is overly positive, sometimes biased, and preoccupied with short-term financial metrics. This contributes to a misallocation of capital and potentially rewards poor corporate practices.
Forty two per cent of analysts said that sell-side research has a detrimental short-term focus. Only 35 per cent think that sell-side research tackles controversial topics and offers negative assessments of companies when appropriate. Significantly, ninety percent said they would take “some additional caution” when writing on topics that were commercially sensitive to their own bank.
This means that many sell-side analysts do not apply enough scrutiny to businesses, management projections and risks. As a result, price targets and ratings often present an overly positive view of a company's long-term prospects, which impairs the efficient functioning of the capital markets.
Steve Waygood, Chief Responsible Investment Officer at Aviva Investors, said:
“We commissioned the study to contribute to the debate about how to embed ESG and other long-term themes into sell-side research.
It is particularly interesting that sell-side analysts privately acknowledge many of the failings we anticipated ahead of the poll. While sustainability pays, the short- term nature of sell-side research undermines positive long-term policies and practices at companies that are assessed. More needs to be done to correct these failings, but they can be fixed if all participants in the investment chain work together.
National regulators such as the UK’s Financial Conduct Authority could stipulate that research reports include an outlook of more than year and a specific section on ESG, which requires analysts to demonstrate how material ESG considerations are integrated into their overall conclusions and ratings.
Asset managers could make a huge difference if they directed research payments to brokers focused on long-term analysis that integrates sustainability matters. Asset owners, meanwhile, could seek transparency from their managers about the type of research they are buying.
The Chartered Financial Analyst Institute has recently done some good work in this area. There is scope for it to help further by encouraging its sell-side analyst members to look into these issues in greater depth.
Finally, companies must articulate their integrated long-term strategy for value creation, including the risks and opportunities presented by broader, non-financial issues. Boards should be open to alternative points of view as well, including negative perspectives by analysts.”
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