Institutional Investors Magazine's Research Analyst Survey

One of the factors for measuring sell side analysts' performance in an investment bank is the Institutional Investors Magazine survey.  To sum up, the magazine has regional lists of the largest mutual funds, pension funds, endowments, etc.  Hedge funds have their own separate list.  They are known as the Institutional Investor 300 or Hedge Fund 100 lists and are ranked by the number of assets under management (in descending order).  Every year, questionnaires are sent to the buy side analysts asking them which sell side analysts have been the most effective.  The results are compiled and the top three research analysts of each industry covered are named as part of the All-America Research Team (in the US).  The names are reported in Institutional Investor.  Also mentioned are runners-up/up and comers.

There is an excellent article at briefing.com's Learning Center.  It is targeted to inform an individual investor about the process.  An important point is that an analyst's performance and compensation can be affected by this vote.

The goals in the survey are different based on the business models of the investment banks.  Bulge Bracket firms may try to be Top 3 in all industries and regions.  A boutique bank may desire to be top 3 in a particular sector.  One large firm had developed a strategy where they would have a limited focus.  They would be top 3 in the industries that had the most traded securities.  Quite simply, the stocks that generate the most commissions.  Another business strategy was to de-emphasize the regional ranking.  The firm wanted to target the firms that generate the most trading revenue - hedge funds.  Since they do not have the asset base of a Vanguard, Black Rock or Fidelity, their votes are usually watered down.  Institutional Investor's survey is weighted by assets under management.

Clarification on Portfolio Strategies

Yesterday in my summation of a presentation at the Manager Search Conference at NYSSA. I wrote that a portfolio should hold two main strategies: style-based and flexible. I should clarify these two terms. Style-based means choosing a manager that is constrained in a specific market cap or region. Some examples would be managers in small cap value stocks, emerging markets debt or Japanese stocks. A flexible strategy would allow the manager to invest in the best opportunities that they can find. The more famous managers would be George Soros, Paul Tudor Jones and Ken Heebner.

Updated Concepts in Choosing Investment Managers

One of the more interesting presentations at the Manager Selection Conference at NYSSA mentioned in the previous post was regarding selecting the right investment managers for your portfolio.  I am only the messenger here.  The following is list of ideas from the brain of Thomas Latta, Managing Director and CFA.

The financial crisis of 2008/2009 brought an end to the concept that "beating the market" was good enough for investors. If the benchmark is down 50%, is it good news that a manager is only down 45%? This provided a wake-up call to traditional money managers. The challenge is to fix this error but not commit the old error of timing the market.

This can be done by having improved risk management processes, qualitative analysis of managers and building a portfolio from a mix of different strategies. Better risk management involves managers having strict selling criteria, diversification, tail risk management and close monitoring of active risks. When managers are rated, there is a premium on experience, diversity amongst the managers (in terms of training and process experience) and knowledge of behavioral finance i.e. the science of crowds. The portfolio should hold two main strategies: style-based and flexible. However, this increases the need to monitor at a total portfolio level.

The trend for the advisor is to choose funds with concentrated portfolios of 20-30 positions in either traditional or alternative asset funds. This allows the advisor to choose managers with more freedom in investment decisions, that can manage their Beta and have lower correlation with the market.

Another Type of Conference

I had the pleasure of attending a conference that was not sponsored by an investment bank. It was held by one of the CFA (Chartered Financial Analyst) Institute societies and was decidedly more low key. The accommodations were not at a posh hotel but at the society's offices. It was an open event; there were no gatekeepers. Anyone who would pay the fee could attend. There were also no breakout meetings scheduled. Everything was on a presentation basis, either by a single person or a moderated panel.

In general, there was an industry theme - how to find and select good fund managers. Experts from different financial firms such as Brown Brothers, Bank of America Merrill Lynch and Avenue Capital spoke for about an hour on various topics in Wealth Management, took questions from the audience and gave their views on the current state of the markets. It was an opportunity to sell their products as well.

