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Blame it on the BlackBerry — and on hedge funds. The ubiquitous personal digital assistants and other electronic tools that permit instant, wireless communications from virtually anywhere in the world, coupled with a surge in exacting clients seeking an edge in around-the-clock, ever-more-efficient markets, are profoundly changing the way Wall Street conducts research.
Gone are the days when the news cycle coincided with East Coast trading hours and research operated in a cross-subsidized brokerage environment. Regulatory changes have cut the ties between research and investment banking, so research must now pay its own way, through commission generation. And no one is ringing the cash register louder than hedge funds: Their needs assume top priority. That translates into demand — hear those BlackBerries beep — for a steady stream of long and short ideas in a more-compressed time horizon. “With hedge funds all that matters is the next quarter; with mutual funds it was 18 months,” says portfolio strategist François Trahan of Bear, Stearns & Co.
Combine ravenous investors, an increasingly interdependent global economy, an information explosion and the growing ease of accessibility, and the result is more harried researchers hustling to respond to events quicker and with deeper insight.
“Analysts now have all of 15 seconds to digest quarterly releases before having to provide an opinion,” sums up Jonathan Boersma, vice president for standards of practice at the Charlottesville, Virginiabased CFA Institute, which awards the Chartered Financial Analyst designation.
“There is now so much 24/7 real-time news coverage that you can’t control the rollout of information as much as you used to,” says Charles Gabriel Jr., a Washington analyst for Prudential Equity Group, who finds himself fielding client calls for reactions to events early in the morning, late at night and all weekend long.
In this faster-paced world, investors say, the best ideas, analysis and insights — delivered on demand — come from Lehman Brothers. For a third consecutive year, and by a wider margin than in 2004, Lehman takes first place in Institutional Investor’s annual All-America Research Team rankings, our 34th. The firm secures 52 total team positions, up one from 2004, for a commanding lead over Merrill Lynch, which loses one team position, to 38, and retains its second-place standing. Advancing to third place from fourth is Morgan Stanley, which adds two team positions. Bear Stearns adds five positions and jumps to fourth from sixth, while Citigroup, shedding three positions, holds on to fifth place in a tie with UBS, which loses six positions and slips from third.
Gaining six team positions — the most of any firm this year — is J.P. Morgan Securities, which rises from ninth place to seventh. In eighth place, up one rank, is Sanford C. Bernstein & Co., which gains five team positions. And in a three-way tie for ninth place are Banc of America Securities, up from 11th place; Credit Suisse First Boston, slipping from seventh place; and Goldman, Sachs & Co., down from eighth (see The leaders table).
“We tell analysts that it’s important to be pro-active and call clients first,” says Stuart Linde, director of U.S. equity research at Lehman. “Analysts need to know what their clients are looking for in order to be successful.” Lehman reviews analyst-client calls monthly to be sure the firm is keeping in close touch with its customers. The approach is clearly working: Lehman also leads in overall research strength, which we determine by combining the results of this poll with those of the All-America Fixed-Income Research Team, published in September, which Lehman won for a sixth consecutive year.
Candace Browning, head of global securities research and economics at Merrill, expects her firm’s analysts to be innovative in their customer service. For its part, Merrill is rolling out redesigned research reports this fall that Browning says are “easier to read and easier for clients to find exactly what they’re looking for.”
The firms’ service efforts appear to be pleasing investors, who like what they’re seeing from analysts today more than they did one year ago. Of investors who responded to supplemental questions in the All-America ballots, 92.8 percent said that they are somewhat or very satisfied with sell-side research, compared with 89.9 percent of respondents last year. Nonetheless, these investors think sell-side research quality has slipped, giving it an average grade of 5.84 on a 1-to-10 scale, down from 5.89 last year but up from 5.55 in 2002. Some 27.5 percent of those who responded said that quality has declined over the past 12 months, versus 21.4 percent who said it has improved.
One hedge fund manager complains, “Sure, you can now reach them anytime — nights, weekends, whenever — but it’s pretty unusual for sell-side analysts to find out something we haven’t already found out ourselves.” But another says: “Timeliness of information is important in determining how much credence we give analysts. We look at how recently analysts have updated their information and put more weight on earnings and cash flow forecasts from analysts with more-recent information than their peers.”
