The 2000 ALL-AMERICA RESEARCH TEAM

Wall Street analysts have never enjoyed such prominence -- or courted so much controversy. Being the best means coping with both extremes.

Wall Street analysts have never enjoyed such prominence -- or courted so much controversy. Being the best means coping with both extremes.

By Senior Editors Carolyn Sargent and Jane B. Kenney
October 2000
Institutional Investor Magazine

As in many high-stakes partnerships, relations between investment managers and equity research analysts can get pretty contentious. Investors, desperate to outperform their peers, beat their market benchmarks and shine before their bosses, insist on scads of timely insights and endless hand-holding. Researchers must meet these ever-growing needs while juggling the demands of prickly chief executives and insatiable investment banking colleagues.

And that’s in the good times. When markets sour, as they have this year, the state of affairs can get downright ugly.

In tough times equity analysts ought to be able to add value by steering clients clear of deteriorating companies and putting them in safer stocks that will outperform. But they can’t if they are too busy serving the needs of their other constituencies. For years, investors have muttered about the increasing amount of time analysts spend hustling banking business -- compromising the quality of research while dramatically boosting their annual pay packages. This year, with equity markets sagging and the M&A and underwriting businesses soaring, the muttering has become an outcry.

“Analysts must bring in deals, and there is an inherent conflict of interest there,” says Andrew Barth, director of U.S. research for Capital Guardian Trust Co. “Quality becomes a function of the deal calendar. It’s only natural that the credibility of sell-side research falls as banking steps up.”

One veteran portfolio manager puts it more bluntly: “These guys are selling their souls for investment banking. Today I would just like to work with one intellectually honest analyst.”

To be sure, there’s no shortage of sour grapes in the carping. After all, through mid-September the Nasdaq composite index was down 6.5 percent, the Dow Jones industrial average was off 5.7 percent, and the Standard & Poor’s 500 index had weakened by 1 percent. Half of all the stocks in the S&P 500 had lost value through August. The proportion of winners and losers roughly matches that of last year, but the average highflier of 2000 hasn’t gone up nearly as much as its counterpart did a year ago. And losing stocks have fared about as poorly as they did in 1999. A year ago the geometric rise of a handful of stocks, largely high technology, more than compensated for problems elsewhere. This year technology stocks are part of the problem.

“Stock picking has been very difficult,” says Dennis Shea, director of global research for Morgan Stanley Dean Witter. “I wouldn’t be surprised if that’s contributing to the frustration.”

But the cause of investor disaffection is more complicated than just a tough environment. Declining markets can give savvy money managers a chance to shine if they can identify the gems amid the rubble. And clearly, many of them have excelled. With the limping S&P overweighted toward large-cap growth stocks, active managers picking stocks more broadly -- a not entirely winning strategy in recent years -- have strutted their stuff in 2000. Through June, even as overall returns have fallen, 60 percent of U.S. equity mutual funds had outperformed the S&P 500, the highest level since 1993 -- and five times more than 1997’s low of 12 percent, according to Strategic Insight and Salomon Smith Barney.

Even if managers are doing a bit better, at least relatively speaking, the market’s rocky performance is putting a new kind of pressure on analysts. “When the market or a sector is in a downtrend, a bullish analyst or one whose firm has been involved with recent underwritings is more exposed. There’s not an analyst out there who doesn’t feel stress when stocks aren’t going in the direction of their recommendations,” says Kevin McCaffrey, director of U.S. research for Salomon Smith Barney. “But good fundamental analysis should ultimately lead to good stock picking.”

Frustrations notwithstanding, investors will always crave information and insight from wherever they can get it. And they remain quick to reward the individual analysts and investment houses whose work they deem most valuable, whether for their industry knowledge, dazzling client service, shrewd market calls or access to companies.

The biggest beneficiaries of this recognition in Institutional Investor’s 2000 All-America Research Team are Merrill Lynch and Morgan Stanley Dean Witter. In the first-ever tie at the top in the 29 years of these rankings, Morgan Stanley jumps two spots to share first with Merrill, which has headed the list for the past five years. The two firms enjoy a comfortable lead of nine team positions over last year’s second-place finisher, Salomon Smith Barney, which falls to third, followed by Credit Suisse First Boston, which rises one position to fourth. Two firms share fifth place: Goldman, Sachs & Co. and Donaldson, Lufkin & Jenrette. Goldman drops from fourth, while DLJ climbs from sixth.

