Investors are not getting the information they need to make long-term decisions because sell-side research fails to consider material non-financial drivers of company performance such as ESG factors, according to research by Aviva Investors in a report entitled Investment research: time for a brave new world?
Research has a significant impact on investor and company behavior, but much of the current analysis is overly positive, sometimes biased and preoccupied with short-term financial metrics, notes the report. This contributes to a misallocation of capital and potentially rewards poor corporate practices.
Forty-two percent of the 342 sell-side analysts surveyed admit that sell-side research has a detrimental short-term focus. Only 35 percent think sell-side research tackles controversial topics and offers negative assessments of companies when appropriate.
Significantly, 90 percent say they would exercise ‘some additional caution’ when writing on topics that are commercially sensitive to their own bank, leading the report to conclude 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, notes the report. In turn, the current investment research system does not encourage or reward sell-side analysts for producing long-term, broad-based research, the report adds.
Reasons for this include analysts perceiving a lack of demand from the buy side for long-term research or coverage of broader themes. Many analysts would like to provide more in-depth research but are unable to do so because of commercial conflicts of interest and time spent on non-research activity.
Steve Waygood, chief responsible investment officer at Aviva Investors, says: ‘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.’
The report recommends that policymakers, regulators and all market participants should seize the opportunity presented by Mifid II implementation – which will change how asset managers pay for the research they use – to make investment decisions to encourage and incentivize change and for sell-side research to consider long-term, wider sustainability issues.
‘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,’ Waygood adds.
‘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.
‘CFA 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 from analysts.’