To discover what investors really think of sell-side research, Global Investor gathered together a panel of leading fund managers to air their views on specific questions related to the quality of brokers’ research in Europe.
A number of large houses with extensive in-house research capability – such as Fidelity and Putnam – declined to take part on the grounds that they do not use outside research.
Those who agreed come from a mixture of houses, positions, traditions and experience.
They are:
Dominic Baker,European fund manager at Scudder Threadneedle Investments; Ella Brown, European portfolio manager at JP Morgan Investment Management; Jeff Currington, head of European equities at Morley Fund Managers; Dan Eison, European fund manager with Baring Asset Management; Mark Ferguson, co-head of research at Goldman Sachs Asset Management; and Chris Woods, chief investment officer of State Street Global Advisers.
GI: To what extent is research tailored to the fund manager’s needs?
For the most part, the assessment on this point was broadly positive. Several investors say that they find the sell-side responsive to requests for special pieces of research and, as Morley’s Currington observes: “Generally we find they are quite willing to do something specific. It seems that size is an important determinant of service and that, post-merger (CGU and Norwich Union), we’re large enough to get that kind of service.”
Nevertheless, Currington admits that, realistically, 80% of the research sent out to fund managers ends up in the bin. This is, he says, almost inevitable in that it is difficult to match fund managers’ needs precisely with most of the research produced by the sell-side.
Baker at Scudder Threadneedle has seen the growing trend towards sectoral comparisons over the past eight years and welcomes this as dovetailing with the way in which he looks at the market. There is a widespread expectation that research will develop further in this direction – especially as more of the smaller brokers in each national market are absorbed into their larger competitors. Woods at State Street also welcomes the fact that some houses – such as Merrill Lynch and Commerzbank – are producing the kinds of quantitative research that is interesting to him.
However, Ferguson at Goldman Sachs believes that the large institutional fund manager is not necessarily the most important client as far as brokers’ research is concerned. “If you put it in black and white then it’s not particularly tailored to our needs. That’s because small hedge funds and fast-moving boutiques are more valuable to brokers from a revenue point of view. While the big pieces of research may be tailored to a large and informed audience, day to day notes are often geared to the hedge funds.”
GI: What changes do you want to see from
research?While most of our panel seemed broadly satisfied with the existing state of research, Ferguson is adamant that more global research is called for and, as part of that, more communication among the sell-side analysts to extract cross-sector insights is also needed.
| Scudder Threadneedle’s Baker | ||||||
He believes that more sectors need to be evaluated on a global scale – even those such as retailing which have been principally domestic until recently – in order to understand growth prospects, competition and, with the rise of the Internet, cost and supply factors. But he sees the structure of the sell-side inhibiting this: the revenue generated by widely dispersed and broadly based global research cannot easily be ascribed to particular analysts.
The preference for global research is shared by Brown at JP Morgan. She admits to being surprised by the extent to which global research is now relevant to a lot more sectors than appeared likely five years ago. “There are now very few sectors where global factors aren’t of interest – even in European construction. So any broker still looking at just one market has passed its sell-by date.”
But, as more of the small European brokers are eclipsed, there is a danger, says Baker, that “there will be less independence in thinking, which is what I would actually like to see more of. A lot of work is too compromised. We should have less sitting on the fence.”
Eison at Barings has had the impression that, over the past six years, research has become increasingly geared to reactive pieces in response to earnings announcements. “There’s not much pro-active research, though thematic pieces are always more interesting.”
He also wants to see greater regular factual content in research. “On small cap stocks, particularly, it would be helpful to have a description of the company and its products each time – of the sort that UBS Warburg provides. Too often, follow-up research launches straight into a narrative and assumes too much knowledge on the part of the reader.”
When it comes to factual information, Eison feels that “some people could be accused of not producing standardized numbers,” although Deutsche Bank is an exception.
The nature of the demand for research has changed partly because the structure of fund management houses themselves has changed. Much more research is being done by buy-side analysts and they may find, says Baker, that “companies are willing to tell them more than they tell the sell-side analysts.”
GI: So what role is left for the sell-side analyst to fit in with buy-side research?
The answer, clearly, has to be by offering a complementary research product. This will often depend on building a relationship between individual analysts on the two sides.
At JP Morgan, with its 68 in-house analysts, Brown insists that “a lot depends on the personality of our analysts and the importance of the old ‘know your customer’ motto.” In-house analysts tend to follow a larger range of stocks than their sell-side peers and consequently “they expect extremely detailed understanding” from the sell-side specialist, who can also have rather different industry contacts.
In all, it appears that fund managers have become a lot more demanding. As Baker says: “The sell-side have to be able to give more detail and the buyside will challenge them more frequently.”
GI: What indicators do you use to judge the quality of research?
Fund managers seem divided on how best to judge the value of brokers’ research. Ferguson argues that a detailed understanding of the company is the highest priority, followed by “big picture” analysis. Accuracy of core numbers attains only a low importance. There is, he notes, an inverse relationship between the duration of the asset and the degree of accuracy that can be achieved: the younger the company, the more important it is to get the big picture right, whereas with a mature business, there is a need for a better understanding of detail.
| Cunnington | ||||||
In contrast, Baker at Scudder Threadneedle argues that “accuracy is the key thing, especially in the technology sector where companies that disappoint get marked down heavily.” Baker has observed the phenomenon of the “whisper forecast” becoming more common in Europe – typically this means that results tend to turn out 5% higher than is implied by the consensus forecast. Baker is frustrated by analysts’ reluctance to increase their forecasts to the “whisper” level. “They should put the forecast where they think it will come out.”