The lineup rounding out the top ten remains virtually unchanged. Bear, Stearns & Co. again takes seventh. Returning in eighth place is Lehman Brothers, which gains 12 team positions. PaineWebber drops to ninth, after tying with Lehman in 1999. And J.P. Morgan Securities repeats at No. 10.

Overall, 363 analysts were voted onto this year’s team, down from 384 last year. Most firms lost team positions because the total number of sectors surveyed was reduced from 90 to 82 to reflect the convergence of industries through consolidation, globalization and developing technologies. Among the top ten finishers, only Morgan Stanley, Bear Stearns and Lehman Brothers gained team positions.

Though this year’s first team has many familiar faces -- 57 of the 79 top-ranked are repeaters -- there are a number of noteworthy upsets. Stunningly, the two analysts most widely associated with the bull market fall from the pinnacle: Mary Meeker, the Morgan Stanley Internet phenomenon who reigned over the category since its 1996 introduction, and three-time winner Abby Joseph Cohen, Goldman Sachs’ headline-attracting portfolio strategist. This year the Internet was subdivided into three new categories: New Media, E-Commerce and Internet Infrastructure & Services. Merrill Lynch’s Henry Blodget leaps to the winner’s circle in the first two, narrowly defeating Meeker in New Media and winning handily in E-Commerce, where she finishes second. Morgan Stanley’s Jeffrey Camp wins in Internet Infrastructure. In Portfolio Strategy, PaineWebber’s Edward Kerschner takes top honors, as Cohen falls to third place.

Of the 22 new first teamers, 20 were ranked in 1999, while two appear on these pages for the first time: Banc of America Securities’ Susan Silverstein in Textiles, Apparel & Footwear and Morgan Stanley ‘s Camp in the new Internet Infrastructure & Services sector. One face is very familiar: ISI Group’s Ed Hyman was named Wall Street’s leading economist for the 21st year in a row.

SO MUCH FOR INDIVIDUAL SUPERSTARS. A RISING tide may lift all votes; in down markets, investors raise their voices. This year for the first time, Institutional Investor asked investors to rank the overall quality of sell-side research, and whether they felt it was improving or deteriorating. We received answers on more than 75 percent of the ballots. The results are not particularly flattering for Wall Street.

On a scale of one to ten (with ten the best rating), respondents give Wall Street research a mediocre 5.9 grade. The news gets worse. Forty-four percent of portfolio managers, buy-side research directors and buy-side equity analysts feel that the quality of research has deteriorated over the past 12 months, while just 6 percent say it has gotten better. The remaining 50 percent see no change. To be sure, because this was the first time we asked this question, it’s impossible to compare the results to longer-term attitudes among institutional investors toward brokerage research.

Answers varied by the size of the institution of the respondent, with smaller buy-side firms, which may depend more on Wall Street, somewhat less critical. Funds with less than $500 million under management gave Wall Street its highest marks for research quality: 6.5. The very largest managers -- with the broadest access to sell-side reports and usually the most sophisticated in-house research operations -- gave the sell side the lowest marks, at 5.7. Fewer small investors think quality is falling: 38 percent of managers with less than $500 million say so, compared with half the firms with more than $75 billion. The group most critical of Wall Street research is those respondents working for midsize institutions, with $10 billion to $29.9 billion under management. Some 59 percent think the quality of research has weakened, while just 1.6 percent thought it was improving. Like their largest counterparts, these midsize firms gave research a 5.7 grade.

The complaints are familiar: far too many buy recommendations; sell recommendations that come too late, if ever -- even in a down market. But it’s the pressure to produce banking fees, which investors fear can erode independence and integrity, that continues to grate most on portfolio managers.

The depth of investors’ feelings is striking. “Investment banking is the primary, primary driver behind every decision, from allocation of an analyst’s time to the companies under coverage,” says the director of research for a major mutual fund company. “And that means we must be much more suspect about recommendations.”

