It’s not just the risk of global meltdown which is threatening to shatter the cosy world of the brokerage analyst. The last few years have seen a marked increase in the number of analysts employed in-house by fund management institutions as the money managers seek to gain greater competitive advantage by adding their own analytical twist to the spiralling information stakes.
This ‘do-it-yourself’ approach to research is no new thing, of course. Most large buy-side institutions have had an analyst/fund manager approach for many years. The difference in today’s terms is that the reliance on in-house analysis is on the increase. And that means that investor relations officers should be taking note.
One veteran IR player, Ralph Allen, VP IR at ITT Industries, refers to a comment made by one of his old bosses to draw an analogous picture. Sell-side contact, he said, was working at the narrow end of the funnel. You’re using a few messengers to pump your story out to those floating round in the open part of the cone. Once the buy-side start requesting more direct contact with companies, the time and resources required to meet with them all can spiral out of control. That’s when you have to rely more on careful and selective targeting, says Allen.
‘The big trend is the emergence of global fund management houses with global research capabilities of their own,’ says Bob Cowell, a partner at London-based IR consultancy Makinson Cowell. ‘They’ll begin to dominate over the next decade.’ Cowell, like others, believes there has been a real leap in the quality of buy-side research over the last five years. And that can only be set to continue.
Big getting bigger
Consolidation, consolidation, consolidation. Those are the primary reasons given by analysts on both sides of the fence for the growth in buy-side research. The big institutions – whether portfolio managers or brokers – are getting bigger, which pushes buy-side analysis in two ways. Firstly, and most obviously, the world’s largest institutions have the ability to really flex some research muscle of their own as economies of scale set in. Some, such as Fidelity and Capital Group, have always stressed their own in-house research capabilities. But as others begin to play the same game, these institutions are upping their in-house analytical strengths once more.
Jim Griffin, a Fidelity spokesman in Boston, is keen to emphasize that his firm has always placed a heavy reliance on its own rigorous bottom-up research. That being the case, recent figures indicate that Fidelity investment professionals are continuing to up the ante in the game of making direct contact with companies – a substantial element of their own in-house research.
Last year, for example, Fidelity held 6,807 meetings with companies and issued 26,000 research reports. Some 4,600 of the meetings were direct visits to Fidelity offices by corporate management teams. Yet in the second quarter 1998 of this year alone, Fidelity welcomed 1,300 companies into its offices and issued well over 7,000 research reports. Griffin confirms that meetings in Fidelity offices this year are set to exceed 5,000 and its analysts-cum-fund managers will issue over 28,000 research reports.
Latest squeeze
Does this mean that large institutions like Fidelity are squeezing broker reports out of the equation? Not in most cases. Broker research is still important to most large institutions, but in many cases it is viewed more as a reference point, providing an indication of the consensus view rather than serving as the foundation for decision-making.
Next up, consolidation among brokers means that the really good sell-side analysts are gathering into fewer and fewer securities houses. That means it’s a heck of a lot more difficult for any fund management institution to gain real competitive advantage from a lot of the research they’re receiving. If you’re not using the leading brokers for research you lose out because chances are those you’re relying on don’t have the best analysts in the field. But if you do use them, you can bet that your leading competitors are receiving exactly the same information.
Trevor Greetham, global strategist at Merrill Lynch in London, acknowledges these pressures on the sell-side but says it’s up to him and his colleagues to respond accordingly. Greetham does not believe they signal the beginning of the end of the sell-side – merely a change in the nature of the environment in which they operate.
As buy-side research increases – and Greetham confirms it is certainly on the increase – sell-side analysts will be turned to for different reasons. ‘We have to ensure we come up with a lot of actionable ideas and put them into context,’ he says, adding that the sell-side can also provide a lot of market and sectoral data which few buy-side firms have the time, inclination or resources to put together. It’s then up to the buy-side teams to interpret this information using their own expertise.
Whatever way you look at it, the need for an extra in-house analytical twist is increasingly apparent. Indeed, fund management institutions are also being pushed by the trustees dishing out the mandates. The UK-based Universities Superannuation Scheme recently switched a substantial chunk of its money from Philips & Drew to Capital International (the overseas arm of the Los Angeles-based Capital Group) after what chief executive, Peter Moon, describes as ‘an extensive and thorough review’ of all areas.
Moon refuses to comment on whether Capital’s in-house research strengths were a key reason behind the decision, but others in the know insist that this was high up the priority list. It’s a trend which is expected to continue.
Push from technology
On top of these size-related issues, the increase in buy-side research has been facilitated by the technological and information revolutions. Again, the pressures come from two sides. Institutions have invested heavily in technology, which helps them share information between personnel in several locations. Of course, ease of information sharing is not a reason in itself for an increased emphasis on in-house research: the advantages work just as well for distribution of broker reports. But it does mean that, say, an in-house analyst can share notes on a company meeting with colleagues in other locations a lot more quickly than would have been possible a decade ago.
Technology has changed IR practice, too. As ITT’s Allen points out, he now has the technological resources to keep in contact with a wider range of people than he had five, ten or 15 years ago. The most recent innovations are the web and e-mail releases. But these follow on from teleconferences, videconferences, blast-faxes and more, all of which make mass communications considerably easier.
A few years back investor relations professionals were concentrating more of their time on sell-side analysts, on the assumption that they would duly distribute the information and their interpretations of it to the buy-side firms. Nowadays such a concentration is simply not necessary, nor necessarily desirable. Why let a gatekeeper interfere with your message when the recipients want it – and you want them to have it – first hand? ‘The buy-side doesn’t like all of its information filtered through the sell-side. They want it direct,’ says Allen.
Been there, done that
Direct and to the point, chime in the buy-siders. Most institutions are at pains to stress that they have always had a commitment to direct research and analysis of their own. Nick Clarke, assistant head of UK equities at CGU (the result of the merger of Commercial Union and General Accident) takes this view. ‘We’ve always had quite a significant commitment to research of our own. The only way to invest is to research a company thoroughly. Since the merger our commitment to that has strengthened but it’s always been very high.’
Clarke adds that in-house research is structured according to where there is greatest need. For example, the largest stocks are well-researched by the brokers and he sees no need to reinvent the wheel. ‘The important thing is to use the outside research but draw our own conclusions.’ There is less good broker research on the smaller caps, on the other hand, so Clarke says this is where he believes in-house resources can really give a competitive edge to CGU fund managers.
Graham Wood, head of UK and continental Europe at Standard Life in Edinburgh, also maintains that the in-house research commitment has been high for some years at his firm. Indeed, he attributes Standard Life’s ‘do-it-yourself’ analysis commitment to the changes wrought by London’s Big Bang way back in 1986. ‘Before Big Bang we dealt with all the brokers on an agency basis,’ he says. ‘There was a fear that when we dealt with them as principals it would become increasingly biased.’
Wood explains that Standard Life is not quite at the level of insisting on employing Phd chemists to do its pharmaceutical research, but he does see the buy-side research role becoming increasingly specialized over the next few years. The growing tendency toward sectoral rather than geography-based research is helping to push things in that direction. And the coming of the euro is likely to accelerate that movement.
So will such specialization and growth within buy-side research automatically lead to a decline of sell-side analysis? ‘I don’t see it as an antagonistic thing,’ says Wood, implying that growth of one does not necessarily lead to the collapse of the other. ‘The sell-side will continue to be very conscious of what kind of service they give to what clients. The challenge for them is to ensure that each institutional client gets value for money without one subsidizing another.’
