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August 17, 2005
Generation Gap: Young Sell-Side Analysts Fail to Fill Void in Sustainability Research
    by William Baue

A survey expecting to find the upcoming generation of securities analysts eagerly assessing environmental, social, and governance issues in their recommendations discovers the exact opposite.


Traditional wisdom holds that if you want to effect transformation, plant seeds of change in the upcoming generation. In the case of seeding social and environmental sustainability through investment, securities analysts represent vital soil to plant, because their research and recommendations influence so many investment decisions. To what degree is the young generation of analysts assessing environmental, social, and governance (ESG) issues in their recommendations?

The World Business Council for Sustainable Development (WBCSD) and the United Nations Environment Programme Finance Initiative (UNEPFI), which both advocate sustainable and responsible investment (SRI), recently surveyed 18 analysts under the age of 35 to see if sustainability is taking root. The surveyors hypothesized that the young analysts they interviewed, most of whom work on the sell-side of mainstream brokerages in Europe, Hong Kong, and the US, might be more amenable to integrating ESG considerations into their research than their older colleagues. Their findings, however, let the air out of this balloon.

"Our work suggests that this anticipated 'generational change' is not happening," state members of the WBCSD's Young Managers Team (YMT), a group of 25- to 32-year-old corporate managers, who authored a report on the survey findings entitled Generation Lost. "Young analysts appear unconvinced over the materiality of most environmental, social, and governance issues to business; unable to consider them because of inadequate information, training, or tools; and unwilling to depart from business as usual because of conflicts with remuneration, career advancement, or culture."

Quotes from those surveyed, which are reprinted in the report, help illuminate the current opinions of these young analysts toward sustainability.

"Environmental, social, and governance issues influence the overall picture, but nothing more," states a sell-side equity analyst for a French research institution. "The core of the analysis is based on medium-term financial data."

"Sustainability is a long-term issue, whereas valuation models tend only to be built [bottom-up] for five-year forecasts with simple extrapolations thereafter," adds a junior portfolio manager of a Dutch pension fund. An equity analyst for a US research institution states: "These issues don't crop up in quarterly conference calls."

This last comment digs to the core of the matter: ESG issues do not crop up in conference calls in large part because analysts do not ask questions about ESG performance. When analysts start asking ESG-related questions, companies will start answering them.

However, the survey finds that most young analysts have a limited grasp of sustainability issues. To address this limitation, the report recommends re-categorization.

"Sustainability advocates could group environmental, social, and governance issues as intangibles along with reputation, strategic vision, brand equity, and other subjectively-valued, but undeniably material, intangibles," state the report authors. "The term non-financial is best avoided, as are moral arguments."

This solution makes sense for those advocating the business case for sustainable and responsible investment. However, the recommendation to avoid moral arguments may strike those advocating SRI for ethical reasons as disingenuous or opportunistic.

Other recommendations may meet more widespread support from sustainability advocates as well as success in convincing analysts to research ESG issues. For example, analysts often cite lack of client interest in receiving research on ESG issues in buy, sell, and hold recommendations. To address this, the report recommends promoting the Enhanced Analytics Initiative (EAI), a project whereby institutional investors incentivize ESG research by allocating a percentage (five percent in 2005) of their brokerage fees to the brokerage houses producing the best such research.

The report also recommends gearing incentives directly to analysts.

"Financial institution executives could consider communicating internally their commitment to incorporate environmental, social, and governance issues, and clearly linking analysts' career progress and remuneration to analysis of environmental, social, and governance issues," states the report. "It will be important to invest in education and the development of quantitative and qualitative tools for such
analysis."

As for getting companies to address ESG issues in quarterly conference calls and other information outlets, the report recommends a more direct method than waiting for analysts to ask.

"WBCSD, UNEP FI, and other partnerships could encourage our members to solicit and present environmental, social, and governance information at corporate results presentations, showcase good examples, and institute an annual prize for incorporating environmental, social, and governance research," the report suggests.

Counterbalancing the cynicism toward sustainability exhibited in the young analysts' quotations, the report presents a more optimistic view from established analysts.

"It is becoming clear that sustainable development will be one of the major drivers of industrial change over the next fifty years and that there is a growing demand from both companies and institutional investors to understand its financial impacts," says Colin Monks, head of European equity research at HSBC. "It follows therefore that the successful brokers will be those that anticipate this demand, respond to it with robust financially relevant research and thereby differentiate themselves in an increasingly crowded marketplace."

 

 
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