The 2004 All-Europe Research Team
In trying times, making it to the head of the class requires insight, integrity and intestinal fortitude. These 275 researchers in 47 categories stand out.
Fined if they do; fined if they don’t. First, equity research analysts were hit with a record penalty for allegedly positive research bias. Now they’re being sued -- successfully, so far -- for writing negative reports. Is there any hope for objective research?
In 2002, Wall Street’s major brokerage firms agreed to pay $1.4 billion to settle charges that their analysts wrote puffed-up research reports during the bull market to help their investment banking colleagues win mandates. The settlement ushered in a range of much-needed reforms as firms buttressed Chinese walls between analysts and investment bankers, openly declared potential conflicts of interest and revived that nearly forgotten piece of advice -- the sell recommendation.
But the success last month of the lawsuit by French luxury goods maker LVMH Moët Hennessy Louis Vuitton against Morgan Stanley threatens to undermine much of the recent progress. LVMH claimed that the firm’s analyst Claire Kent had unfairly denigrated LVMH by writing that the company had failed to keep pace with fashion rival Gucci Group. Though some other analysts shared Kent’s view, their firms weren’t advising Gucci at the time, a fact that evidently left Morgan Stanley open to LVMH’s charge that it had published biased research to favor a banking client.
Should LVMH’s victory -- it won a E30 million judgment against Morgan Stanley -- stand up on appeal, it could encourage other companies to answer analysts’ criticism with lawsuits, pressuring analysts to withhold strong views. Firms may even reduce coverage in controversial areas.
“This is a frightening development because it says if you issue an opinion that is not favorable, you can be sued into submission,’' Stephan Newhouse, president of Morgan Stanley International, tells Institutional Investor. His firm insisted that it would not be muzzled and began moves to press an appeal. Nevertheless, just a few days after the ruling, Morgan Stanley suspended its coverage of LVMH. The “untenable situation’’ created by the lawsuit left Kent “unable to express her honestly held beliefs about LVMH,’' Newhouse said later in a statement.
No less a critic than Eliot Spitzer, the New York state attorney general who initiated the unprecedented U.S. research settlement, said that the French court was wrong to cite the conflicts of interest that triggered his case. “To the extent that the French court found liability without finding that the analyst misrepresented her opinion, I disagree with the finding,’' he told theNew York Times.
The same day that the French court issued its LVMH judgment, Sodexho Alliance, a French contract catering company, announced that it was considering action against Smith Barney Citigroup for an allegedly erroneous research note. That note attributed a sharp rise in working capital at Sodexho’s U.K. subsidiary to previously undisclosed securitizations. The company requested that France’s new regulator, the Autorité des Marchés Financiers, investigate a drop in its share price. Sodexho phoned the analyst, Adrian Cattley, and explained that the securitizations were not new and hadn’t affected working capital. Cattley issued an amended note that accepted the company’s explanations but maintained his sell recommendation. Both sides said they were satisfied with the outcome, though the industry remains alert to a heightened risk of lawsuits.
“Investment banks have done quite a lot of good work to create lots of blue water between analysts and corporate financiers,’' says Keith Jones, chief executive at Morley Fund Management, a unit of British insurer Aviva. “And here we are with analysts under attack from the other side. The last thing we want is a dumbing down of analysts’ views and opinions.’'
Indeed, more than ever, investors continue to crave sharp, insightful research from investment banks, and the firm whose equity research they prize the most, according to the results of the 2004 All-Europe Research Team rankings, is UBS. The big Swiss bank boasts eight first-place winners.
This year Institutional Investor is presenting the best analysts in European equity research in a new way to correspond more precisely with prevailing market practices. In the current issue we reveal the overall European research team winners for pan-European industry sectors, developed-market macro disciplines and Western European countries. In March we will publish the industry, macro and country rankings for the emerging markets of Europe, Middle East and Africa, which were previously included in the February rankings. Last year’s results in the leaders tables have been adjusted to reflect these changes: UBS, for example, is credited with three first-place winners in 2003, when it also finished first on a recalculated basis. Smith Barney Citigroup repeats in second place, followed closely by Credit Suisse First Boston and Merrill Lynch, which tie for third.
The leading firms’ reforms appear to have reestablished a greater rapport with investors. Nearly two thirds of survey respondents say that they trust sell-side research, and quality concerns seem to have abated. Voters rated the overall quality of sell-side research at 6.25 on a scale of 1 to 10 (the highest); the ratings compared favorably with last year’s 5.93 and reversed two years of declines.
Investors retain serious concerns about the state of European equities research, though. Their two biggest worries? Analysts are still too reluctant to criticize companies because they depend on management for information, and -- despite the reforms -- conflicts of interest caused by investment banking relationships may compromise the objectivity of research. (For complete details, see our Web site, www.institutionalinvestor.com.)
