Analysts are being knocked off their pedestals. And they risk taking with them the reputation of those surveys dedicated to ranking the best sell-side analysts in the market. Although the publishers of the Thomson Extel Survey, Institutional Investor magazine’s rankings and Greenwich Associates’ publications may argue the opposite, the financial community’s view on these studies could well be changing fast.
‘Not necessarily in a bad sense, however,’ defends one former researcher of analysts who prefers not to be identified. She suggests that it’s precisely in the kind of crisis of credibility now being faced by the analyst community that such surveys become so valuable, since they help verify who the buy side still trusts.
But there are distinct differences between the US and Europe in this area. Steve Kelly, head of the Thomson Extel Survey, says the investment community in Europe tends to be more institutional; in the US it is more retail-oriented. ‘Professional investors don’t use analysts’ research as recommendations, but just as advice which they may take or leave. Institutional investors always have their own views on the market and don’t rely so much on third parties.’
For these reasons, Kelly maintains that the Extel survey is still seen as ‘realistic’ and ‘independent’ by the investment community. London-based Extel ranks pan-European analysts.
Although most of the recent analyst scandals have come from the US, Mike Carroll, editor of Institutional Investor magazine, says the new environment is not affecting the surveys his magazine does among fund managers to identify the top sell-side analysts. On the contrary, Carroll says, ‘The polls are a reflection of the general sentiment of the investment industry about the investment climate.’ And this has always been the case. He points out that when the magazine released its first surveys around 30 years ago, they clearly reflected the bear market the world was enduring following the early 1970s oil crisis. In the period immediately after that, analysts were consistently viewed as ‘useless’; in the 1990s, they became stars.
More recently, Carroll claims, II’s surveys showed that some analysts were quickly losing favor in the investment community. And this was even before the scandals were uncovered. For instance, ‘Jack Grubman [Salomon Smith Barney’s analyst now under investigation for conflicts of interests] dropped in our polls well before his stocks were losing favor.’
For her part, Melissa De Vries, director at strategic consulting firm Greenwich Associates, is equally confident of the continuing integrity and value of her firm’s output. ‘The scandals do not impact us because we are an unbiased resource for strategic research on global financial markets,’ asserts De Vries. Also, she adds, ‘We do not publish the top analysts in each industry. In fact, we do not even ask for specific analysts’ names when we conduct our US equity analyst study. Buy-side analysts only mention the broker’s name when evaluating an industry sector.’ GA’s survey is only available for its clients.
New times
Although Extel, II and Greenwich Associates’ rankings are considered the most prestigious surveys of their kind, the number of surveys has multiplied in recent years in line with the growing number of analysts themselves. However, the scandals that have cast a cloud over the perceived integrity of some analysts are now starting to reduce analyst numbers, leaving space for those who do more fundamental research while condemning to oblivion those who just regurgitate company information. As that happens, the volume of ratings publications will likely decrease in parallel, which could increase the relevance of those surveys rating fundamentals-oriented analysts.
Extel’s Kelly agrees that the number of analysts has been decreasing in the last few years due to the business climate. He also says that recent question marks about analyst independence could lead to certain changes in Extel and other surveys. They might well, for instance, start identifying which analysts are independent from investment banking functions and the degree of their independence. He denies though that the Extel survey could introduce distinctions between quantitative and qualitative researchers, or any other methodologies. ‘We don’t try to prejudge the reason why fund managers vote for a certain person or company,’ he explains.
And Carroll is in agreement: ‘We ask investors who has given them the best advice in the whole year, without making distinctions.’
For its part, Greenwich has conducted topical surveys on current issues. ‘We’ve recently addressed the question of the integrity of brokers and potential conflicts of interest via our equity research studies,’ explains De Vries. ‘In particular, buy-side people have voiced their opinions of sell-side analysts, including the characteristics of a most trusted analyst, as well as revealing further interesting trends such as the increase in in-house analysts at buy-side institutions and their need to contact company management more frequently.’
As for the potential nominees, ‘We don’t give interviewees a menu of a certain number of analysts to choose from,’ says Carroll at II. ‘They can vote for any existing analyst in the market, regardless of the size of the company they work for, or anything else. So the analyst who obtains more votes is considered the best guy in the year under review.’ II’s survey claims to cover 90 percent of the market, with trillions of assets represented by the research output of the analysts covered.
Similarly, Extel’s participants can vote for anyone they want if they choose to vote via the hard copy format; if they vote via the internet they have a list of 300 people from which they have to pick five. Extel’s 2001 results came after verifying responses from 860 fund management institutions, representing a total of over $11 tn of assets under management.
From its Connecticut base, Greenwich Associates has also been conducting research and providing consulting services to financial service providers for over 30 years. Its studies typically represent about two thirds of the institutional marketplace. But unlike the other researchers, Greenwich does most of its interviews in person. Mail surveys typically constitute 20-30 percent of the returns, compared to 60-70 percent in face-to-face interviews. ‘This way, we can confirm that each respondent took the interview seriously,’ comments Melissa De Vries. ‘Secretaries and/or junior assistants cannot participate in our studies.’
