The best of the buy side 2005

Shifting industry dynamics are forcing institutional investors to carry a greater share of the research burden, but these analysts are more than up to the challenge. Witness their stock picking.

As of late October, with major stock market benchmarks pointed south and colored red, there appeared little doubt that 2005 would go down as a year that rewarded prescient stock pickers rather than slavish market-followers. And as leading asset management firms step up their commitment to developing research talent pools as deep as those on the sell side, the buy side can claim, more than ever, to produce many of today’s best stock pickers.

This year, as we have many times over the past 26 years, Institutional Investor asked brokerage firm analysts who received votes in the annual All-America Research Team survey (Institutional Investor, October 2005) to nominate their counterparts at money management firms -- the ones they consider to be the best at discovering and selecting winning investments, providing guidance and insight and serving investors. In all, more than 550 analysts at 85 securities firms cast votes. The analysts and portfolio managers who drew the most votes in each of nine industry categories constitute our Best of the Buy Side.

This year’s all-stars include perennial favorites Ann Gallo, Harriet (Tee) Taggart and Denis Walsh, as well as other past winners and a trio of newcomers. All stand out for their track records of developing investment ideas and making money for clients.

Four winners come from a single firm: T. Rowe Price Associates, the Baltimore-based mutual fund company that has $245 billion in assets under management. Next, with two top researchers, is Wellington Management Co. ($511 billion in assets). BlackRock ($428 billion), Credit Suisse Asset Management ($327 billion) and Morgan Stanley Investment Management ($424 billion) each produced one winner.

William Stromberg, T. Rowe Price’s research director, attributes his firm’s strong performance to a culture that prizes extra effort and teamwork and nurtures young talent. “We’re big believers in internal research,” he says. “We invest a substantial amount of time and energy into building that research effort, which means recruiting, mentoring and developing analysts’ skills while increasing the amount of responsibility we give them over time.”

Last year the firm had 34 full-time analysts on staff. Stromberg is tight-lipped about exactly how much he has beefed up his team since then (“I don’t want to signal the recruiters”), but he admits that he’s still scouting talent. He’s not alone: Money managers are expanding in-house research to generate winning ideas, compensate for the growing gaps in brokerage coverage and profit from more-open corporate disclosure.

“While many have said that buy-side hiring will slow, the reality is that it’ll probably speed up,” says Michael Mayhew, CEO of Integrity Research Associates, a Darien, Connecticut based consulting firm that evaluates independent research. He observes that sell-side coverage continues to shrink and that Prudential Equity Group has dramatically curtailed, and Wells Fargo Securities has eliminated, equity research in recent months. “These aren’t the last,” he adds.

With so many small-cap stocks orphaned by the Street, institutional investors looking for insight into the shallow end of the market must either pay extra for third-party analysis or do the research in-house. If they choose to do it themselves, they will find a regulatory environment more conducive to buy-side research than in the past. Regulation FD, intended to end selective disclosure of corporate information, has allowed analysts at money managers to build source networks among issuers that in many cases rival those of leading brokerages. Indeed, buy-side researchers often enlist Wall Street in this information-gathering effort by demanding that firms arrange high-level corporate access for them.

What about stock picking, a traditional component of Street analysis? Those featured in II’s Best of the Buy Side have shown that they can generate plenty of stock ideas, thank you, especially in corners of the market where brokerage coverage has evaporated.

Some winning buy-siders have found their best performers on foreign exchanges. Steven Wharton of Morgan Stanley Investment Management has reason to be happy with his bullish call on Sumitomo Mitsui Banking Corp.: Despite its heft as one of the world’s ten biggest banks, it still trades over-the-counter in the U.S. and is covered by only a handful of Western brokerage analysts. The stock was up 50.8 percent for the 12 months ended mid-October.

P. Robert Bartolo of T. Rowe staked a significant portion of his T. Rowe Price Media and Telecommunications Fund’s assets on two Canadian wireless companies that have risen by more than 80 percent in the past 12 months. Meanwhile, his colleague Henry Ellenbogen has discovered alpha overseas in the form of NHN Corp., often known as South Korea’s Google. NHN is up 106 percent this year through mid-October. Deep in the domestic microcap arena, Ellenbogen unearthed the Knot, a Web-based publisher serving the about-to-be-married and newly married; it has gained 104 percent this year through mid-October.

