1. My fund doesn't do Socially Responsible Investing (SRI) so how is this initiative relevant for me ?
EAI serves the needs of mainstream portfolio managers, whether or not they have an explicit SRI interest. People have confused extra-financial issues with earlier debates about ethical investing or socially responsible investing. While specific strategies may rely on negative screens or a “best in class” approach, extra-financial factors are simply fundamentals that have the potential to impact companies' financial performance or reputation in a material way, such as reputation/brand management. Often these long-term factors develop slowly but when they happen, they become material in the “short term” as well.
2. How will this add value to investment decisions without being intrusive to the way our investment process works?
Research resulting from this Initiative will simply provide buy side analysts and portfolio managers with a more complete view of invest me nt risks and opportunities by better analysing a more complete set of drivers of long-term company performance. What the buy side does with this research is entirely up to each fund manager to decide.
EAI members believe this research will add value to both asset managers and asset owners by:
identifyingresearch providers that are most dynamic in providing differentiated research;
providing investment insight relevant for mandates which have a fundamental research approach or who have absolute risks/returns or unconstrained mandates;
providing the research which would allow more objective prioritisation of engage me nt activity with companies (i.e. for those investors who adopt an active owner perspective);
ensuring corporate executives are challenged on a more complete set of issues which drive risk and reward.
3. If this sort of research is so valuable, why don't we just do it in-house?
Most buy side fund managers use some external investment research to supplement their own internal research. This is because it is not easy to build up the kind of research function internally that would completely replace the sell side on traditional research issues. The same is the case for extra-financial issues (see vi for some specific reasons).
4. Doesn't this assume too much of the sell side?
There have, of course, been criticisms of falling standards in third party investment analysis. However, we believe that by incentivising research providers to integrate EFIs into their analysis, we are creating a market mechanism to reward those parts of the research community who can demonstrate how they can truly add value.
It is true that analysts are, as yet, relatively inexperienced at developing research methodologies to deal with issues which defy simplistic linear projection models. But the tides are changing. Already, EAI has evidence that with the right kind of incentives, the best research houses can do much better on integration of EFIs into traditional research that had appeared possible even in the recent past.
Cost pressures on the research community are a reality and providers will inevitably respond in different ways. What EAI does is to create positive business incentives for those research houses that want to better fulfil client expectations by ensuring their research is as differentiated as possible. Enhanced analytics is a good way to do this. If larger research houses don't respond to this market demand, we can be sure independents will step in.
5. We already cover this with in-house specialists so what value does it add?
EAI is entirely comple me ntary to having an in-house team of corporate governance and SRI specialists. In fact, having such a team should allow an EAI me mber to make better use of such research by helping their mainstream colleagues interpret this extra-financial research and engage with companies as active owners.
Many EAI members also have specialist teams assessing ele me nts of the issues in question (i.e. corporate governance and SRI research), but are happy to acknowledge that small teams of professionals are not resourced to do what third party research providers can do in terms of coverage, both of the range of EFIs and all key markets; the ability to model the financial effects of EFIs; and access to highest level corporate manage me nt on a consistent basis.
In addition, many on the buy-side have learned to trust particular analysts and are often highly influenced by the views of these analysts.
6. This all sounds very worthy but our organisation has many things to do. Is this really a priority?
Each organisation must determine its own priorities but when deciding how much importance to allocate to EAI, it may be useful to consider the following factors:
Finding new ways to avoid risk and find new sources of alpha – there is growing evidence that analysis of this type could have direct invest me nt value;
Re-establishing trust – the trustees of pension funds and their members have lost trust in the investment system in part because of a well documented tendency for intermediaries to be unwilling or unable to align internal processes with end beneficiary interests. Any fund manager who is willing to acknowledge this and who has the leadership commitment and management capacity to respond constructively will, over time, reap rewards;
Accessing some mandates – some asset owners have chosen to join as “associate members” which means that they will seek to encourage their fund managers to join EAI. EAI membership is likely to become one of the core criteria used in the selection process for new mandates. The clients will adopt an informed “join or explain” approach and this should provide those fund managers who choose to join EAI with some commercial advantage.