De Vries adds that the 80:20 rule applies widely in institutional financial services (in other words, 80 percent of the business is generated by 20 percent of the clients). So Greenwich tries to focus on the most important firms in its interviewing process to ensure that large institutions are well represented. This includes hedge funds, whose assets under management tend to belie the commissions they generate, according to De Vries. ‘We weight our results by commissions/business generated rather than by assets under management,’ notes De Vries, ‘thereby reflecting the way our clients view the structure of institutional business.’
Mostly, however, surveys do tend to weight votes according to the assets under management of the firm the voter belongs to – the larger the volume of assets, the greater the weighting of their votes.
Popularity contest
Nevertheless, analyst rankings are often criticized by voices in the industry alleging that the results are rendered invalid because some of the largest fund management businesses don’t ‘bother’ to vote. ‘They do their own appraisal internally and don’t have time to fill anyone else’s questionnaires,’ affirms Heather McGregor, a former IRO and investment analyst, currently working at Taylor:Bennett, an executive search firm specializing in communications jobs. (She is also a regular contributor to this magazine.)
Other critics reject these surveys on the grounds that they are no more than a ‘popularity contest’. They argue that the results are not based on analysts’ reports but on their interpersonal skills. ‘During the couple of months of voting, you can’t book a single table in any of London’s best restaurants at lunchtime because analysts are there, taking fund managers to lunch, trying to get their votes,’ says one City insider. And it’s widely accepted that the results of such surveys can have a huge impact on the winners’ compensation packages.
While producers of the surveys are willing to accept the influence of their rankings on analysts’ incomes, they are reluctant to believe that fund managers are influenced by analysts taking them out for lunch once or twice. ‘By the same token, we could say that every time a journalist is invited to a restaurant they are going to write good stuff about whoever is paying,’ counters Carroll. ‘But that would be presumptuous.’
At Greenwich they don’t even accept the charge of contributing to salary inflation. Indeed, they claim their methodology is aimed at avoiding this. ‘We ask for evaluations by firm rather than by individual, and ask participants to focus, for instance, on tried and tested criteria to pinpoint a firm’s analyst strengths and weaknesses,’ explains De Vries. ‘Our purpose is to benchmark and improve the service to institutional clients, not to produce an analyst star system.’
But what is the real use of these surveys, then? Are they of any value to IROs, for example? All the investor relations officers consulted for this article – with just one exception – denied they looked up such surveys when targeting analysts.
‘In this current environment, with markets the way they are and small caps struggling as research houses cut back on coverage, we do not refer to analyst rating surveys,’ says Ruth Cotter, IR manager at Irish small-cap Trintech Group. ‘We prefer to do our own research when targeting analysts so as to find the best fit for us. We check out competitor analyst coverage, sector analyst coverage, and word of mouth in the investment community.’ Cotter adds that given the cost of the surveys it’s cheaper to do her research ‘on the ground,’ since information is very accessible through the web for checking out who’s who in the analyst pecking order. This is also the approach used by Tektronix in the US. According to its IRO Sue Kirby, ‘Since the number of analysts covering our sector is so reduced it’s not difficult at all to do our own research.’
IROs at the world’s big global companies, such as Nokia, point out that the top analysts are already covering their companies. They also insist that they treat all analysts equally, regardless of their rankings. Andy Mann at BAE Systems in London does admit to reading analyst surveys: ‘It’s interesting just to discover the perception of the investment industry about the analysts following your stock, but we don’t use these surveys to target analysts,’ he says. Kiran Bhojani at Germany’s E.On is also adamantly opposed to them: ‘I don’t take them seriously at all,’ he declares. ‘I’ve heard lots of stories about how they are done.’
José Marcos Treiger, head of IR at Brazil’s CSN, which is listed on the New York Stock Exchange, concludes that he tends to look for long-term US investors. ‘As a result, these rankings are not much use; after all, the top-ranked analysts may change from year to year.’
Questioning impartiality
However, other voices in the industry question whether IROs are really as disinterested as they often claim. An online financial communications expert vows that when doing conference calls or webcasts for clients, ‘Some companies specifically ask us to reach these top-ranked analysts and to ask them to be present at their online presentations.’
McGregor also doubts whether IROs really avoid these studies. She says rankings may have their limitations but they are still very useful for finding out who the top analysts are. They tell you who is perceived to be the most influential in the market and who is most highly regarded by the buy side. And as an IR headhunter, McGregor confesses that she often asks top-ranked analysts who they rate as the best IROs in their sector.
However, with more regulations still coming to ensure companies are providing everyone with timely and equal information, IROs must be cautious and not proclaim to the four winds how much they like having the top analysts covering their stocks.
But the real question remains: are those analysts really the best? Or are they just the ones who put on the best appearance in the various annual beauty contests?