Buy-side analysts today participate more actively in investment decision making than did their predecessors, who were more likely to wait for a brokerage to make a pitch. Increasingly, money management researchers are constructing their own models to test their investment hypotheses before making calls.

Several sell-siders speak of their relationships with their buy-side counterparts as an ongoing dialogue in which they exchange ideas, share information and discuss possible outcomes. One sell-sider declares that T. Rowe’s Technology winner, Scott Berg, “knows more about some of these companies” than sell-side analysts.

One voter says that top Consumer buy-sider Erik Mace of Credit Suisse Asset Management does so much homework that their conversations begin where most other calls end, enabling both of them to explore new territory.

A sell-side counterpart of Capital Goods/Industrials winner David Giroux says that the T. Rowe analyst “essentially knows the answers to 90 percent of everyone’s questions before he goes into a meeting, but still attends to ask questions or because he feels he has not gotten honest answers out of management.”

With the pool of highly skilled buy-side researchers growing wider and deeper, a question has begun to gnaw at research directors: How do you retain the best analysts? As Bob Johnson, managing director of the CFA Institute’s Certified Financial Analyst program, observes, “The attraction of working for hedge funds is a big factor for both buy-side and sell-side firms in retaining proven talent.”

T. Rowe and Morgan Stanley Investment Management encourage top researchers to take on investment manage- ment responsibility. Of the five analysts from those two institutions who make this year’s list, three either manage or comanage a mutual fund; a fourth, Giroux, will join the list of managers next June.

Many buy-side analysts, though, prefer crunching numbers to running money, and they are encouraged to pursue their research bliss. T. Rowe’s Berg, for instance, finds plenty of satisfaction in that realm. He “wouldn’t be good at some of the other stuff” required of portfolio managers, he says.

“Some of our people move into the portfolio manager role; some just want to be analysts,” notes T. Rowe’s Stromberg. “We make sure to keep both career paths attractive.”

This feature was overseen by Director of Research Operations Group Sathya Rajavelu, Assistant Managing Editor for Research Evan Cooper and Senior Editor Jane B. Kenney, with assistance from Associate Editor Donovan Hervig.


T. Rowe Price Associates


As a financial executive at MGM Grand, P. Robert Bartolo caught the investing bug when he worked on the 2000 merger of his company and Mirage Resorts. “I learned how to value companies,” says the 33-year-old. He graduated from the University of Southern California with a business degree in 1994 and then signed on with Deloitte & Touche, where he became a certified public accountant, before joining MGM Grand in 1997. In 2000, Bartolo went back to school, earning an MBA at the University of Pennsylvania’s Wharton School; he joined T. Rowe Price upon graduation in 2002.

With all his fans, the Las Vegas native could be mistaken for one of his hometown’s headliners. Sell-side colleagues especially respect Bartolo’s CPA and industry background. “When you have to dig into the numbers yourself, you have a better understanding of a company,” notes one booster. Another says he “has an in-depth knowledge of models and numbers and knows his companies inside out.”

A winner in 2003, Bartolo follows 35 companies in the wireless, wireline, tower and cable businesses. In January he became co-manager, with Henry Ellenbogen (this year’s Media category winner), of the $1 billion T. Rowe Price Media and Telecommunications Fund. Year-to-date, it was up 9.43 percent through mid-October, while the Standard & Poor’s 500 was down 2.23 percent.

Bartolo looks for companies that have sustainable competitive advantages and managers who are effective at allocating capital. For the past year he has been advising T. Rowe’s portfolio managers to underweight wireline companies in favor of wireless companies and tower operators. Bartolo is especially fond of Canadian wireless companies Telus Corp. and Rogers Communications. He purchased their U.S.-listed shares at about $22 each in fall 2004, and as of mid-October this year, the stocks were at $39.73 and $40.69, respectively.


Wellington Management Co.

Basic Materials

Harriet (Tee) Taggart attracts superlatives the way a proton attracts electrons. “She simply knows more about every chemical company than anybody else in the business,” marvels one sell-sider.

To the Boston-based Taggart, who makes her sixth consecutive appearance on the Best of the Buy Side, chemicals are a springboard to a spectrum of specialty materials and environmental services companies that make up her impressive global roster of 600 stocks; at any one time she keeps 200 under the microscope.

