Analysts and investors have been ecstatic over the green shoots they see sprouting in the ravaged U.S. economic landscape, but nowhere are the signs of life more surprising than in the fields of fixed income — ground that not long ago seemed so polluted by toxic subprime debt that many people believed growth would not be possible for a long, long time.
Despite the widespread pessimism of the past two years, however, interest in fixed-income investing is blossoming like never before. Unprecedented financial assistance from the federal government, including its plan to buy up to $1.25 trillion worth of mortgage-backed securities, appears to have gone a long way toward restoring investor confidence in debt instruments (see “The 800-Pound Gorilla in Fixed Income’s Corner”).
“We’ve never had such demand from clients for fixed-income research,” asserts Lawrence Kantor, global head of research at Barclays Capital in New York, noting that a Global Capital Markets Outlook conference in January was so oversubscribed that the firm had to cut off attendance at 1,000 people; last year the same conference drew only 750.
“This year, as markets begin to normalize, the importance of fixed-income research will increase,” says Chicago-based Terrence Belton, who heads up J.P. Morgan’s fixed-income and derivatives coverage.
(Click here to see the All-America Fixed-Income Research Team rankings.)
Although investor interest is rising, the number of firms publishing fixed-income research is down, as one financial institution after another fell victim to the economic crisis that originated in the same fixed-income arena their analysts were covering. In the aftermath of the meltdown, a few key players have emerged, often with their research ranks bolstered by the acquisition of former rivals and their share of the fixed-income market surging in consequence.
BarCap “has grown enormously,” Kantor notes. Industry figures support his claim: BarCap’s cut of agency and Treasury trading grew by nearly 60 percent year-over-year in the second quarter, from 9.9 percent in 2008 to 15.7 percent this year, according to the Federal Reserve Bank of New York, which grants the primary dealer status that allows banks to serve as counterparties in open-market operations and participate directly in Treasury auctions.
Of course, the firm got a huge boost last fall when parent company Barclays acquired the North American assets of Lehman Brothers Holdings, the legendary Wall Street outfit felled by overexposure to subprime-related assets. Among the treasures Barclays got was Lehman’s highly regarded, 165-strong fixed-income research department, which for the previous nine years had captured top honors on the All-America Fixed-Income Research Team, Institutional Investor’s annual ranking of the U.S.’s leading fixed-income analysts. Kantor integrated the ex–Lehman analysts with BarCap’s team of 80, expanding coverage in such growth areas as mortgage strategy and fundamental credit research, scaling back coverage and eliminating positions in structured securities and other areas of declining investor interest and upgrading the firm’s technological offerings to get information to clients faster.
The result? A 160-member U.S. fixed-income research department that outshines all others, according to participants in this year’s survey. BarCap wins 46 total team positions on the 2009 All-America Fixed-Income Research Team, including first-place analysts in 15 sectors; last year, as independent entities, BarCap and Lehman captured a total of 55 positions, including 17 first-place winners.
Coming up strong behind BarCap is J.P. Morgan, which returns in second place but trails the leader by a much narrower margin than before: The firm, which picked up eight fixed-income analysts after last year’s government-backed takeover of Bear Stearns Cos., nabs 42 total positions, six more than last year, including 19 teams in first place — four more than in 2008. Third-ranked Banc of America Securities also returns to the same spot as last year — strengthened by its government-sponsored acquisition of Merrill Lynch — with 34 positions, the same total the two firms earned last year as separate entities.
The only firm in the top five that hasn’t been involved in a merger or acquisition is Goldman, Sachs & Co., which rises one rung to fourth place after gaining four positions, for a total of 22. Wells Fargo & Co.’s December merger with Wachovia Corp. vaults Wells Fargo Securities into the top five for the first time; the firm, with 14 positions, finishes in fifth place, one notch better than Wachovia Securities last year.
Consolidation of formerly separate research departments into a single, smoothly running operation involves not only eliminating overlapping coverage among analysts, but also integrating proprietary technological platforms and establishing relationships with thousands of new clients. That’s a daunting task in the best of times, made all the more difficult by the turbulence that has rocked the markets for the past 18 months.
Joyce Chang, who added oversight of J.P. Morgan’s credit research department to her role as director of emerging-markets coverage in January, following the retirement of Margaret Cannella, says she kept her senior staffers in place while eliminating a number of junior analysts and support personnel positions. “We made a strategic decision to keep our experienced sector analysts and strategists, even expanding sector coverage to include homebuilders and regional banks,” explains the New York–based Chang, who with Luis Oganes leads the top-ranked team in Emerging-Markets Sovereigns & Economics and the No. 3 team in Emerging-Markets Strategy. J.P. Morgan now has 22 senior analysts and strategists covering high-yield and investment-grade sectors and 46 following derivatives. “Keeping that investment has very much paid off in this environment,” Chang adds, not just in revenue but also in growing the firm’s client base.
She also increased the number of publications her department puts out, adding more thematic pieces, such as a “U.S. Banks Stress Test” report, an 80-page tome published in March that outlined weaknesses not only in the financial services sector in general but also at specific institutions — and scooped the federal government’s similar analysis by nearly two months. In June her team launched a weekly Sector Snapshot that includes highlights of each analyst’s coverage area. “As we’ve seen higher levels of defaults, and with new investors coming into the asset class, credit research is more important than ever,” she asserts.
