Research Broadens Its Focus

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EPS, move over. Make room for ESG - "environmental, social and governance."

The practice of evaluating prospective investments along ethical and environmental lines - as well as financial ones - is increasingly moving into the mainstream of financial analysis on both the buy and sell side, advocates say. That means expanded career opportunities for analysts and portfolio managers who can incorporate extra-financial issues into their methodology. However, the U.S. is lagging behind Europe and the U.K.

On the sell side, Wall Street firms from Goldman Sachs to Citigroup have weighed in on how researchers can best combine what were once largely separate approaches. In October, Merrill Lynch unveiled a strategic marketing relationship with Swiss-based ESG information firm Asset4 Ltd.

On the buy side, institutional fund managers are paying greater attention to ESG issues, and there is a proliferation of ESG rating services as well as indexes that track the stock prices of companies that meet ESG-linked criteria. Independent firms active in the space include Boston-based KLD Research & Analytics, and Innovest Strategic Value Advisors in New York, Toronto and London.

Increasing Integration Between ESG and Financial Analysis

"We see the growth throughout the investment management supply team - on the research side, the fund management side, and the consultant side as well," says Craig Metrick, U.S. head of responsible investment for Mercer Investment Consulting. The firm's Responsible Investment group has grown from one person in 2004 to 13 today, adding six this year alone. Two more hires will start in January, Metrick says. The Toronto-based team helps institutional investors integrate environmental, social, and corporate governance considerations into investment decision making and ownership practices.

Metrick sees a trend toward integration of social and financial methodologies, even within a single individual's career path. For example, more people from social responsibility backgrounds are pursuing the Chartered Financial Analyst designation, he says, and more financial analysts are taking up ESG.

Established financial analysts can broaden their skill-set by simply working environmental, social and governance issues into their own research. If you're covering a sector, use existing research as a starting point to identify ESG issues that may be material for your sector. Even raising non-financial issues in your report and concluding they aren't material, "can still be useful if you can back it up," Metrick believes.

Formal training is available too. These days there are university programs on corporate citizenship, and MBA programs with an environmental focus.

Most Investors Look at Corporate Responsibility

Although social responsibility and corporate governance represent decades-old niches for select mutual funds and activist investors, a tipping point toward the mainstream came roughly three years ago. In March, a survey by Thomson Financial found that 82 percent of institutional investors consider corporate responsibility criteria when evaluating companies, and 33 percent have separate analyst teams dedicated to such issues. Thomson also found that 73 percent of shareholders and 59 percent of corporate investor relations officers believe corporate responsibility impacts share price.

The movement is spawning a bewildering plethora of labels - ESG, sustainability, SRI (socially responsible investing), corporate responsibility, EFI (extra-financial issues), 3BL (triple bottom line), to name just some. Separate organizations champion each version - some with substantial blue-chip corporate, financial or governmental backing.

For example, the United Nations Environment Programme Finance Initiative established in 2003 an asset-management working group that today includes heavyweights like HSBC, Mitsubishi UFJ, Legg Mason, Henderson Global Investors, BNP Paribas, RCM and ABN AMRO. It's sponsored a series of studies delving into how ESG factors influence company value and investment returns, and how to integrate them into the investment process.

A commercial program is the Enhanced Analytics Initiative, launched in 2004 by a consortium of mostly European and U.K. pension funds and managers representing more than $2 trillion total assets under management. Members agree to allocate a share of brokerage commissions "for rewarding sell-side analysts who are most effective in analyzing corporate performance on extra-financial issues or intangibles," including political or regulatory risks, HR practices, or corporate ethics. In its latest semi-annual review of sell-side research, the group gave its highest grade to seven institutions: Morgan Stanley, Citigroup, JPMorgan, Merrill Lynch, and the French banks Crédit Agricole Cheuvreux, Oddo Securities and Société Générale.

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