This year Taggart, 57, who comanages Wellington Management’s institutional sector portfolios, profited from her long-standing bullishness on agricultural chemicals companies, especially Potash Corp. of Saskatchewan, a fertilizer supplier. In June, Potash sealed an agreement with China’s state-owned Sinochem Corp. to purchase a 10 percent interest in a new, publicly traded fertilizer spin-off, Sinofert. Says Taggart: “This was a major coup. The only way Western agricultural companies can succeed in places like China is to establish new logistics and distribution systems, and Sinochem controls much of that infrastructure.” Potash shares, which Taggart has favored since mid-2003 on the basis of strong demand for its products, were up 174.82 percent in the 27 months ended in mid-October.

Taggart is known for her focus on valuations. “There’s an appropriate price for everything,” she says. “The goal is to understand how much upside there may be in the share price, or if it’s ahead of where it should be.” In March 2005, for example, when plastics producer Chemtura Corp. (formerly, Crompton Corp.) announced plans to merge with cleanser maker Great Lakes Chemical Corp., many observers were thrilled. Not Taggart. At $14.72, Chemtura stock “more than fully” reflected the combined value of the companies, she says. Although the shares did jump to nearly $18 in August, a month after the merger, by mid-October they had plunged to $10.35.


T. Rowe Price Associates


In just his fifth year as an analyst, T. Rowe Price’s Henry Ellenbogen, 32, makes the Best of the Buy Side for a third year running. Praised by one sell-side counterpart as a “superstar,” the Baltimore-based media analyst impresses colleagues with his big-picture perspective and his nimble stock picking.

Ellenbogen concentrates his research on 20 stocks in a 50-stock universe, while also managing the $250 million media-and-Internet portion of his firm’s $6 billion Capital Opportunity Fund (known to institutions as the Structured Research Common Trust Fund) and comanaging T. Rowe’s $1.5 billion Media and Telecommunications Fund.

His ambit is global. In August 2004, after paying several visits to Asia, Ellenbogen bought shares in NHN Corp., a South Korean Google clone, at the equivalent of $80.84 a share, for the media and telecom fund. His bet: that NHN would imitate the rise of its U.S. counterpart. By mid-October 2005 the stock had more than doubled. On the domestic front the avid bicyclist and onetime water polo player selected two Internet content providers in October 2004: CNET Networks, a producer of technology-related information and other online services; and Knot, a small-cap operator of Web sites offering advice, discussion groups and ads aimed chiefly at brides- and grooms-to-be. He dubbed the two “the MTV networks of this generation.”

Citing CNET’s online destinations dedicated to consumer technology, video games, television and photography, Ellenbogen contends that the San Franciscobased company “is doing a great job of building niche brands that target specific user interests and leverage a common ad sales platform.” Similarly, the Knot, headquartered in New York, delivers a variety of online content and e-commerce shopping links using a common technology infrastructure and sales force. For the 12 months ended in mid-October 2005, the stocks leaped 42.29 percent and 104 percent, respectively.


T. Rowe Price Associates

Capital Goods/Industrials

David Giroux is a man of few words. One sell-side analyst, who covers many of the same industrial conglomerates as the T. Rowe Price analyst, describes this Best of the Buy Side newcomer as “very quiet, very strategic.” When Giroux calls, he says, “it’s because he wants to know what he wants to know -- which are the things that make stocks go up.”

If Giroux is all business on the phone, it might be because the 30-year-old analyst follows a larger-than-average number of companies -- 55, all of them machinery manufacturers. As a result, says the sell-sider, Giroux is interested in “minimizing the B.S. factor and not wasting time.”

Giroux came to T. Rowe in 1998, straight from Hillsdale College in Michigan, where he earned a BA in finance and political economics. He has seen manufacturing stocks trade in the best and worst of environments, and this has fueled his respect for value as a stock-picking criterion.

“If valuation levels and earnings estimates are too low for the wonderful when it happens, they’re in the perfect spot,” he says. Some of Giroux’s favorite stocks over the past year have been Roper Industries, a diversified products and systems maker; Teleflex, a specialty engineered-products manufacturer; and TRW Automotive Holdings. Each is up more than 40 percent since his recommendation. “I covered Roper for three years,” he says, “and didn’t touch it until I felt that it had gotten too depressed.” Giroux made the move near a split-adjusted $19 in August 2003; by this October Roper was trading at $35.72.

