Filling the Investment Information Deficit

As the recession deepens, investment firms are cutting back on ESG research. That’s a mistake.

Even in the current economic downturn, the level of assets under management with socially responsible investment (SRI) mandates reached unprecedented levels globally in 2008. Interest from mainstream investors in exploring the financial materiality of ESG issues has also been increasing in recent years.

Nonetheless, basic investment research in general—and environmental, social and corporate governance (ESG) research in particular—is facing severe cutbacks, especially in the United States. JP Morgan, Citigroup and Merrill Lynch have all recently cut their dedicated ESG research departments.

ESG research is essential for SRI asset management and critical for mainstream investors seeking to understand the financial materiality (i.e., impact) of ESG issues. Cutting dedicated ESG research is short-sighted, particularly now.

First, at least a portion of the cause of the crisis can be attributed to financial analysis that undervalued long term risk. If anything, the financial crisis increases the need for investment research that has a long-term horizon and considers a broader range of issues, as is the case with ESG focused research.

Second, ESG thematic research better equips investors to analyze how the companies they invest in are truly positioned to manage complex challenges and take advantage of opportunities. As the global environment crisis deepens, the need for investors to understand the implications for the companies they invest in is essential.

ESG research by financial institutions has a lot of room for improvement and expansion. While there is plenty of climate-related research, particularly for heavy emitting sectors such as utilities, ESG research in other sectors such as banks, pharmaceuticals, and telecommunications is still sparse.

Mainstream banks are limited in their ability to serve long term investor needs. The provision of free research to clients necessitates cost recovery from the investment banking business which creates a fundamental conflict of interest that can negatively impact research quality. In addition, the complex relationships between the buy and the sell side that financial institutions face further compromises their ability to be transparent about negative information.

In this environment, independent ESG research is more important and relevant than ever before. WRI’s Envest research is helping to fill the gap by analyzing and quantifying the financial implications of environmental risks and opportunities, and working to increase disclosure of relevant data by companies and regulators.

Envest’s independent research helps investors better understand the financial relevance of environmental trends that impact their investments. One example is our recent report, “Rattling Supply Chains,” which demonstrates the necessity of sustainable sourcing strategies for firms in the fast-moving consumer goods sector. The report concludes that firms will face price increases for key commodity inputs.

In a turbulent investment market, it’s all the more important that investors understand the dynamics and risks that environmental issues present that affect their investments. Independent research and risk analysis is more vital than ever.