Recent research by the 2° Investing Initiative and The Generation Foundation claims that analysts and investors with a short term focus may overlook risk to the long-term viability of companies, especially since the value of institutional investors’ portfolios is mostly based on cash flows beyond five years.
The ways in which long-term risk analysis has grown to become more prominent in equity and debt analysis, as well as the growing integration of environmental, social, and governance (ESG) risks into credit ratings, was the subject of a panel discussion hosted by S&P Global Ratings, which included representatives from Mercer’s Equity Boutique, Generation Investment Management, Jupiter Asset Management, the 2° Investing Initiative, Morgan Stanley, and the Bank of England.
Stan Dupré, founder and CEO of the 2° Investing Initiative, said: “Financial policymakers responded to the crisis by increasing capital charges to strengthen the ‘financial cushion’ of financial institutions, but the core problem remained unaddressed: financial analysts and investors still do not assess long-term risks that are non-cyclical and non-linear.”
Dupré continued: “Analysts’ focus on short-term risks is not surprising, since there is basically no demand for long-term research from investors. However, this is a failing that the whole financial community should address.” In their research, long-only equity fund managers revealed average annual turnover rates of 58%, implying an average holding period of 21 months. In the bond market, corporate debt is only held for 1.5 years on average – deterring the need for longer-term analyses.
In response, Michael Wilkins, Managing Director, Global Infrastructure Ratings, S&P Global, stated: “S&P Global is increasingly switching its headlights to full beam to achieve a longer-term perspective of risk, and to incorporate that risk into our ratings analysis.”
Wilkins continued: “While the headline rating is an indication of our opinion of the probability of default, underneath that headline rating is a lot of in-depth analysis. This analysis, contained in our reports, gives a much wider perspective of how S&P Global views risk, as well as the timeframe in which we view that risk materializing. There is much more to a S&P Global credit rating than just the letters that you see on the page.”
Wilkins concluded: “S&P Global is developing new tools to help us understand longer-term risk. One of these is the ESG assessment, which looks at the environmental, social, and governance (ESG) factors that would affect a corporate issuer; it also looks at management risk. This methodology not only looks at the short to medium-term – two to five years – but also considers the longer-term horizon that is beyond five years.” More about the ESG assessment and Green Evaluation can be read at S&P Global’s Infrastructure Hub.