Anyone interested in experiencing a conference without being in a buy side firm can go to one sponsored by their local CFA Institute society. You can go to www.nyssa.org to view a list of conferences to attend. Unfortunately, the food is not as good as an investment bank's industry conference.

Industry Conferences

Buy side money managers and analysts are always seeking insight on the companies currently in their portfolios or on their watch lists. They are looking for any information that would affirm or change their investment thesis. One of the venues where this occurs is an industry conference sponsored by a sell side investment bank. Here, corporate clients such as Intel or Altria will send their officers to speak to the buy side either in a presentation or meeting.

This is where the size or importance of the firm make an impact. In the beginning, the salesperson will invite all their interested clients to the conference. The buy side representative will indicate which corporates they wish to speak to in a group or 1-on-1 basis. This is contingent on the corporates' availability. Some of them will only speak in a presentation setting. Others will desire to have meetings.

Depending on the conference and the sponsoring firm, conferences may or may not be exclusive. So the firm may allow all buy side requests to be approved for attending the conference. Other times, attendance will be tightly controlled. However, for all conferences, meetings and activities (such as golf outings) with corporates are controlled and scheduled by the corporate access team. The meetings and activities are where having a good research salesperson can help a buy side firm. Obviously, for the giants such as Fidelity, S.A.C. Capital or Capital Group; their requests are given precedence. But for a firm on the border, having an advocate that can persuade management to give them a meeting is invaluable and would result in a better broker vote.

A Day in the Life of a Research Analyst

Research analysts have less predictable days than either a research salesperson or salestrader. Their workday is somewhat less tied down to the market's trading hours. They are the experts of an industry or group of companies. Any news that must be incorporated into their models can arrive at any hour of the day. When an analyst has any breaking news, they want to be on the 7:30 morning call. When they are scheduled, they can be found in the office at 6-6:30; preparing for the meeting. At the call, they will present their thesis and answer any questions from the sales force. After the call, they will call their most important buy side clients while the research salespeople are calling theirs. If a particular client is interested in their viewpoint, they will ask to speak to the analyst. A highly regarded and ranked analyst can move the stock price.

Other days, the analyst has plenty of duties to occupy their time. There are financial models to be updated, clients to be called, research and marketing to be done. Analysts have 2 different client universes: buy side and corporate clients. The buy side includes the investors of the securities covered by the analyst. Corporate clients are the companies covered with the analyst. They speak with corporates to keep abreast of any industry news. Analysts also speak with third party sources such as suppliers and customers of the company, journalists and other industry experts.

Analysts also go on marketing trips. They talk to buy side clients about their research ideas. They may visit 4 cities in 5 days and have 15 meetings during the trip. This is arranged by a special analyst marketing group that parallels what corporate access does for company management.

An analyst's performance is measured by how the perform on the:

• Broker vote
• Rating by Research Sales
• Institutional Investor (II) ranking
• Greenwich ranking

Institutional Investor is a famous publication that has "All-Star teams" for each industry. It lists the top 3 analysts annually and has an up-and-coming team for promising analysts. The article is printed in 1 of II's magazines. Greenwich Associates has an annually survey that focuses on the qualitative rankings of the sell side analyst. In this survey, questionnaires are sent to be filled out by the largest buy side firms. The answers are analyzed by Greenwich and results are sold to the sell side.

Sometimes, they are also rated on the trading commissions for the stocks that they cover. This can be unreliable if they cover thinly traded securities.

You may be asking, "What about the accuracy of their recommendations?" Let me reiterate. The buy side is not solely interested on whether a stock is a buy, hold or sell. They are interested in the analyst's thought process and story.

A Day in the Life of a Salestrader

Like a research salesperson, a salestrader's day starts early. They receive the morning call's research via email or in hardcopy and have a separate trading meeting at 7:30. Talk about early. The people that distribute the research are there long before 7:30. There is a review of the yesterday's activities: how many shares were traded, what stocks were particularly active and any other market color. Then the position traders will inform them of any large blocks of stock in the firm's inventory that can be traded. They will be notified of any IPO's coming up.