Adds a portfolio manager: “Most analysts just go with management’s story. They get brainwashed into believing the hype. There’s very little outside due diligence.”

To some extent, Wall Street’s research directors are used to such criticism. “Investors have always said that the quality of research has never been worse. It’s like complaining about the weather. It’s an old story,” says Jack Blackstock, head of DLJ’s U.S. research operation. But, he concedes, “in a broad sense, and it’s unfortunate, our relationship with the buy side has become more distant. Electronic dissemination makes communications faster, but there’s a trade-off in that it depersonalizes things. And with a deal calendar that has been this busy, analysts get pulled in many directions.”

Analysts have their hands full trying to follow companies that are rapidly changing shape and direction: embracing new technologies, going global, acquiring and shedding operations. Institutional investors will have a hard time getting analysts’ minds off their banking work. Even after the spring rout in tech stocks -- which sent the Nasdaq down 37 percent in about ten weeks -- deal flow, and therefore investment banking business, will likely still reach record levels this year.

New equity issuance through mid-September, at $158.5 billion, is not far from 1999’s full-year $169 billion record. Deal size has soared in recent years, from an average $71 million in 1996 to $237.5 million today, meaning intensified competition for fewer, but more lucrative, deals. Merger and acquisition activity is also robust, with 7,735 transactions announced through mid-September valued north of $1.36 trillion and approaching last year’s $1.56 trillion total, according to Thomson Financial Securities Data. Underwriting alone has generated at least $8.5 billion in fees this year so far. “Over the last several years, there was so much deal volume that analysts were hard-pressed to do their jobs the way they had grown accustomed to,” says Morgan Stanley’s Meeker.

Although trading commissions, which once amply funded research departments, have risen nicely in recent years, their per share payout doesn’t stack up against underwriting fees. As one investor puts it, “The bottom line is that trading commissions of 5 cents a share can’t touch the 60 cents a share that comes with underwriting.” With the rise of new electronic trading systems and discount brokerages, the growth of commissions at the major firms is expected to slow in the future. According to the Securities Industry Association, total commissions at the major firms and national brokerages hit $9.5 billion last year, well below the roughly $24.6 billion in overall investment banking fees.

TO BE SURE, SOME ON THE BUY SIDE REMAIN
champions of the value of sell-side analysts. “Some research is extraordinary, far better than anything I saw 20 years ago,” says one investor. “There are more analysts publishing, and they are often better trained, with MBAs or CFAs. And thanks to today’s compensation, the field is probably attracting even smarter people.”

Not surprisingly, Wall Street’s research directors agree. “Research is so much better than it was ten years ago because the process is much more efficient,” says Steven Hash, director of U.S. equity research for Lehman Brothers. “The reality is that technology frees analysts up from more mundane reporting functions and research teams are bigger -- providing more support -- so analysts now have the time to think more, to do more theme-based research. Ultimately, what you get is much better.”

The best may be yet to come, some research directors say, in part because the Securities and Exchange Commission’s new fair disclosure regulations may put analysts back on the track of fundamental analysis. Regulation FD, which takes effect on October 23, aims to make any material information about publicly traded companies available to all investors -- at the same time.

In concept at least, Reg FD will put a premium on the hardworking analysts who do the nitty-gritty research on a company’s or industry’s prospects -- rather than those with friends in high places. “The analysts who have an information advantage because of high-level management contacts will see that advantage slip away,” Salomon Smith Barney’s McCaffrey says.

Most sell-siders say it’s too early to tell how Reg FD will play out, though they expect it to make companies more cautious about how they interact with the Street (see story, page 42). “We may see more and more value coming from those analysts that are putting together the mosaic themselves, rather than taking the picture as it is given to them by management,” says Sallie Krawcheck, director of research for Sanford C. Bernstein & Co.

“The quality of research is not in massive decline,” says DLJ’s Blackstock. “With changes that make communications faster, and with the advent of Regulation FD, an analyst cannot simply be a conduit for information. That’s why I say we’re potentially on the cusp of a golden age for research, not its funeral.”