Forecasting accuracy and big picture analysis are both important skills for the analyst.
Fund managers like Currington accept that it is rare to find an analyst who can deliver on both. Likewise, says Eison at Barings, “a combination of detailed and thematic is best.”
And, he adds: “You can’t beat experience among the analysts, although industry background alone isn’t enough. Nor are the best analysts necessarily those who make the best calls, but the ones who really know the companies.”
Accuracy often goes hand in hand with the consensus. Analysts tend to be right or wrong as a body because there is considerable pressure on them not to stray too far from consensus forecasting. In these circumstances, fund managers’ attention is caught by outlying forecasts. In the case of the quant houses like State Street, moves away from the consensus are significant because they may point to a trend, says Woods. More and more houses are looking to model this kind of movement.
For other fund managers, there is the simple recognition that, as Brown puts it, “if all analysts do is cluster around the consensus then they won’t establish much of a relationship with the fund managers.”
Similarly, says Eison: “We pay more attention if they have a punchy forecast.” At the same time, he does not want to encourage analysts to be mavericks for the sake of being mavericks.
Besides the consensus, fund managers detect the influence of corporate finance relationships at work in shaping forecasts.
All of them accept it, with varying degrees of disgruntlement, as a fact of life in the research business. Investment managers recognise that the sell-side revenue equation dictates that corporate finance relationships are very important and that research will be affected. “It hasn’t got any better or worse.
It will always be there,” says Woods.
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JP Morgan’s Brown: looking for fresh ideas |
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Currington finds that corporate finance can make unwelcome demands on the analysts at critical moments. “We have had big telecoms issues, for instance, where all the analysts have been tied up giving presentations or marketing and there has been no-one to talk to.”
There are ways round the issue for the analysts and the sell-side generally. “A good salesman will make sure you know what the angle is,” says Eison, “and in a one to one with a good analyst you will find that the answers don’t always coincide with the rating.” In other words, it is up to the sell-side to assist the fund manager in reading between the lines – something which Currington believes the good ones have proved able to do, while less good ones struggle with this part of the job.
Fund managers do recognise that there are benefits in the corporate finance relationship. “Working on deals for 10 years means that analysts amass a tremendous amount of knowledge about the management, history and personalities of the companies. It would be purist and naive of us to ignore the value of that,” says Brown.
GI: How do you feel research should be distributed in the Internet age?
Fund managers are in agreement that the new distribution methods have improved the flow of information, so that “the post tray is no longer my most important source of research” as Baker puts it.
Brown argues that research should be made available in as many forms as possible – hard copy, e-mail, websites, voice mail, presentations, conferences and via third party distributors such as Multex and First Call – allowing the fund manager to pick and choose the most convenient means of access.
Each of these different channels is, arguably, better suited to a particular type of research. The website saves the fund manager a trip to the library to check previous research material. A one page document will get read on screen; a 10 page document in hard copy. Eison thinks that monthly or quarterly CDs from the brokers would be useful and facilitate the removal of more paper files.
Interestingly, the availability of so much research in so many forms is recreating the need for the sell-side to flag the pieces that are particularly appropriate to an individual fund manager. Ferguson at Goldman Sachs says that even those research houses who do not deal regularly with a particular fund manager should be willing to phone up when they have some worthwhile research. “It does mean sticking their necks out and they could burn their bridges if it doesn’t live up to the billing, but we are open to ideas,” he says.
And the need for pointers of this nature could mean, says Currington, “a slight renaissance for the specialist salesman, who has been a bit neglected in recent years.” Equally, says Brown: “We definitely value specialist sales.
We’re looking less for maintenance research than for something fresh and original.”
Analysts Still struggling to hit the bull’s eye
No-one would pretend that the ability of brokers to hit the bull’s eye of earnings numbers is the only way of judging the quality of research.
But there is increasing pressure on researchers to get their core numbers right.
The pressure comes partly from within broking firms, where some managements see forecasting accuracy as a measure of the analyst’s fundamental understanding of a company’s business. But it also comes from outside the firms. AQ (Accuracy Quotient) magazine was established – at the urging of fund managers – to introduce a greater degree of accountability into brokers’ forecasts.
Having started out assessing only UK market forecasts, it has recently published its first set of European results, based on an analysis of the accuracy of earnings per share (eps) forecasts for the largest 100 European companies. And accuracy in Europe is noticeably poorer than in relation to the FTSE 100 companies.
This is partly the result of the less developed state of the investor relations industry in Europe. It is also the product of the sectoral composition of Europe’s largest companies. There are, for instance, more autos companies on the continent and the restructuring and foreign exchange complications affecting this sector have a negative effect on accuracy. This is because the AQ formula penalises brokers who change their forecasts frequently or by a large margin.
The average AQ for European brokers is also dragged down by the particularly poor scores which many analysts record in relation to German companies.
This is a consequence of Germany’s accounting laws, which allow substantial last minute adjustments to final results.Brokers do, however, score well on Daimler Chrysler, which operates on US standards.
At the other extreme, analysts notch up high scores in relation to Benelux companies. This reflects the high quality of investor relations in the Netherlands in particular, where investment managers have a long history of investing outside as well as inside their home markets. The fact that they have had to compete for investment funds has meant that Dutch companies have made greater efforts to ensure that investors are spared any nasty surprises in the form of results that are way off market expectations.
Small brokers emerge from AQ’s first European results with credit: in Germany BFG Bank takes the honours, while Paris-based Exane notches up a very respectable sixth place overall. But the big boys are still there in force: Merrill Lynch is the overall winner and JP Morgan also puts in a solid showing.