Giroux has been tapped to comanage the T. Rowe Price Capital Appreciation Fund with fellow analyst Jeffrey Arricale starting next June. “As far as I’m concerned, it’s completely appropriate,” says one brokerage booster. “He will do it and be polite and diplomatic, but relentless.”


Credit Suisse Asset Management


When shares of May Department Stores Co. dipped below $25 in mid-October 2004, Erik Mace of Credit Suisse Asset Management decided the embattled company was a bargain, despite concerns over its long-term viability. The St. Louisbased retailer, which operated 487 stores in 47 states, “generated a fair amount of cash, and the value of its assets was attractive to a potential acquirer,” he explains.

Sure enough, in late February, rival Federated Department Stores said it intended to purchase May at $35.50 per share. Mace reckoned the stock would go even higher -- and it did, closing at $39.75 on its last day of trading as an independent company in late August.

Best Buy was another undervalued company, in Mace’s estimation. The Richfield, Minnesotabased consumer electronics giant had made significant operational improvements, he says, a development investors hadn’t recognized. He bought Best Buy at a split-adjusted $30.87 in September 2004 -- and watched the price rise to $46.89 over the next 12 months; by mid-October the stock had slipped to $41.00.

In his third consecutive Best of the Buy Side appearance, Mace, a graduate of the University of Virginia and Columbia Business School, is praised by one sell-sider for “cutting through the noise of Wall Street.” Another says that his consistent focus on valuation is “more rational and strategic than the typical retail analyst’s obsession with predicting next month’s sales figures.”

A self-described bottom-up researcher, the 36-year-old Mace monitors 100 companies, offering what he calls “more-detailed thoughts” on 40 of them. His other duties at CSAM, which has $327 billion in assets under management, include comanaging an internal fund.

“Erik and I never have a one-way conversation; it’s more an exchange of views,” says one Wall Streeter. “I like that he lets you know where he stands; that’s different from a lot of other buy-side folks.”


T. Rowe Price Associates


One sell-sider confides that when he and Scott Berg compare notes about the financial technology companies they follow, “we both tend to be a little smarter when we hang up the phone.” Other clients praise the 33-year-old Australian for what one calls his knack for “creating a friendly working relationship.”

Berg, making his first appearance in the Best of the Buy Side, joined T. Rowe Price in 2002 after earning a BA in economics at Macquarie University in Sydney and an MBA from Stanford University. He describes his approach as “standard": reading Securities and Exchange Commission filings on each of the 30 companies he covers, discussing his views with three or four sell-siders (a bull, a bear and one or two in between) and scanning every research note relevant to his stock universe. Declares Berg, “If a sell-sider has taken the time to write a 20-page initiation report, it’s worth my time to read it.”

Since one business he covers, transaction processing, tends to be stable, Berg tries to seize unusual opportunities. One example: a secondary offering by Global Payments in May 2004. Berg thought sell-side models that deemed the stock to be fully valued at the $46 offering price failed to take into account management expertise. Explaining that “I really love their management team,” Berg bought the stock -- and watched it rise to $81.20 as of mid-October.

A believer in the Warren Buffett credo that investment success is more about avoiding mistakes than about finding big winners, Berg shunned online banking facilitator Digital Insight when other analysts, valuing it on untaxed earnings, were enthusiastic. “In early 2004, Digital started reporting on an aftertax basis,” Berg notes, “and earnings per share dropped from 90 cents to 60 cents, collapsing the multiple.” After the drop he started buying. That was in April 2004, when Digital was at $20; in mid-October of this year it closed at $26.09.


Wellington Management Co.

Health Care

Returning to the Best of the Buy Side for a fourth straight year, health care analyst Ann Gallo, 40, of Wellington Management Co., says she continues to learn new things every day. “I still find my job fascinating,” she reports. “I honestly can’t imagine anyone being successful in this business without a passion for what they do.” Gallo clearly has that passion.

“Ann’s knowledge of the health care industry is unparalleled,” says one sell-side analyst. Adds another: “Ann is extremely detail-oriented and is in the know on all of the key issues having an impact on the industry. She also has an extensive network of company contacts and seems to be a step ahead of the Street.”

Gallo, who has been covering health care for more than a decade, draws a distinction between discovering great companies and discovering great stocks. “In some cases the two go hand in hand, but not always,” she says.

