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November 23, 2004
Enhanced Analytics Initiative Offers Sell-Side Analysts Cash to Cover Intangibles
    by William Baue

A group of European institutional investors launched EAI to encourage mainstream investment analysts to include issues such as corporate governance and climate change in their research.

While many in the sustainable and responsible investment camp understand that extra-financial and intangible issues impact long-term corporate performance, mainstream investment analysts tend to focus on short-term issues such as quarterly earnings. So how do sustainability investors convince sell-side analysts to include intangibles such as corporate governance, climate risk mitigation, and human rights protections, in their research and recommendations? The simple answer is: offer cash on the barrelhead.

A group of European institutional investors have done just this by launching the Enhanced Analytics Initiative (EAI), to entice sell-side analysts to cover intangibles by allocating five percent of their broker commissions for such research.

"The founding members recognized that there was a chicken and egg situation: sell-side analysts currently do not routinely provide analysis of extra-financial issues in their reports and their clients, the fund managers, do not ask for it," said David Russell, responsible investment for UK-based EAI founding member Universities Superannuation Scheme (USS). "The fund managers do not ask for it [because] they are often unaware of the implications that these issues could have on the companies in which they invest."

"By providing the financial and business case for the sell side to incorporate these issues, the EAI will break this negative cycle," Mr. Russell told

Other founding members include France-based BNP Paribas Asset Management and AGF Asset Management, Germany-based Deutscher Investment Trust (dit) and dresdnerbank investment management (dbi), Netherlands-based PGGM, and UK-based RCM and Generation Investment Management. Altogether, the founding members manage some €364 billion in assets, and estimate that five percent of their brokerage commissions will amount to approximately €4.5 million.

Why five percent--why not three or seven percent?

After consulting with several brokers and discussing the issue amongst themselves, the founding members determined that allocating five percent of broker commissions sends a meaningful signal and provides a real short-term business reason for adapting to a new client demand. Furthermore, a five percent commitment provides enough compensation to justify an allocation of sufficient human resources and management time on a permanent basis.

Why sell-side analysts?

"The sell side is a key information conduit between fund managers and companies," Mr. Russell explained "Fund managers often rely heavily on their research into past corporate performance and predictions for likely future performance, prior to investment decisions being taken."

"EAI members concluded that, as investors who want to see more extra-financial and intangibles analysis in the reports we receive, the most appropriate way to achieve this was to use the money we are already spending on broking and research to incentivize the sell side to provide what we want," he continued.

The criteria by which EAI will determine outstanding extra-financial and intangibles research include comprehensiveness, comparability between companies, integration of extra-financial into financial analysis, coverage of a broad universe, and responsiveness of service.

Some sell-side analysts exhibited strong foundations of understanding of these extra-financial and intangible issues in a set of research reports sponsored by the United Nations Environment Programme Finance Initiative (UNEPFI) Asset Management Working Group (AMWG). The report written by Anthony Ling of Goldman Sachs received particular praise.

Brokerage houses that attended a November 2, 2004 meeting which EAI convened to explain its project included ABN AMRO, Bank of America, Bear Stearns, Citigroup Smith Barney, Deutsche Bank, JP Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, UBS, and WestLB.

EAI members have commissioned Ivo Knopfel of onValues to conduct an independent review of the extra-financial and intangibles research brokers have produced in the last 18 months, and will assess how the project is proceeding every six months. Fiduciary duty requires the trustees to justify the appropriate use of commissions, which are after all client assets.

"This is a great opportunity for those fund managers who recognize the implications of extra financial and intangible issues to use existing market tools and client power to ensure that they are taken into account in mainstream investment decision-making," said Mr. Russell. "Current EAI members would welcome new members from all markets to drive this process forward, increasing capacity on these issues across the investment sector, and hence encouraging better corporate management of extra-financial issues."

"US investors would particularly be welcomed as the US market is so important in a global context," he concluded.


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