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