Goldman Sachs Software analyst Richard Sherlund, a first-teamer for 17 straight years, says 24/7 connectivity lets him respond to news developments “before I go to sleep, rather than being ambushed first thing in the morning. When clients check their BlackBerries at 6 or 7 a.m., my notes will be there.”
To cope with the flood of information and to speed communication, firms have created structures in which assistants, compliance officers and technology experts stand ready to support analysts around the clock. Although the faster pace has helped to push some researchers toward the exit doors in recent years, many of the top analysts are thriving. Indeed, after rapid analyst turnover early in the decade, a measure of stability has returned. In this year’s 71 sectors, clients return 55 first-team winners to the top for at least a second year in a row — four more returning first-teamers than last year. That’s a retention rate of 77.5 percent for first-teamers this year, compared with a 71.8 percent rate in 2004 and 72.1 percent in 2000. Of the 16 new first-teamers this year, ten individual analysts and one team were ranked No. 2 last year, two analysts were third-teamers, and two were runners-up. Just one first-team analyst was previously unranked; 37 of 342 ranked analysts or teams, or 10.8 percent, are new. Stalwarts return: Top Economist Ed Hyman of International Strategy & Investment Group and Bear Stearns’ veteran Accounting & Tax Policy leader Patricia McConnell make their 26th and 15th straight appearances, respectively.
As important as speed and rapid responsiveness have become, good ideas remain most important — especially in a market that advanced just 2.1 percent this year through mid-September. Many analysts managed to produce substantial gains in sectors that fared worse than the market overall. For example, in Retailing/Food & Drug Chains, which declined by 3.0 percent this year through mid-September, Lehman first-teamer Meredith Adler found a winner in Great Atlantic & Pacific Tea Co. She upgraded the supermarket chain to buy in March, at $12.19, convinced that a major action to enhance shareholder value was coming. A&P delivered in May, announcing that it would sell its Canadian operations. In mid-September the stock was at $27.03, a gain of 121.7 percent. In Airfreight & Surface Transportation, down 17.8 percent this year through mid-September, No. 1ranked Edward Wolfe of Bear Stearns put a buy on freight forwarder Hub Group last December. His call earned mindful investors a split-adjusted 59.9 percent through mid-September. In a sector that was off 0.7 percent year-to-date through mid-September, Lehman first-team Metals & Mining analyst Peter Ward backed copper producer Phelps Dodge Corp. in June 2004 and coal miner Peabody Energy Corp. in August 2004. By mid-September 2005 the stocks had risen 50.4 percent and a split-adjusted 197.1 percent, respectively.
Even in advancing sectors, such as Electric Utilities, which was up 20.2 percent this year through mid-September, good advice adds value. First-teamer Steven Fleishman of Merrill captured a 32.4 percent gain for clients year-to-date through September by recommending Exelon Corp., the Chicago-based company that announced merger plans with Public Service Enterprise Group.
Many valued calls were those that urged a sale. UBS’s Robin Farley, top-ranked in Leisure, steered investors away from Harley-Davidson in January. After they peaked in March, the motorcycle maker’s shares skidded and lost 16.7 percent on the mid-April day Harley lowered expected earnings. In August, Bear Stearns’ top Radio & TV Broadcasting analyst, Victor Miller IV, disagreed with Gray Television’s plans for an asset spin-off and rated Gray an underperform, just before a 15.0 percent price decline.
In what may have been the year’s boldest negative move, Merrill’s Jessica Reif Cohen, who is top-ranked in Entertainment, declared that the pricing target set for Warner Music Group’s May initial public offering was too high. Cohen’s call led Merrill to pull out of the offering, which debuted in May at $17.00, well below the underwriters’ original target of $22 to $24; the stock closed at $18.45 in mid-September.
“At a time when there has been concern about a too-cozy relationship between banking and research, Jessica’s stance on Warner made an important statement,” says one client. Similarly rewarding, if less high-profile, investment insights marked the contributions of the other research professionals who take their place on this year’s All-America Research Team. For investors, in a period when earning even historically average returns would be stellar, the added value brought by the 2005 team is especially welcome.
