The writer is a former chief global equity strategist at Citigroup
Let me take you back to September 1989. It was my first day at a long-forgotten UK securities house. The head of equity research asked my father’s profession — a farmer. Perhaps inevitably, I was assigned to the Food Manufacturing team. It was my job to get the coffee, help spread the load on busy results days, prepare stock notes and pore through industry statistics, very much in that order.
My farming background was little help, but I did free up my boss to spend the day calling or meeting investors. It struck me that, for somebody called a research analyst, he didn’t spend much of his time doing research or analysis. Instead, he worked to build and maintain a network across his companies and the investors who owned (or could own) their shares. It was intense work. His main performance measure was the annual Extel survey, which polled institutional investors for their favourite analysts. The most highly ranked were those with the widest and deepest networks, not always those who made the best stock calls. The Institutional Investor magazine survey carried similar significance in the US.
Top-ranked analysts were coveted for the trading commissions they brought in, but also their potential to attract lucrative investment banking business. It was easier for a banker to win the mandate to handle an initial public offering if they had a big name analyst in the sector. “Ranking and banking” was the battle cry of the late 1990s. This led to inevitable conflicts. Were analysts being paid by investors who wanted an independent view, or by companies who wanted a positive case put to the market? This was a difficult tightrope to tread and not everyone succeeded — leading to significant fines and reforms introduced by former New York State attorney-general Eliot Spitzer, which sought to decouple analyst pay from banking revenues. The decline of sellside research had begun.
Whatever you think about the late 1990s model, it did support big budgets and broad coverage of many stocks. Some of that coverage may have been conflicted but, in my experience, analysts were much more motivated by their Extel ranking with institutional investors than their popularity with companies.
Then the buyside started to change. The rise of passive funds drove down the profitability of active fund managers. These pressures were passed on to the sellside via lower commissions. The Mifid 2 rules, which unbundled payments for trading and research, compounded the squeeze. Under the traditional commission-based model asset managers paid for sellside research using client funds. Following Mifid 2 they paid directly out of their own revenues. Predictably, these payments collapsed, a fatal blow for some independent research houses.
Few readers will mourn the decline of sellside analysts, and many will criticise the inaccuracy of their stock recommendations. But that is to neglect a key contrast: on the buyside, performance is everything, while on the sellside, getting stocks right is just a part of the job. Building that network is more important.
I am not trying to justify the continued survival of my profession. The corporate bond markets seem to function well enough without armies of sellside analysts. I’m not convinced that plans to revoke parts of Mifid 2 will reverse the decline in sellside research, which was well established before the regulation arrived. There has always been value in the networks built by the best sellside analysts. However, clumsy attempts to monetise those networks have provoked regulatory crackdowns, and so reduced future revenue opportunities.
Big banks still employ hundreds of company analysts. Alternative financial support for sellside research might come from prime brokerage, derivative trading or wealth management. Investment banking still pays a large part of the cost. The Spitzer reforms helped to safeguard the independence of analysts. But it didn’t stop the cross-departmental subsidy. To quote one large-bank chief executive: “research is a cost of bringing footfall to the franchise”. It might be tough to justify sellside research as a revenue generator nowadays. It’s easier to justify as a marketing expense.
Even if the glory days are gone, sellside company research remains a fulfilling career for the energetic and analytical. It’s a great place to learn how to research companies and build networks — valuable skills in any profession. I eventually moved on to more macro roles, but I never regret where I started. I hope I made my father proud.