The Boston-based analyst started out this year maintaining her big bet on managed-care stocks, despite the sector’s five-year run-up. Her reasoning: Consumer health spending would keep on rising. As of mid-October she still endorsed many of these stocks, including Aetna, Health Net, Humana and PacifiCare.

She also upgraded the hospital sector at the start of the year because “valuations were low and fundamentals did not look like they were going to get meaningfully worse.” By the end of June, some of her favorites -- HCA, LifePoint Hospitals and Triad Hospitals -- were up 43 percent, 45 percent and 47 percent, respectively. They exceeded her price targets, so she significantly reduced her positions. “I was caught off guard by the speed and extent to which the hospital stocks took off, and wanted to lock in profits,” she says.




Denis Walsh of BlackRock sums up his analytic and portfolio management approach to the energy industry in one word: interrelations. “We look at the various microinterrelations within this very broad sector,” says the six-time Best of the Buy Side winner. “We consider not only crude and natural gas but also coal from places like China.” He believes China’s coal-powered industrialization will continue to raise that fuel’s value, even as greater global energy demand drives other fossil fuel prices higher.

Walsh, 45, a graduate of the University of Massachusetts with an MA in finance from Boston College, joined State Street Research & Management Co. in 1999. BlackRock acquired the firm earlier this year, becoming a $428 billion-in-assets behemoth.

“When it comes to understanding the direction of the energy markets, Denis brings the skilled eye of a geopolitical expert,” says one sell-side analyst. Observes another, “Denis has a great working knowledge of the interplay of different fuels and, as a result, is generally ahead of the curve and the crowd.”

Walsh says one of his favorite stocks, because of its “product diversity and multiple lines for expansion,” is EOG Resources, a diversified independent oil and gas company whose shares gained 91.88 percent this year through mid-October.

Similarly, he has been a steady booster of Chesapeake Energy Corp. for both its reserves and its exploration efforts. Shares of Chesapeake, an independent oil and gas company, had risen from $16.41 at the start of the year to $33.18 as of mid-October -- a gain of 102.19 percent. Some of his other longtime energy favorites, including Arch Coal, Consol Energy and Peabody Energy, have continued to perform strongly, up 47.40 percent, 73.64 percent and 95.75 percent, respectively, this year through mid-October.


Morgan Stanley Investment Management

Financial Institutions

Steven Wharton, who is making his first Best of the Buy Side appearance, has a knack for numbers. “He does more thorough modeling than other buy-siders,” says one sell-side analyst, who recalls reviewing earnings models at Citigroup with Wharton recently and having the Morgan Stanley Investment Management analyst “point out areas where I made mistakes.”

Wharton has an extra incentive to get things right: He’s also a portfolio manager. From May 2004, when he came over from Loomis Sayles & Co., through mid-October 2005, his $220 million Morgan Stanley Financial Services Trust returned 11.02 percent, and the firm’s $800 million Morgan Stanley Global Advantage Fund -- Wharton manages its $200 million financial sector portion -- was up 16.62 percent, in contrast to the S&P 500’s 8.16 percent gain for the period. Managing portfolios has helped him become a more effective analyst, Wharton says, because now he “thinks like an owner.”

Wharton follows 24 financial companies, including credit card companies, securities processors, brokerages and superregional U.S. banks. In his 18 months at Morgan Stanley, which has $424 billion in assets under management, he has underweighted real estate investment trusts and banks -- especially regionals -- while overweighting brokerages. He particularly likes Goldman Sachs Group, which he sees profiting from upturns in M&A and equity issuance and from its stake in Japan’s Sumitomo-Mitsui Banking Corp. Wharton also favors Merrill Lynch & Co., whose big private client business is riding a positive demographic trend and which could benefit from a share-buyback program. From mid-May 2004 through mid-October of this year, Goldman shares had risen 27.86 percent and Merrill’s, 13.70 percent.

Wharton, 35, grew up in Columbus, Ohio, majored in economics at the University of Ohio and earned an MBA from Miami University of Ohio. He interned in college at Congress’s Joint Economic Committee and in graduate school at the Luxembourg Stock Exchange. Upon graduation, he worked for two years at the Ohio Public Employees Retirement System. Investing, says Wharton, “is a constant learning process.”