Any new development promoting independence should help, because other influences are making it even more difficult for analysts to criticize the companies they cover. Corporate managements, compensated in equity options for stock performance, have become more bold in punishing analysts who fail to toe the party line. Venture capital firms, which typically hold stock in corporations that have recently gone public and now control many of the hottest private technology companies, can coerce analysts by threatening to withhold banking business on future IPOs. And surprisingly, in light of their criticism, there’s tremendous pressure from fund managers not to go negative on companies in which they have big positions. “That’s the great irony of our business,” says Lehman Brothers’ Hash. “Portfolio managers don’t want us to downgrade stocks.”

The pressures felt by analysts don’t all come from outside their firms or even from their investment banking departments. Rapid consolidation within the brokerage industry is changing research, too, raising new questions about analysts’ roles. In just the past four months, four of the top 12 ranked firms in our poll have been acquired: Sanford C. Bernstein, DLJ, J.P. Morgan and PaineWebber. And Schroder & Co., ranked No. 15 last year, folded its U.S. research operation early this year. It’s much too early to specify the impact, but investors who use these firms’ research see little reason to cheer.

At CSFB, which is acquiring DLJ, Alfred Jackson, head of global research, says there shouldn’t be any concern that research quality or objectivity will diminish following the integration. “We have a strong tradition of letting people say what they want,” he notes.

CSFB could wield a lot more clout in what it says, soon. If the newly combined research department were able to retain the highest II-ranked analyst in each of the categories surveyed this year, CSFB would catapult to the No. 1 spot to beat Merrill Lynch and Morgan Stanley by two team positions. Even so, duplications would probably eliminate about ten II-ranked analysts -- and more than 25 analysts in total -- rich fodder for competitors. Integration -- and CSFB’s dominant role as acquirer -- is bound to lead to more fallout.

The combinations of PaineWebberUBS Warburg and J.P. MorganChase Manhattan Bank also significantly bolster both acquirer’s research departments. UBS Warburg, gaining 18 team positions from PaineWebber, would finish in PaineWebber’s spot at No. 9 with 19 team members. And Chase, with J.P. Morgan’s 17 positions, would finish at No. 10 with 18 total positions.

Investors also acknowledge the pressures inherent in their relationship with the Street and the value that analysts can offer. “We’ve had conflicts for a long time, though it may be more of an issue now, as investment banking fees rise and commissions go down,” says Gary Steiner, a senior analyst at Awad Asset Management. “The quality of research has always been hit or miss, depending on the firm and analyst. Plus, analysts add value in different ways. An analyst might not be great at modeling or spend a lot of time on proprietary research, but he may still add value by calling clients with informational updates.”

That said, institutional investors are starting to take matters into their own hands. Portfolio managers report that they make less time to talk with new sell-side analysts and sometimes refuse face-to-face meetings with researchers altogether. “I stopped meeting analysts in person when I looked at my portfolio and realized that I did not own any names or any ideas that came from the sell side,” says one. “Now I just rely on two guys I really trust.”

In many cases, the largest institutional investors are trying to strengthen their direct relationships with companies. Analysts and salespeople sometimes find themselves shuffling around out in the hall during the very meetings they arrange between company executives and portfolio managers. “A lot of investors leave the analyst or the salesperson at the door,” says Capital Guardian’s Barth. “If we think it’s an important meeting, we’ll ask them to wait outside, too, because we can pick up a lot more information without them.” As a general practice, Fidelity Investments discourages sell-side analysts from attending meetings during nondeal road shows. American Century Investments, Prudential Investments and Putnam Investments are just a few of the firms that do the same.

A large number of firms use analysts in more limited ways than they once did. “It’s now a servicing job,” says one former sell-side analyst who has switched to portfolio management. Adds a buy-side analyst, “I’ll pay analysts for access to management, a timely flow of information, field trips, facility tours and -- if I’m not up on it -- an industry primer.” Stock picking, once a researcher’s most important job, these days takes a backseat. This year, when asked to rank the importance of securities recommendations, investors place it seventh out of ten leading analyst attributes, ahead of only broader equity services such as the quality of a firm’s sales force, market making and primary market services; in 1999 investors ranked stock picking fifth, while in 1998 it was the No. 2 attribute, following industry knowledge. “As an investor,” one client notes, “you’re not taking their stock picking at face value.”

