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July 23, 2004
Sell-Side Analysts Confirm the Materiality of Sustainability Issues in UN Report
    by William Baue

A United Nations Environment Programme Finance Initiative report documents belief in the materiality of corporate social responsibility issues by 11 brokerage houses.

While many socially responsible investment (SRI) advocates view social, environmental, and corporate governance issues as material to companies' stock performance, the mainstream investment community has been slow on the uptake. However, the case for the tangible effects of these intangible issues became stronger after last week's release of an important United Nations Environment Programme Finance Initiative (UNEPFI) report.

The UNEPFI Asset Management Working Group (AMWG), a group of 12 asset management firms spanning five continents, compiled the report. The working group asked more than 50 brokerage houses globally to prepare a report (for free) on extra-financial issues in one of seven sectors (later extended to eight). Specific issues covered include climate change, occupational and public health, corporate governance and trust, and human, labor, and political rights.

"The strength of this report is that it shows clearly that mainstream sell-side analysts are beginning to see social and environmental aspects of company performance as material to their financial value," said Barbara Krumsiek, CEO of the Calvert Group, an AMWG member. Other working group members include Citigroup Asset Management, UK-based Morley Fund Management, Norway-based Storebrand Investments, South Africa-based Old Mutual Asset Managers, and Japan-based Nikko Asset Management.

While buy-side analysts' research is typically proprietary and affects internal decision-making, sell-side analysts' research is typically more publicly available and hence exerts a greater influence on investment markets. To date, buy-side analysts have been much more likely to be aware of sustainability issues compared to sell-side analysts, a dynamic that increases the significance of the report.

"Analysts, particularly on the sell side, have been so short-term focused that long-run considerations of any magnitude are usually neglected," Ms. Krumsiek told "But eventually, the long-run factors impact the immediate results, and companies that are well prepared will hold their value much better than the companies whose efforts were dedicated to making the quarterly earnings estimates."

"However, this study also illuminates the fact that methods to quantitatively value many social and environmental criteria are lacking," Ms. Krumsiek added. "As well, the study covers a range of industries--from pharmaceuticals to energy--suggesting that these criteria have relevance in all industries."

On the other side of the coin, the report also has its limitations.

"The weakness is the relatively low participation in this report by US-based research analysts," said Ms. Krumsiek.

In fact, no North American brokerage houses participated.

"Those that responded to the AMWG declined on the basis of a perceived difficulty in analysis due to barriers associated with inadequate disclosure of these criteria . . . , internal restructuring, or a lack of research capacity," the AMWG states in the report.

The report stresses the importance of government regulation in driving the consideration of intangible issues in investment decisions. Given the reluctance of the US government regulate corporate social and environmental issues (for example by refusing to ratify the Kyoto protocol or enforce disclosure of material environmental liabilities), the lack of US brokerage house participation is not surprising.

"We strongly believe in a full and consistent disclosure of corporate social responsibility data by companies so that they can be included in fundamental company analysis, where we believe they belong," said Anthony Ling, a managing director at Goldman Sachs, a brokerage house whose sector report received praise. "We see such issues as being an integral part of successful management in the modern world and that they should be taken into account in financial analysis and therefore investment considerations."

All 11 of the brokerage house reports find that social, environmental, and corporate governance issues are relevant to long-term shareowner value. Other brokerage houses that prepared reports include ABN AMRO Equities, Deutsche Bank, HSBC, NikkoCitigroup Japan, and WestLB.

"A critical next step will be the uptake and implementation of the wide-ranging recommendations in the study by investors, analysts, and public sector policy-makers," said Klaus Toepfer, executive director of UNEP.

Report recommendations include urging companies to include social, environmental, and corporate responsibility reporting in their annual reports and financial statements. It also urges governments and regulatory bodies to require disclosure of such information and to update definitions of fiduciary duty to cover such issues.

Going forward, the most significant aspect of the AMWG's work is the establishment of a Responsible Investment Initiative tasked with developing a set of globally recognized principles for responsible investment. The prominence of the UN will carry weight in legitimizing and mainstreaming these principles.

"We do not necessarily expect instant results, but even measured progress in incorporating social, environmental and governance criteria in financial analyst reports can provide incentives to corporations to perform as responsible citizens," concluded Ms. Krumsiek.


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