Salestraders are a firm's filter for their research ideas but the focus is on short term trading. The buy side uses these ideas in hopes of making a quick profit. After the daily call, the salestraders hit the phones with their clients; putting in orders before the market opens. When it opens, there is a frenzy of activity as these orders are executed. 9:30 - 10:30 is the busiest hour of the day. When the investment bank is the lead bookrunner of an IPO, the entire first day is busy as the firm has to make a market in the new security. At other specific times, there will be a burst of trading such as after any Federal Reserve Board meetings or unemployment reports. The last 30 minutes of the trading day are also hectic.

During the day, the salestraders will be in constant contact with his clients - on the phone, through email or instant messages. They will be executing their client's trades at the best price possible. Most of the time the buy side initiates them. At this point there may be conflicts with the position traders. In order to get the best price for their clients, the position traders' p/l statement will be hit. They and management will also approve or deny requests for capital commitment on their client's trades.

After the market closes, there are client reviews and team meetings to attend. Salestraders may have a client dinner or event after the end of the work day. Again, their purpose is to build relationships with their buy side counterparts.

Goals of Research Salespeople

Yesterday, we walked through the activities of research salespeople. So how does management measure the work they do? In five ways:

1. The broker vote of their client base
2. Internal vote from research analysts
3. Market share
4. Commissions
5. Cross selling

The first two indicate how well they are marketing the firm's research capabilities. Market share and commissions are the tangible results. Market share studies are run by third party firms and will be handled later. Cross selling is harder to measure. In large institutions, management encourages referrals to other product lines. In practice, this is hard for salespeople to do because they are staking their client relationship on another person who may or may not provide excellent service.

A Day in the Life of a Research Salesperson

Work in the Securities Division starts early. Most salespeople are in the office for the daily 7:30 AM research call. (This is particularly hard for people in California.) These meetings are run by the product management group. An email is sent before the call with the daily overview of ideas. There may be twenty of them. Product management decides which stories are most compelling based on the content, the reputation of the analyst and how it will affect the markets. Then they ask the analysts to promote their ideas in front of the sales force. There is usually only enough time for three analysts. During the call, the sales force will be asking analysts questions about their research.

After the call, the sales force will call their clients. They will use their knowledge of their clients and their importance to the firm to determine the order of their calls. Some items that will influence this decision are:

1. If the client holds the security in their portfolio
2. If the client is interested in buying or selling the security
3. The time a client wants to be called
4. Amount of trading commissions generated by the client

Generally, the salesperson will reach the voice mail of their client. This is the time when preparing a good script or participating in Toastmasters pays off. If you are able to sell an idea quickly, concisely and accurately, then you will be able to call more clients. They will also send emails. For the largest clients, this all happens from 8:15 - 9:00 AM. Then second tier and third tier clients will be called. If the clients are interested in the research idea, they will call back asking for more details or to talk to the analyst.

After this initial frenzy of activity, the sales desk calms down a bit. Salespeople begin setting up follow-up calls for their clients and the analysts, interacting with corporate access to get their client into a conference or non-deal roadshow, talking to Capital Markets about future IPO deals, sending out any research reports, talking to the salestraders to get market information (or color) and addressing any issues their clients may need help with. At times, this will be interrupted by a "Midday Call". In this case, an analyst will have late breaking news and the process for the morning research call is repeated.

Another call is held after the market closes. Sometimes, the day is recapped. An analyst may appear on the call but the urgency is not as strong as the morning call. It's generally more relaxed. Then the sales force returns to serving their clients and may take the clients for a dinner or an event to build strong relationships - which are the essence of business.

Please note that the times relate to the US markets. Other markets such as London, Tokyo and Hong Kong have their own calls but the process is generally the same. This is true for all the native markets. There are salespeople that cover clients in Europe and Asia for the US markets. For a person in London, the morning call would be at 12:30 PM and the evening call would be at 9:30 PM.

Personalized Information

Access to Intellectual Capital

Buy side firms are hungry for information as more recent and more accurate data give them an advantage when deciding on investments. There are two main sources: the research analyst at a sell side firm and corporate clients i.e. the companies that are covered.