Where, then, will investors turn for stock picks? To their own research departments and independent research firms. Many investment firms, from giants like Putnam and Franklin Templeton Group to midsize firms such as Pioneer Investment Management and Lord, Abbett & Co., are spending more lavishly to build up their internal research capabilities. And many more say they are using hard-dollar research firms, such as the Center for Financial Research & Analysis; OTA/Off the Record Research; Gartner; Simmons & Co. International and Midwest Research, to get unbiased views on individual stocks or industries.

THE TENSIONS BETWEEN WALL STREET ANALYSTS and investors are running high right now. Is there any prospect of a reconciliation? Some buyers say the tide may be turning as deal flow, still strong, gives indications of flagging over the next year. “It’s very early yet, but I do see signs that analysts are getting back to good fundamental work,” says a portfolio manager. “They understand that as the deal calendar slows, they can add value in other ways.”

As many analysts will attest, investors are a tough group to please. Even the prospect of fewer distractions and better fundamental research doesn’t thrill everyone. Some giant asset managers say the narrowing scope and occasionally slipshod quality of sell-side analysis creates a less efficient market -- just the sort of environment they love. “We don’t mind that sell-side research has declined,” says Capital Guardian’s Barth. “It has only created more opportunities for us, and that’s a good thing.”

PICKING THE TEAM

To select the members of this year’s All-America Research Team, Institutional Investor sent questionnaires covering 82 industry groups and investment specialties to the directors of research and chief investment officers of major money management institutions. Included were those managers on the II 300, our July ranking of the largest institutions in the U.S., as well as other key U.S., European and Asian investors. Directories and industry data sources were tapped to ensure that the survey universe was complete. We also contacted key institutional clients from lists submitted by Wall Street research directors and sent questionnaires directly to analysts and portfolio managers at many top institutions. In total we mailed ballots to more than 725 institutions.

Rankings were determined by using the numerical score each analyst received. Scores were produced by taking the number of votes awarded to an individual analyst and weighting them based on the size of the voting institution and the place that the respondent awarded to the analyst (first, second, third or fourth). For Convertibles, Equity Derivatives, REITs and Washington Research, votes for all analysts covering those fields at each firm were combined; we then highlighted the head of the team effort in the commentary.

To meet this magazine’s production schedule, analysts who changed firms after August 7 are cited at their previous organizations. The acquisitions of Donaldson, Lufkin & Jenrette, PaineWebber, J.P. Morgan Securities and Sanford C. Bernstein & Co. were not recognized this year, as none had closed by our cutoff date. Several analyst moves took place after the cutoff this year. Eric Sorensen, who takes third place in both Quantitative Research and Equity Derivatives, left Salomon Smith Barney to join Putnam Investments, and Stephen Shobin, the first-teamer in Technical Analysis, retired from Lehman Brothers.

Sectors are organized into broad industry groups: Basic Materials, Capital Goods/Industrials, Consumer, Energy, Financial Institutions, Health Care, Media, Technology & the Internet, Telecommunications and Macro. The sectors were determined by Institutional Investor in consultation with buy-side and sell-side research directors.

We’ve made several changes to the sector lineup this year to reflect the changing economy. The Internet & New Media has been subdivided into three categories: New Media, E-Commerce and Internet Infrastructure & Services. Data Networking and Wireline Telecommunications Equipment were combined to reflect convergence. We also combined a number of overlapping categories: Railroads and Trucking now form Ground Transportation; International and Domestic Oil make up a single Integrated Oil sector; Nonferrous Metals and Steel have been put together into a single Metals (including Steel) category; Agricultural and Major Chemicals are both captured in the Commodity Chemicals sector; and last year’s Electronics/Connectors & Other Components has been folded into Electronics Manufacturing Services. Gaming and Lodging have been rejoined as a single sector, as have Cosmetics & Personal Care Products and Household Products (now Cosmetics, Household & