Ten years after the start of the subprime mortgage crisis analysts and investors still largely ignore long-term financial risks, warns a report launched today by the think tank 2° Investing Initiative and The Generation Foundation.

It found that equity research analysts and credit rating agencies focus three to five years ahead and overlook risks to the long-term viability of companies, even though the value of institutional investors’ portfolios is mostly based on cash flows beyond five years. Lack of demand from the investment community for long-term research is partly to blame.

“The financial sector fails to properly assess the impact of the low-carbon energy transition, artificial intelligence and other long-term trends, said Mona Naqvi co-author of the report.

“If assets are not priced accurately investors may suffer unexpected losses and stock market bubbles may form, imposing tremendous costs on society when they burst. Short-term analysis may also miss business opportunities and lead to underinvestment in sectors that can benefit society.”

The report says it was not an unpredictable “black swan” event but a “white swan in the dark” which could have been spotted if analysts had looked further ahead and not relied on the assumption that homes would always sell for more than their purchase price.

“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, like the oversupply of homes they suddenly discovered in February 2007|”, said Stan Dupré, founder and CEO of the 2° Investing Initiative.

What they’re still doing wrong

According to the report, these financial institutions are still guilty of the following “white swans”:

The value of stock and bonds portfolios is usually based on companies’ ‘expected’ long-term cash flows (to pay dividends, repay debt and fuel stock price growth) which are exposed to long-term risks.

A majority of asset owners have long-term liabilities and invest to optimize returns over 10 to 50 years. Households and pension funds alone own 48% of the US domestic equity market.

In most sectors of the S&P500 more than 70% of the net present value of a company is based on cash flows beyond five years. For most S&P500 corporate bonds, the value derives from cash flows of 10 years or more.

However, equity analysts almost exclusively focus risk analysis on the next one to five years and extrapolate future cash flow trends: 74% of forecasts fall within three years and 94% within five years according to analysis of entries on the Bloomberg terminal. Credit ratings agencies largely focus on the next three to five years and risks beyond that period rarely influence ratings action.

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