Dealing with information overload
European Brokers Poll: Overall European results
European Brokers Poll: Country results
European Brokers Poll: Sector results
European Brokers Poll: Methodology
Considering that the European single currency is billed as an event of dramatic and historic proportions most equity fund managers are remarkably relaxed about it. Mark Pignatelli, head of Baring Asset Management’s European team, says their preparations were complete a long time ago. “We changed our investment process three years ago in anticipation of this. We already have, if you like, a euro-friendly process.”
David Ballance, a European fund manager at Threadneedle Asset Management, concurs: “The financial markets decided that Emu was a done deal 15 months ago,” he says
For brokers too, the move from country research to a pan-European sector approach was begun long ago. Charles Scott, managing director and head of European research at Morgan Stanley, says: “We were the first to organize ourselves on pan-European sector lines and we’ve worked that way since 1991. The way we’re set up at the moment is we have pan-European sectors with some UK specialists as appropriate. We don’t have country research and we don’t have a separate UK research department.”
Going global
This pre-emptive move towards sectors prompts Stephen Jones, head of the European team at Gartmore, which invests $5 billion in Europe, to the view that the impact of European monetary and economic union is being overstated. “Emu is irrelevant, people are getting too hung up about it,” he says. “The US houses started reorganizing in the late 1980s/early 1990s.”
Tim Orchard, head of European equity research at Warburg Dillon Read, says it operates in a similar fashion to Morgan Stanley. “The advent of the single currency is not going to make much difference to the way we operate or the way we conduct our research,” he says. “Equity research in Europe is, for the most part, constructed along sectors, both by ourselves, by all our biggest competitors and by our clients.”
The next step, Orchard says, is global: “The average international money manager, for some time now, has operated on the basis that he would not consider buying shares in, say, Fiat, without taking a reasonably detailed look at Peugeot, Volkswagen and Ford, and possibly even Honda,” he says.
Houses like Warburg Dillon Read, Morgan Stanley and Goldman Sachs have spent much time, effort and money reorganizing themselves on sector lines and they have a substantial head start on the smaller domestic brokers, which are now trying to catch up.
Enskilda Securities which, with Alfred Berg, leads the way in Scandinavian coverage, is a typical example of what is happening. Fredrik Nygren, head of Nordic research at Enskilda, says: “We are restructuring and rebuilding so that we will continue to concentrate on the Nordic region but we are also going for sectors. We realize this will be very tough to do but it has to be the way forward.”
Gianpaolo Trasi, head of research at IMI Sigeco in Italy, tells a similar story. He says: “We have a strong domestic franchise and we are leveraging quite strongly on that but we are also specializing in three sectors. We know we can’t compete with the global players on their level but we can add value in other ways.”
Local brokers realise the importance of small-cap and mid-cap companies to their business. Clive Heathcote, director of sales at Banco de Negocios Argentaria in Madrid, says: “There’s going to be increasing demand for small-cap and mid-cap companies, there’s more coming onto the market all the time through new issues. That plays right into our hands because you need a strong local presence to cover them.”
Baring’s Pignatelli says his firm is happy to use local players for mid-caps. “You don’t really need to know who the president of Switzerland is but you do need to know what is going on in Italian politics and there’s a lot of mid-cap companies in Scandinavia and that’s what we’re looking for out of a local broker.”
Morgan Stanley’s Scott is prepared to concede this ground to the local players. “Our small-cap coverage is really restricted to growth areas. The regional firms will have a bigger role to play because they’re closer to the firms on the ground,” he says.
Niche brokers in domestic markets will continue to have a role. As Ballance says: “I believe most houses are going pan-European but we’ve had a house in this afternoon, dealing in Scandinavian stocks, who say they have evaluated the business prospects and they are going to remain pan-Nordic rather than pan-European.”
However, the likelihood of regional brokers being successful in their attempt to reposition their research product is called into question by fund managers and rival firms. The head of European investment at a large UK fund manager, says: “What they [local brokers] say they can do and what they actually can do are two different things. They are not at the cutting edge.” He offers only a crumb of comfort to smaller firms: “They may be able to survive by dealing with smaller or more domestically oriented firms, but this will naturally restrict their ability to expand.”
Those brokers that have not already been taken over face a difficult future, says the fund manager, because of the way the big investors operate. “If the brokers are playing to their strengths by covering smaller and mid-size companies, that then presents them with problems. People, particularly the US investors who are putting a lot of money into Europe now, are looking for large, liquid stocks and familiar names.”
Warburg’s Orchard agrees that small brokers face uncertain times. “Amongst all the talk about Emu, it is important to remember that half the European market cap is in the UK and Switzerland so that will still be outside euroland,” he says. “But if you are a country-specific broker inside euroland you will probably be feeling pretty uncomfortable.”