Conflicts are “so endemic in the system,’' says Crispin Odey, eponymous founder of hedge fund Odey Asset Management. “Very few analysts are independent thinkers. You can’t write something bad -- you just don’t get access after that.’' The two recent French incidents underscore what many analysts have contended all along: that, in the words of one senior research executive, “your average analyst has far more pressure from corporates than they ever got from investment bankers.’'
Investment banks will have ample opportunity in 2004 to prove they are addressing these and other pressures. London-based banks face a July deadline for complying with new rules from the U.K.'s Financial Services Authority governing potential conflicts of interest among researchers, investment bankers and traders. The regulations bar analysts from participating in investment banking pitches or road shows, restrict dealing by analysts and their firms ahead of research publication and prohibit compensation based on investment banking deals.
The European Commission, the European Union’s executive agency, also is considering a September report from an advisory panel that recommended a set of principles designed to provide greater disclosures and safeguards against potential conflicts of interest. No legislative proposal is expected right away; in the wake of the Parmalat scandal, concerns about equity analysts have given way to worries about accountants. Nevertheless, the big role played by several investment banks in marketing the Italian food giant’s debt and recommending its shares could create pressure for new EU rules on research.
More far-reaching, and potentially more disruptive to current research practice, is another set of proposals under consideration at Britain’s FSA. These would require fund managers to pay for sell-side research out of their own pockets rather than through dealing commissions. The idea of unbundling research costs has been promoted by Paul Myners, the former Gartmore Investment Management chairman who has advised the British Treasury, as a means of increasing transparency in research and reducing asset management costs. Many analysts and fund managers are urging the FSA simply to require greater disclosure about research costs. Mandatory unbundling would cause a fresh shakeout in research departments that have already shrunk substantially, the critics say. The net result, they contend, would be to put London at a competitive disadvantage compared with financial centers that don’t require unbundling.
Whatever route the FSA takes, analysts face growing pressure to show that their research adds value. Fund managers seeking ways to save money are fine-tuning their assessments of sell-side research quality and trying to award more of their commissions to firms whose work they deem most helpful.
Baring Asset Management’s in-house analysts rate their sell-side counterparts twice a year, says chief investment officer Michael Hughes. Last year, for the first time, they rated individual analysts rather than firms, a change designed to identify precisely who is doing the best sell-side work.
“Research has to have real value,’' says Hughes. “Key recommendations -- buy, sell, hold -- are still what it’s all about. You’ve got to make money. But people here do value researchers who can give insight into industry trends, management and the like.’'
Of course, research directors are being asked to confront new legal and regulatory threats and meet demands for more original and tightly focused research without adding staff. In most cases, research department head counts have been cut by 30 percent or more since 2000. Some analysts are simply opting to decamp. William de Winton, who this year co-leads the top-ranked Banks team with Davide Serra at Morgan Stanley, left the firm in January to join hedge fund manager Lansdowne Partners. “The industry is more regulated than it was five years ago and less remunerative than it was three years ago,” says de Winton. “You’ve got to work harder for less. Therefore it’s less enjoyable.”
Few people have more cause to complain about the state of the research business these days than de Winton’s former colleague Kent, the Morgan Stanley analyst at the center of the LVMH affair. The French court ruling publicly questioned her credibility. Kent, whose Luxury Goods team slides to second place this year after six years in first, declines to comment, but Morgan Stanley sources say that it was her decision to suspend LVMH coverage, out of fear that the ruling could make her vulnerable to open-ended liability on any new research she produces.
The case stemmed from the failed attempt by LVMH’s controlling shareholder, Bernard Arnault, to acquire Gucci, a Morgan Stanley client. The research that LVMH cited included a view that its Louis Vuitton unit had reached “maturity.” Unlike some of the notorious abuses that inspired the Spitzer settlement in the U.S., LVMH produced no evidence to show that Morgan Stanley had coerced Kent to write negative opinions. Instead, LVMH relied on the fact that the U.S. research settlement signed by Morgan Stanley had shown that conflicts of interest exist at investment banks. The firm, the French ruling said, “was a source of prejudice for its clients and investors.”
Any litigation that has the effect of muzzling analysts risks curbing the flow of information and distorting markets, says Smith Barney Citigroup research chief Andrew Pitt, who had to deal with the Sodexho challenge. “Is it in the interest of corporate clients to have this happen?” he asks.
“Analysts have to have real independence,” says Philippe Sanlaville, head of equities at French brokerage house Exane. “They must have the right to make an honest mistake.”
The ranking was compiled by Institutional Investor under the direction of Assistant Managing Editor for Research Lewis Knox and Senior Editor Jane B. Kenney with Senior Associate Editor Tucker Ewing. European Editor Tom Buerkle wrote the overview. Contributing Editors Ben Mattlin, Scott McMurray and Mike Sisk and Contributors Pam Abramowitz, Robert Kapler, Rochelle Kass, Leslie Kramer, Suzanne Lorge, Scott Martin, Craig McGuire, Nina Mehta, Michael Rudnick and Paul Sweeney wrote the sector reports that follow.