Sovereign-debt crises in Europe dominated the headlines throughout much of the past year, casting a pall over economies still struggling to recover from the market meltdown of 2008. Real gross domestic product growth in the euro zone inched up only 1.9 percent year-over-year in the third quarter, according to statistics from the European Union, while unemployment in the region has hovered just above 10 percent for months. The silver lining to those dark clouds is the buying opportunity that arose as stock prices fell.
“We’ve reached a point where equity markets are at a multiyear low in terms of valuations,” says Timothy Whittaker, Barclays Capital’s head of equity research for Europe, the Middle East and Africa. “Many companies have been delivering positive quarterly results and outperforming consensus estimates, making the equity markets an attractive place to invest.”
Not all investment opportunities are created equal, however. “It’s times like these when lots of stocks tend to be treated in the same way, but the ability to differentiate between those stocks is dependent on your understanding of the fundamentals,” adds Jonathan Jayarajan, associate director of EMEA equity research for Deutsche Bank.
Investors need reliable guidance to help them distinguish between shares unjustly dragged down by market turmoil and those that hold little promise for growth. The analysts whom portfolio managers credit with providing the most astute investment insight can be found at Deutsche Bank, which catapults five places to finish in first place for the first time on the All-Europe Research Team, Institutional Investor’s 26th annual ranking of the region’s best equity researchers. The German bank claims a whopping 37 total positions — 20 more than last year — and triples its number of teams in first place, to six.
Deutsche’s stunning advance bumps longtime champ UBS, which had ruled the roost for the past nine years, down to second place, even though the Swiss bank enjoys its own enviable gains, adding six positions, to bring its total to 34 — eight of which are for teams ranked No. 1. In fact, when the results are weighted on the basis of rank, UBS retains the top spot.
BofA Merrill Lynch Global Research also strengthens its reputation as an equity research powerhouse, rising from fifth place to third after picking up seven positions, for a total of 28. Two firms that tied for second place last year, Credit Suisse and J.P. Morgan Cazenove, slip to share fourth-place honors with Morgan Stanley, which vaults from seventh place; the three firms win 23 positions each.
The biggest gainer is Barclays Capital, which rockets from No. 14 to tie for eighth place with Sanford C. Bernstein, last year’s No. 9 firm. BarCap picks up ten team positions, for a total of 12, while Sanford C. Bernstein adds two positions but sees its number of teams in first place soar from two to seven. Results are based on responses from more than 1,900 money managers and investment officers at some 700 institutions managing an estimated $5.6 trillion in European equities. Access the complete results , including profiles of teams in second and third place.
With sovereign-debt woes on many investors’ minds, many firms have been placing greater emphasis on macroeconomic coverage and strengthening ties between analysts and strategists.
“The workload has increased dramatically because of the sovereign crises and other events,” says Stéphane Déo, who leads the UBS team to No. 1 in Economics for a third consecutive year. “The way I do my research has changed — there is a political dimension now, and it is extremely important to have as many contacts as possible in the diplomatic world.”
Sharing political insights with other researchers has become vital for economists, according to Richard Smith, Deutsche’s director of EMEA equity research. “Over the last 12 months, we have made sure to have strong interconnectedness between our economists, who are well plugged in to what is going on with peripheral countries within Europe, and our own company-research analysts,” Smith explains. “We make sure that our equity analysts are on top of what is going in the world around them.”
And what a world! In late April, Standard & Poor’s downgraded Greece’s sovereign-debt rating to junk status; the move — and fears that the country would default on its obligations — sent shivers through world markets. The following week, euro zone countries and the International Monetary Fund agreed to lend Greece up to €110 billion ($146 billion) to shore up its ailing economy — provided that Athens impose a number of austerity measures, including tax hikes, pension and pay cuts for public sector employees and an increase in the retirement age. The agreement sparked protests and rioting, with tens of thousands of angry demonstrators taking to the streets.
As the year continued to unfold, soaring budget deficits in other countries on the euro zone periphery — notably Ireland, Italy, Portugal and Spain — began to resurrect the spectre of sovereign-debt defaults and even cast doubt on the future of the region’s single-currency system. In November, Ireland became the first country to be bailed out with funds from the European Financial Stability Facility, an entity created in the immediate wake of the Greece bailout and one that is backed by euro zone countries, the European Central Bank and the IMF. However, market reaction to Ireland’s €85 billion rescue package was muted, as investors wondered if, when and where another European nation would need to be bailed out — and whether assistance would even be available.
“The political economy began with the Greek crisis,” Déo says. “The clients’ level of sophistication is a big part of the story, because people outside Europe often have difficulty understanding what’s going on. For example, the probability of a breakup was very small — that was very clearly not an option — but people outside the euro zone were talking about that a lot.”
