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Last June, when the Financial Services Authority detailed how the U.K. would implement the European Union’s Market Abuse Directive, fixed-income professionals viewed the new rules as equity-oriented moves that would not change their business. But the FSA’s implementation paper -- laying out how the City will comply with guidelines about revealing research sources, methods and recommendations -- already has had a marked impact. Citigroup and Barclays Capital physically separated researchers from traders; J.P. Morgan divided its team into desk analysts who are allowed to speak to traders and publishing analysts who are not; and Goldman Sachs International has all but stopped formally publishing fixed-income research, although it shares opinions with clients electronically and in person.
“It is uncertain how you can satisfy the requirements [of the market directive], but what is certain is that it applies to fixed-income research,” says Bertrand Huet, European legal and regulatory counsel at the Bond Market Association, the U.S.-based trade group. Huet and his organization have been lobbying the EU to roll back some of the new rules, arguing that they are counterproductive and financially burdensome. The BMA frets that dealers put off by greater cost and compliance hurdles in Europe will simply scale back their fixed-income research. “By trying to promote total disclosure, you end up with regulation that is likely to lead to less information being readily available,” Huet says.
For now that worry remains a distant one. Cheered by handsome market returns -- the Lehman Brothers euro aggregate bond index returned 7.37 percent last year, up from 4.54 percent in 2003 -- investors voted the top three firms of 2004 to the same winning positions in Institutional Investor’s 2005 All-Europe Fixed-Income Research Team. Indeed, the three -- J.P. Morgan, first; Deutsche Bank, second; and Citigroup, third -- increase their total team positions to 48 from 35.
Below these market leaders the landscape changes. UBS jumps to fourth from sixth place, while U.S. fixed-income powerhouse Lehman Brothers -- which recently said it is taking a “hybrid” approach to research’s structural issues in Europe by continuing to publish while clearly acknowledging potential conflicts -- leaps from ninth to fifth. BNP Paribas and Morgan Stanley fall to a tie for sixth place, from fifth and fourth places, respectively. Credit Suisse First Boston and Barclays Capital, which tied for seventh place last year, drop to eighth and ninth places, respectively.
J.P. Morgan benefited from the continued strong growth of credit derivatives, where it has long been a power, as well as from investor demand for structured credit vehicles like collateralized debt obligations.
“In 2003 you made money if you were long credit. But in 2004 fundamental credit calls were not going to make any money; we started focusing on where you are on the curve and started integrating our derivatives products,” says Katherine McCormick, head of corporate credit research at J.P. Morgan and co-leader of the top-ranked Distressed team, who notes that the role of researcher has changed, with quantitative-based strategies becoming more prevalent. “We have added a lot of bodies, and now we are two thirds traditional company research and one third derivatives structure and strategy.”
That’s not to say there wasn’t money to be made the old-fashioned way -- in high-grade corporate credits. Andrew Crawford, investment-grade portfolio manager at Threadneedle Investments, rode the bonds of Britain’s Royal & Sun Alliance Insurance Group for a gain of more than 200 basis points from July to mid-January, a move that he credits to a call by Christian Dinesen, head of European credit research at Merrill Lynch, which finishes in tenth place. “We participated, made a lot of money and are quite happy, thank you,” Crawford says. “I wish it was always like that.”
Unfortunately, it’s not. Crawford and other traditional investors say sell-side research has become geared toward short-term trading strategies more suitable for hedge fund flippers than “real-money” investors. Particularly in an environment where spreads are so tight and volatility is low, some investors complain that the research ideas aimed at them are too often missives intended to generate transactions. Indeed, just 25.6 percent of those who responded to a question about client satisfaction in this year’s survey say they are very satisfied with brokerage firm research, down from 34.3 percent in 2004.
“There are fewer and fewer resources on the research side; the coverage is very mixed, and the comments are not that useful. It was very hard to find value,” says Philippe Graeub, investment-grade portfolio manager at Swiss manager Pictet & Cie., which runs about E1 billion ($1.3 billion) in high-grade credit. Adds Bernard Possa, head of global fixed income at Credit Suisse Asset Management, which runs $8 billion in global bonds: “It’s always good to have someone questioning the consensus, even if they are not right, because it makes you think.”
One researcher the buy-side finds provocative is Matthew King of Citigroup, leader of the top-ranked Investment-Grade Strategy team, who wins high marks for his specific, actionable analyses. “We rate him very highly -- he calls the market well and tends to call it right. His analysis is a lot more detailed and better presented than anyone else’s,” says one investor. A hedge fund investor agrees: “Matt is the first guy I read. He made some interesting curve-trade and capital-structure arbitrage recommendations throughout the year.”
Another leading analyst, Duncan Warwick-Champion of UBS, who leads the winning team in the Investment-Grade Telecommunications, Media & Technology sector, earns praise from investors for his bullish calls on France Télécom and Deutsche Telekom and for his work on the step-up coupons that are such a prominent feature of the European telecom landscape. “He is the top analyst in terms of his understanding of the sector and his ability to read into management and interpret what they are doing and how it is likely to influence the credit metrics,” says one London-based asset manager. A hedge fund buyer adds: “Duncan’s very good on the step bonds; he’s been very clear and comprehensive about covering them, and a lot of people don’t do it. He also doesn’t waste my time.” Investors credit Warwick-Champion’s previous experience at Standard & Poor’s with boosting his mastery of step-ups, since ratings activity can reset the coupons of these securities. “He’s been in the business for a long time, knows the management teams and has a real feel for the direction of spreads. It takes a while to develop that package of goodies,” says one U.S. buyer.
Thomas Crawley, co-head of European credit research at Citigroup and leader of the No. 2 High-Yield TMT team, acknowledges that banks have indeed increased their focus on developing short-term trading ideas at the expense of more traditional research. He too attributes the shorter focus to the growing prominence of hedge fund investors and to credit stories’ being so few and far between. “It’s a simple formula: Hedge funds equal trading. Real-money investors are not motivated to do trades that lead to 5 basis points of relative value; they are not motivated unless there is supply or a major event,” Crawley says.
How the sell-side communicates short- or long-term investment ideas under the new regulatory rules is still evolving. Some firms may choose the route of 12th-place Goldman, which has all but ceased publishing yet still employs analysts and makes trade recommendations. “We are a nonpublishing group nowadays, but we do work with customers and communicate very actively,” says Sandy Rattray, head of a new fundamental strategy effort that replaced the former credit research team and includes equity-focused analysts. “It’s not research, it’s strategy.” Rattray says his group can better serve its clients by providing “actionable strategy” rather than long, traditional research pieces.
Other firms may opt for the desk-analyst approach, which could lead to fixed-income research’s being used in a proprietary role for dealers and their top clients. In this scenario, less-established analysts would be used as publishing faces. Another view is that publishing will attract the best and brightest because they will want to act as a firm’s public face. “Because of the regulatory changes, we’re at an interesting hinge point for where credit research is going,” says Gary Jenkins, European head of fundamental credit strategy at Deutsche Bank.
The ranking was compiled by II under the direction of Director of Research Operations Group Sathya Rajavelu, Assistant Managing Editor for Research Lewis Knox and Senior Editor Jane B. Kenney, with Associate Editor Carolina Santos.
