Responsible Investor

But from a financial system perspective, it would represent a massive duplication of effort. It would also be impossible to manage for the directors and senior executives on the receiving end of investor enquiry, and so would break down. Most importantly, it would be a sure-fire way of ensuring that the information that cost so much to gather would end up pooled by some data gatherers rather than being disseminated across the market. This is why we would have to invent something like sell side research if it did not exist.
For all its weaknesses, sell side research is a massively efficient centralised resource, motivated to gather and to share investment relevant information. Like their buy side clients, sell side analysts are motivated to be right – perhaps even more so given the smaller job market in which they work. Crucially, they are also motivated to be public and loud about their opinions.
Sell side data flows, and, in many instances, is pushed through the financial system. The sell side can therefore have a large effect on market perceptions about particular stocks; in contrast the buy side has much less to gain from sharing data with others and is largely motivated to secrecy. This means that the sell side makes a vital contribution to market efficiency: the collective intelligence of the market, which aggregates the divergent opinions of its constituents into price setting, is at its best in the presence of shared learning about stock price formation that is widely available at low cost. In addition, corporate management is clearly influenced by sell side analysts and their expectations. The five or 10 top sell side analysts in each sector have unrivalled access to senior management.

If an issue is on the agenda for these analysts, it will be taken very seriously at board level where directors often use sell side research as a way to check what they are told by management. This is important when sell side research runs counter to current financial valuations, such as Deutsche Bank’s famous study on genetically modified organisms (GMO), which effectively called the demise of Monsanto.
If an issue is not on the sell side agenda – or worse, if top-ranked analysts act as if it is irrelevant – it sends a strong, negative message to management that can lead to misallocation of attention, and thus capital, at all levels. The problem, of course, is that if the sell side generally ignores certain aspects of corporate performance – such as the culture of risk management at investment banks – then the collective intelligence of the market and its allocative efficiency suffers from the related information gap. Equally, investors cannot expect to stock pick their way out of trouble when the problem is a systemic issue that the sell side does not give due recognition. As experiences such as WorldCom, Exxon, dotcom and sub-prime keeps reminding us, these systemic risks can be very costly.
Raj Thamotheram is director of responsible investment at AXA Investment Managers
(1) Members of the UN Principles of Responsible Investment collectively account for $13trn.
(2) ‘The worst market crisis in 60 years’, George Soros, Financial Times, 23 January 2008
This is the first of a two-part article. Next week looks at the future of the Enhanced Analytics Initiative.

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