Concerns that the union might unravel were driven in large part by what appeared to be the reluctance of member countries to intercede on Greece’s behalf, but that perception was misguided. “When you take a decision in Europe, you have 16 people bargaining in the euro zone and 27 people in the EU,” Déo explains. “That’s a lot of bargaining — there are many issues — and it can be difficult to get a clear view.”
The uncertainty has been keeping money managers on edge. “Understanding the appetite for intervention is critical; if investors thought there was no appetite to intervene, then some of the sovereign-debt stresses would have become a full-blown financial crisis,” Deutsche’s Jayarajan explains. “Markets need reassurance that there is a willingness to intervene at any cost.”
Deutsche sponsors what it calls “reverse road shows” to help keep clients abreast of developments. “We take investors to see major players in real estate markets, local government officials and central bankers,” says Smith. “They speak to a range of individuals who can give them local color on what is happening and offer unique insight.”
Money managers are interested in learning about developments that will affect not only stocks but also related instruments. “We’ve worked more with our research colleagues in areas such as credit and foreign exchange derivatives to assess the cost of protection in different markets, both to interpret signals coming from asset classes outside of equity and also to see where protection may be the most cost effective,” explains Pamela Finelli, who with Nicolas Mougeot guides Deutsche’s Equity Derivatives team to the top spot. “With an increasing focus on tail risk and a proliferation of funds dedicated to monetizing extreme market events, sourcing inexpensive protection is an ongoing theme these days.”
That theme became more dominant over the past year, she adds. “Since the financial crisis started — and in particular after the May sovereign sell-off — we’ve seen a greater awareness of risk management from our clients,” Finelli says. “We’ve been conducting more customized work for investors who wish to thoroughly analyze how a hedge may change the risk profile of their portfolios — and using equity derivatives to better manage risk remains at the forefront in the minds of many of our clients.”
Downside protection is crucial in a market environment in which all stocks are vulnerable, regardless of their relative merits. That was the case last year, according to Deutsche’s Luis Fañanas Martinez, whose team makes its first appearance atop the ranking in Small- & Midcapitalization Stocks. “It was a period of market collapse where there was no differentiation, everything was collapsing — the good companies, the great and the bad,” the Madrid-based analyst says.
Small- and midcap companies lagged large-caps for the past couple of years, Fañanas says, but that trend is reversing and smaller companies are poised to outperform. To help clients identify likely winners, the team launched a new quarterly publication in July, “Pan-European Quality and Value Selection,” that assesses smaller companies on the basis of valuation, earnings momentum and other criteria.
“We apply the value-investing philosophy, which is trying to select great-quality companies at the lowest possible price,” Fañanas explains. “For us the most important issue is the competitive position of the company and the barriers to entry into the business.”
Smith says more and more clients are looking for guidance in determining which companies are best positioned to deal with the sustained economic slowdown, what impact foreign exchange volatility is having on company earnings and the likely effects of quantitative easing, an often-controversial practice in which a central bank increases the supply of money in an attempt to stimulate the local economy — but at the risk of spurring inflation. Two quant analysts were among the six Deutsche hired, bringing its department head count to 94. The firm’s analysts now track 706 stocks, up from 681 at this time last year, and Deutsche plans to hire six more in the coming year so that it can continue to expand its coverage.
At Morgan Stanley, “demand for more time with our economists and macro teams has been exceptional this year,” says Rupert Jones, head of European equity research. In response the firm launched a series of Blue Papers, in May, that focus on investment themes across regions, sectors and asset classes and include insights from analysts, economists and equity strategists. Topics addressed have included an analysis of the petrochemicals industry and Solvency II, EU regulations that take effect in January 2013 and require insurers to align their capital reserves more closely with the risks to which they are exposed.
The need for more sources of oil has fueled interest in the Oil Services sector, newly added to the survey this year. Martinus (Martijn) Rats, who shepherds Morgan Stanley’s squad to first place, points out that the credit crisis has proved advantageous in that the cost of building new energy infrastructure fell significantly in 2009.
“The reason for this decline was the worldwide slowdown in demand for many different items, such as steel and equipment, and also for subcontracted services,” he notes. “Basically the oil companies were saying, ‘Look, we are sitting on very significant reserves, and the oil and gas needs to be developed at some point. We’d better build these gas-processing plants, refineries and chemical installations now that the cost of infrastructure is very low.’”
The boom in developing new facilities has spurred a rebound in the sector, largely because of increased expectations about future earnings, Rats explains. In addition, he says, “what has been a really encouraging factor over the last 12 months is that oil demand globally has turned out to be strong and robust.”
