Responsible Investor

increasing presence of sell side houses at almost all responsible investing events today. This is indicative of their credibility with asset owners as much as fund managers. Good sell side commentary on extra-financial performance is giving mainstream buy side and asset owners the confidence to factor relevant ESG issues into their investment decisions.
Worryingly though, some sell side houses have regressed and lost specialist staff. Despite repeated requests for better corporate governance coverage, progress has been slow. The one house that had such expertise has recently lost it. This raises questions as to whether sell side firms are able to address the conflicts of interests that hinder such ‘sensitive’ commentary, or whether EAI and others will have to focus on independent brokers. In addition, coverage of the North American market remains very weak. Some houses still struggle to secure the intellectual engagement of their US-based analysts: one of the reasons perhaps for why the sub-prime contagion started there. ESG coverage of sectors in North America bears little relevance to market weightings. In three years, EAI members have seen approximately 50 automobile but only 25 banking sector reports they considered appropriate for evaluation. Finally, credit rating agencies, which were not included in the EAI process, have made very little progress on extra-financial risk assessment. Furthermore, some buy side professionals are yet to be convinced about the merits of the EAI. They argue that they do not depend on sell side research and are therefore reluctant to reward it explicitly. The reality, however, is that few buy side firms have unbundled and even fewer have stopped paying

for research completely.
I have yet to hear of a firm that never meets sell side analysts. Others assert that they already see and reward good ESG research. It is difficult to reconcile the average quality of sell-side research on ESG matters with the number of managers who say they are rewarding it. What is certainly true is that changing allocations to sell side research is an intensely political issue, so it is not surprising that other reasons are used to explain an understandable resistance to change.
It is also true that many portfolio managers ignore the output from a given sell side valuation model when they come to making stock decisions. Although such valuation models can be an important resource for some buy side firms, what many buy side analysts want is better access to the raw data that the sell side has gathered. They also want better access to the sell side analysts for the bespoke and deeper data dives they can facilitate, for their thinking about the variables in the valuation equation and for easier access to key corporate executives. Since this information exchange promotes the market efficiency that all active investors rely on to ensure that the mispriced stocks they invest in gravitate towards their proper valuations, access to the right sell side research is worth rewarding. If extra-financials have been forgotten from that calculation of fair value, the buy side will generally transmit that failure.
As with any successful growing project, especially where the context itself is fast moving, there also comes a time to review it. The initial design of EAI focused on a specific percentage of brokerage commissions to be allocated to a small list of extra financial ‘winners’.

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