J.P. Morgan researchers are also expanding their use of technology to keep investors up-to-date. In December the firm delivered its year-end 2008 fixed-income market outlook, which covers 14 sectors, exclusively via Webcast so that clients in diverse regions could receive the information simultaneously (or at their convenience), then request published research on the sectors that interested them most. The Webcast garnered 3,100 “hits,” or requests for access. The analysts followed up in June with a midyear-2009 outlook that attracted more than 4,000 hits.
Belton says a key innovation that J.P. Morgan introduced this year is a proprietary system that collates trading information in five-minute intervals throughout the day to identify inflection points affecting various debt instruments, allowing analysts to make immediate recommendations. Using this data the firm introduced an overcrowded-position index in June. Belton’s group has also expanded coverage of agency products, in line with Uncle Sam’s broadened role in the mortgage market.
The government’s hastily arranged (and highly controversial) marriage of BofA and Merrill Lynch left Michael Maras, New York–based director of global fixed-income and equity-linked research, with a battalion of 232 analysts worldwide, many of whom covered the same fixed-income sectors, and two very different cultures that needed to be aligned. For example, Merrill had ceased publishing research on investment-grade instruments, opting instead to use desk analysts, so all of the researchers retained to cover investment grade came from BofA. Conversely, the Charlotte, North Carolina–based bank had moved its mortgage team to the desk model, whereas Merrill continued to publish research on the troubled sector, so Maras shifted some BofA analysts back into publishing.
Desk analysts don’t have the time to focus on areas that aren’t immediately actionable the way that, say, Washington analysts covering health care legislation can, explains Maras, who was in charge of fixed-income research at Merrill before being named to a comparable post at the consolidated firm. “Plus, there is always a question of the independence of opinion with a desk analyst,” he adds.
When all was said and done, the consolidated research department encompassed 122 analysts worldwide, about 80 percent of whom came from BofA, Maras says. Of that total, 38 analysts are based in the U.S., and Maras has encouraged them to coordinate with their overseas counterparts in meeting clients and publishing research on issues that have a global focus. For example, the team directed by David Peterson, No. 1 in Investment-Grade Health Care for a fourth straight year, now covers European as well as U.S. high-grade pharmaceuticals.
Once the staffing issues were settled, Maras turned his attention to ensuring consistency among analyst reports. He opted to keep the rating system Merrill had introduced in the summer of 2008, which the New York firm had created to increase transparency and set parameters for recommendations. Securities are assigned one of six recommendations: They are overweighted or underweighted at 30, 70 or 100 percent, based on a three-month time horizon. For instance, a bond with a 30 percent overweight is one that an analyst believes has a spread wide enough for the carry (coupon minus interest costs) to be attractive, but little potential for spread tightening; a bond with a 30 percent underweight recommendation is one that he or she feels has an unattractive carry, but little likelihood of spread widening. The system gives investors perspective on whether the analyst thinks price or yield will drive returns.
Next, Maras focused on marketing the strengths of the consolidated firm to clients. He found a receptive audience. “The buy side is seeing a significant reduction in resources available to them,” Maras notes. “Plus, they are covering more sectors, so they appreciate and are willing to pay for the availability of published research.”
More changes are in store at BofA-Merrill: Maras says he plans to hire four or five recent graduates to serve as junior credit analysts in areas where senior associates will carve out their own subsector coverage later this year.
Finding those extra analysts may not be easy. Over the past few months, increased revenue has brought banks more resources to devote to research, and rising customer demand has created a greater need for fixed-income analysts, notes BarCap’s Kantor. In addition, foreign firms such as France’s BNP Paribas and Japan’s Nomura Group are in the process of expanding their U.S. presence.
In late July the Federal Reserve Bank of New York named Nomura Securities International one of 18 primary dealers. Immediately following the announcement, Tarun Jotwani, who became Nomura’s head of global fixed-income research in December, announced plans to quadruple his U.S. research team, to 200 analysts, by the end of the year.
“There is a lot more competition for talent,” Kantor says. “We have a lot of people who are getting bids from elsewhere — and we are pleased with our track record of attracting and retaining analysts.”
Even so, BarCap lost one of its most accomplished researchers when Scott Shiffman, who was the top analyst in Investment-Grade Media & Entertainment and Investment-Grade Telecommunications Services for the past five years and the No. 2 analyst in Investment-Grade Technology last year, joined Chapdelaine Credit Partners in June. “I left to pursue this attractive opportunity to be head of research and cover the telecommunications, media and technology sectors,” explains Shiffman, who finishes third this year in Technology and is a runner-up in Telecommunications Services. CCP, a New York–based boutique, is a fixed-income broker-dealer focusing on analytics and trading of investment-grade, high-yield, crossover and distressed bonds.
Despite the heightened investor interest in research and increased demand for fixed-income analysts, few market observers believe that the battered U.S. economy has found solid footing yet. Jan Hatzius, who guides the Goldman Sachs team from runner-up all the way to first place in Economics, expects continued improvement through the rest of the year. “We still expect 2010 to be very weak,” he says.
That means continued volatility, wide spreads and higher risk premiums — all of which add up to big profits for the banks.
“I don’t know where we’re going to end up, but if the next six months are as good as the last six months, the numbers will be very good,” asserts BofA-Merrill’s Maras.
Click here to see the All-America Fixed-Income Research Team rankings.