Access to the research analyst through meetings or phone calls is coveted. These interactions with the analyst allow the buy side to understand the thought process behind their recommendations. It is not the actual buy/hold/sell opinion that interests the fund. The meeting would be held with the PM or buy side analyst. During the last two years, there have been staff reductions in the research departments of mutual fund firms. The trend has been towards more reliance on the sell side analyst's ideas since some sectors are no longer covered. Outside of the financial centers (New York and London), research analysts make trips to different regions to discuss their ideas. In the centers, there is a critical mass of firms and the analyst can just take a taxi or train for a meeting. In a regional trip, the analyst may have five meetings in three cities in a day. This is called Analyst Marketing.

Corporate access comes in the form of meetings with important officers of corporate clients such as the CEO or the CFO. There are many formats. Sell side firms sponsor conferences for different sectors and/or regions. Many corporate clients are invited to speak at them and, if they desire, to hold meetings with investors. Another venue is the Non-Deal Roadshow. This is when corporate officials travel to a region(s) to tell their company story to their current and potential investors. They may also set up a Field Trip to a third site. For example, an oil company may have the investors visit a refinery or off-shore drilling rig to experience the business firsthand. These events are allocated by the sell side firm. Here is where the research salespeople spring into action and try to get their clients approved for attending the limited amount of events.

Both types of meetings are very important for client service and, hence, the broker vote.

Serving the Buy Side

Research, Sales and Trading

The main elements of the broker vote revolve around research and best execution. To better understand this dynamic, look at the traditional roles on the sell and buy sides and their lines of communication. On the sell side, there are four main actors: research analysts, research salespeople, salestraders and position traders. Their counterparts at the buy side are research analysts, portfolio managers (PMs) and salestraders.

Sell side research analysts are the idea generators for an investment bank. They follow a sector or industry and get to know the companies intimately through analyzing financial statements, talking to the company's officers, following industry news and speaking to suppliers, clients and competitors of the firm. They compile all this information into opinions about the prospects for the company's business and stock price. This is known as the "Mosaic Theory". The analysts interface with the buy side's research analysts and PMs; giving them their talking points about different companies. Their recommendation is often boiled down to a buy, hold or sell in the press. The buy side is NOT solely interested in that. They are interested in the thinking process behind an analyst's stock recommendations.

Research salespeople are advocates for their buy side clients. It is their job to obtain the resources needed by them from within the investment bank. This may be a meeting with a sell side analyst or getting them into an industry conference. They market the bank's research capabilities by acting as filters - passing on the most impactful research to a client. For example, if a client has a large position in Microsoft, the salesperson will relay any important research reports regarding that stock to them. A better salesperson may relay news regarding Dell and Hewlett Packard as their sales affect the volume of Windows packages are sold.

Sell side salestraders communicate with the PMs and buy side salestraders. They execute trades and are trying to minimize the transaction prices for the buy side. The calculation of any investment return is dependent on the price of the security when bought. They also act as filters of the investment bank's research. Their ideas are more geared to day trading than any long term investing. Most of the orders are originated by the buy side. At times, they will ask the sell side to facilitate a trade by committing capital. This is something only the largest institutional clients are able to ask for and get.

Position traders interact with the exchanges and salestraders. They have a trading book which has a profit and loss (p/l) statement that is measured constantly. When an order comes from the buy side, the broker/dealer's salestrader will execute the trade through the position trader. Ideally, it will be in the book's current inventory. This is where some friction will appear between the sales and position traders. If the salestrader executes the trade at a good price, the customer will be happy and be more willing to allocate trades to the firm. However, a good price adversely affects the trading book and the p/l statement.

All four roles are large contributors to the broker vote. Whether research or trading is more important is firm specific although each side thinks that they contribute more to the vote than the other. Beyond the client service aspect, there are other items that influence commission allocation such as:

1. Is there is a prime broker relationship?
2. Corporate access
3. Does the investment bank sell the buy side firm's funds?

We will explore these factors later.