Orchard says smaller houses may not have the resources to reorganize successfully. “A lot of them are trying to broaden their coverage beyond their domestic market but they will find that very tough. It takes time, money and effort, as well as access to the institutions. There are a lot of obstacles for them to overcome and on top of that, all this is happening against a backdrop of people continuing to cut down on the number of brokers they use.”
The value of service
A further factor counting against the brokers is downward pressure on commission fees. However, Orchard is quick to point out that quality of support will always attract customers. “I wouldn’t want to forecast apocalypse for all these firms because there will always be room for those that are smart, have good ideas and provide a good service,” he says.
Even so, fund managers are using ever fewer brokers, and handing bigger and bigger slices of commissions to the global houses. “We are concentrating our commissions and the bulk of it is going to the global sectoral players,” says Gartmore’s Jones. “We have been following this trend for some time now, moving away from the local brokers. Sectors are becoming more important all the time.”
The head of the European team at another London fund manager agrees that polarization is increasing. “The local brokers’ place in the market is diminishing. The top 10 global firms get the great bulk of our business,” he says.
There is a further problem for smaller houses trying to hold on to their share of the commissions. The big players outgun them when it comes to trading.
At Fleming Investment Management, which places £3.5 billion ($6 billion) in Europe, Mark Davids, an analyst on the European team, says there is a further reason to go for larger brokers. “The movement is increasingly to concentrate firepower. Trading capacity is very important and obviously the big houses are going to be better than the smaller houses,” he says. Fleming uses about 15 brokers regularly, with 10 more getting some business. However the bulk of the commissions go to five houses.
Added to this, says Davids, the big brokers are more likely to have higher-profile analysts. People who stand out at smaller firms often move to bigger and better-paid jobs elsewhere. “Ultimately it comes down to buying power and how good an analyst you have,” says Davids. “It comes down to individuals and that militates against the smaller houses.”
The move toward sectoral research is inevitable, given the preference for investors managing money on those lines. As Morgan Stanley’s Scott says: “We are certainly seeing investors becoming increasingly pan-European-oriented and that goes for the continental European investor base too, which is clearly an important growth area of European equity investment.”
Comparing like with like
Opinions differ as to how best to go about sectoral research and how easy it is to compare, say, a French bank with a German one. Morgan Stanley’s Scott says some sectors are easier than others. “It works more purely in some sectors, for example, in pharmaceuticals, the comparison with US companies is absolutely key. In emerging telecoms it’s very important, in energy there are more and more major oil companies and for commodity stocks it is a very global marketplace.”
The starting point for Morgan Stanley, he says, is to see how companies perceive themselves. “Nestlé or Unilever see themselves as global consumer-products companies and so that is the way you have to look at them. The pan-European dimension, when you’re talking about a Nestlé, is actually one step back from the way they see themselves, which is global, so you have to have the capability to look at that from a global perspective.”
He adds that client demand, as ever, is crucial. “The way we present our research is driven by the client and I think as they become more pan-European we will just increase our own drive to that, but we have been set up in the right way for some time, so it’s just a matter of degree for us.”
Warburg’s Orchard says: “We have put a great deal of effort into arranging our equity research resources into global industry teams.” In Warburg’s set-up each sector (there are 20) has a coordinator whose role is to make sure information is exchanged regularly in order to ensure a comprehensive view of global industries. “It sounds terribly simple but it is much harder than it looks to span the regions.”
Threadneedle’s Ballance says comparing companies in euroland throws up all sorts of problems, particularly in valuation. “Some of the newer valuation techniques we’ve seen develop over the last year or so are meant to iron out some of these accounting problems because German companies depreciate their assets to keep profits down and keep the tax bill low,” he says.
Baring’s Pignatelli says a pan-European approach is not necessarily the only way forward. “It’s very silly to look at some of these sectors on an entirely pan-European basis because you’ve got to get a bank analyst who understands all the different dynamics in the countries and what’s happening to financial disintermediation and all the risk premiums and all the property prices in all the different countries,” he says. “After that you require the insurance-sector analyst to duplicate the work and maybe come up with a completely different view.”
Competing with the bulge bracket
There is little doubt that the balance of power has shifted heavily to the global houses, partly thanks to the long bull market. Pignatelli says favourable markets have enabled the US firms to spend money building up European operations. “The stock-market cycle we’ve had in the US has allowed the big US bulge-bracket houses to leverage off the profits they have got from there, almost oligopolistic profits, and they’ve clearly put a lot of money into building up their European franchise.”
He adds that mergers among European investment banks such as that between Union Bank of Switzerland and Swiss Bank Corp give them the chance to fight back. “The Europeans have had a tough time competing head to head with the Americans but they may be able to redress the balance by merging.”