To keep money managers informed of emerging trends and developments in a time of extreme volatility, Morgan Stanley implemented Sunday night calls. “People want to be updated on key breaking issues such as bank stress tests ahead of the market opening, so we started ad hoc our Sunday night conference calls, which have been extremely well attended,” Jones says.
Morgan Stanley’s 70 European researchers, who increased stock coverage by about 10 percent over the past year, to 800 companies, have also been availing themselves of the expertise of colleagues in Asia and Latin America, to provide clients with broader-based insights into European companies with exposure to emerging markets. “They need to know which companies are best placed to tap into global growth, which means they need us to properly mobilize our global research effort,” Jones explains.
BarCap followed a similar approach. “We have a global research team, and we work with our colleagues based in different regions to understand what is going on around the world,” research director Whittaker says, noting that over the past year the firm has published reports with a macroeconomic focus on issues such as health care and financial services reform in the U.S. and the drug pipelines of global pharmaceuticals companies.
That’s a fairly new concept for the bank, which only began building a global equity research team after Barclays acquired the North American assets of the bankrupt Lehman Brothers Holdings in the fall of 2008. Since then the firm has been aggressively hiring analysts in Asia and Europe. Although Whittaker declined to disclose the number of European equity analysts the firm employs, he does note that his researchers track about 400 companies.
BofA also has been widening its coverage universe; its 100 Europe analysts, six more than the firm had last year, follow 650 companies, 20 more than a year ago, according to Simon Greenwell, head of EMEA equity research. “It was a year when country risk reemerged in the euro zone,” he observes. “Investors continue to seek our input on macro concerns affecting interest rates, growth rates and sovereign debt.”
Clients have also been requesting more information about environmental and corporate social responsibility programs, Greenwell notes. The massive oil spill that followed the explosion of BP’s Deepwater Horizon oil rig in the Gulf of Mexico last April raised awareness of the potential for environmental disasters and the need for better safety and sustainability measures. “It’s on investors’ minds, prodding analysts to look at companies over the long term not just the next 12 months,” he says. The interest in CSR compels analysts “to look at nonfinancial metrics when evaluating stocks,” he adds.
To meet this rising demand, BofA hired three senior analysts in London and two junior analysts in Mumbai to make up its Socially Responsible Investing team, and evidently they have already impressed investors: The group, under the direction of Sarbjit Nahal, is No. 1 in the sector. “For ten years people have been saying SRI is just a fad — well, it’s not just a fad,” declares Nahal. However, he agrees that the BP oil spill has prompted more fund managers to consider factors beyond a company’s financials. “In the past people have said that safety is not an issue, but when you have 11 fatalities and $40 billion in damages, they start to look into the matter,” he explains.
Nahal’s team has been developing a set of metrics that will enable investors to highlight environmental risks that companies may face, and the analysts have published research on issues such as the corrosion of pipelines, safety challenges posed when oil and gas exploration companies look to drill in such areas as the Arctic, and regulatory changes. “We look at how these issues will impact business models to find out which companies can benefit and which could be at risk,” Nahal says. “We look at what issues are on page 43 of the newspaper that are going to be on page one of the paper in five to seven years.”
A key element of SRI is looking at companies that find ways to reduce greenhouse gases and protect the environment through the use of Renewable Energy, another sector added to this year’s survey. The UBS team debuts in the top spot under the direction of Alberto Gandolfi, who (with Per Lekander) also co-leads that firm’s top-ranked team in Utilities, and Patrick Hummel.
Gandolfi says that investors are demanding to know whether governments will continue their support of renewable-energy companies, many of which have subsidized wind- and solar-powered projects, or focus their attention elsewhere.
“Given the economic backdrop, the pressure put on consumers, and rising unemployment, the debate shifted from the high growth prospects of renewables to access to subsidies,” Gandolfi explains. “The market has become too negative on subsidies and has taken the view that troubled governments will not pay for renewables.”
However, with the sector’s stocks at bargain prices, now is the time for investors to take another look, he adds. The UBS team has been publishing reports that emphasize long-term growth prospects as well as current cash flow and valuations. “This is going to be key for the next year,” Gandolfi says. “The news flow will be less intense, now that stocks are discounted, so we are looking more closely at fundamentals. We try to see what return expectations are reasonable.”
Managing expectations is essential in a time of market turmoil, which is why many analysts and research directors temper their long-term optimism about Europe’s equity markets with a note of short-term caution. “Europe still has challenges to face, as many countries are showing large deficits, but it’s unlikely that we’ll see the same kinds of bailouts being necessary,” says BarCap’s Whittaker. With valuations low, “it’s a multiyear opportunity to invest in equities right now,” he adds. Investors looking to avail themselves of that opportunity would do well to seek the guidance of the battle-tested analysts on the 2011 All-Europe Research Team .