Warburg’s Orchard says his bank is well placed to go forward. “Our approach to the equity business has always been global. That is what institutional investors want and our challenge now is to make it all work and deliver.”
Threadneedle’s Ballance believes the US houses have a considerable advantage as they have never drawn a distinction between the UK and Europe. “The UK-owned or European-owned houses started going more sector-based as it became clearer that Emu was going to happen,” he says. “but they are still catching up.”
However, as Pignatelli says, it is no surprise that Warburg performed well in this year’s survey as it provides a unique service. “They have a local broker present in each market and they centralize it all back in London as well as on a sector basis, so while it not only has French and Italians in the Paris and Milan offices, it also has Americans and British. There is a local feel and there’s an Anglo-Saxon angle relayed back to the fund manager which is very helpful.”
He is also impressed by Warburg’s ability to control its large European network. “It’s obviously creates a headache for Warburg to come up with a list of their 30 best stocks if you’ve got a lot of clever people with strong egos dotted around Europe.” It is quite some feat to filter as many as 100 ideas down to 30. “That’s obviously easier if you’ve got all the analysts in one room. But Warburg is getting to that stage where it is able to do that,” he adds. “As fund managers we like the fact that we’ve got some local access relayed back to us in a language we can understand.”
Using fewer brokers
Fund managers are using their commission firepower to give clear expression to the firms they wish to deal with. Baring has cut down the number of brokers it uses in Europe from 30 last year to nine global firms and three regional houses. “We’re able to focus more commissions on fewer people so we get a better service,” says Pignatelli, who evaluates the brokers twice a year. “You really shouldn’t need to have four views. Consequently our assessment is getting tougher. In order to choose just three instead of six. It’s more qualitative.”
Pignatelli adds that quality of research is still a key concern, but there are caveats. “Research is important to a large extent but the salesperson is part and parcel of the research anyway, he’s no longer trying to sell you stock, he’s really trying to work out what it is you’re thinking, what you are looking for and how do you access the analyst,” he says. “A large part of what we do is definitely rewarding that.”
Threadneedle has a less-structured approach to awarding commissions than some of its peers, says Ballance. “Commission is invariably awarded on the basis of quality of research ideas backed up by the ability to deal and in particular keeping us closely in touch with stocks after we’ve bought them,” he says. “An investment bank’s primary market deal flow is something else we would keep in mind.”
Threadneedle reviews its commissions each quarter and research is at the forefront. A broker’s presence in providing secondary-market liquidity is also vital, says Ballance. “If our dealer says Merrill Lynch has a lot to offer then even though the idea hasn’t come from Merrill Lynch, perhaps we’re struggling to buy from Warburgs who generated the idea. Obviously we’re going to take the block of stock from Merrill Lynch. It’s no use having a great idea if you then can’t get hold of the stock.”
Fleming reviews its brokers twice a year. Davids says the team relies a lot on the research it receives from analysts, but also places great emphasis on trading capacity. This is where the big houses win out. Another leading UK house, which relies on brokers for only about 25% of its investment ideas, says decisions on which firm wins business are made as much on the trader’s views on execution as on research.
Davids adds that the quality of research in Europe continues to improve but he fears that as large international houses increasingly dominate, it increasingly becomes driven by the primary business. “There is a lot of money to be made in the primary market and that is colouring their research,” he says. Nevertheless he remains committed to using brokers. “There are a number of analysts out there who clearly know an awful lot and we would be very short-sighted if we did not use them.”
Polarization
There are far more brokers in Europe than can survive and this will inevitably lead to further polarization. As Pignatelli says: “Europe is massively overbroked at the moment and I think it’s going to be tough for local brokers to survive. You’ll probably get the same thing that you have in the US where you do get the local broker, particularly if you get an equity culture developing in these markets but I think there is going to be a bigger polarization, you’re either going to be very big or quite focused and small.”
Davids of Fleming says it makes sense for local brokers to reposition themselves but adds that at least they are operating in a market that is attracting increasing interest from investors. “It is inevitable that local brokers have to restructure but the positive aspect for them is that Europe is seen as a safe haven, relative to the rest of the world. World markets are increasingly volatile but the long-term outlook for Europe remains favourable.”
With more US investors moving in, there is a demand for more sophisticated research. Ballance says US firms will want more detail and be more demanding, stretching the capabilities of some of the smaller firms.
The huge resources of the US houses give them a great advantage. Even in a market as large as the UK, big local names such as NatWest Markets and BZW pulled out of the business after realizing they could not compete with the likes of Merrill Lynch, Morgan Stanley and Goldman Sachs. So what price the smaller European houses?
As Gartmore’s Jones says: “Are local brokers dead? Possibly. They have to reinvent themselves. They can try to become sectoral or be local and the best at it.”
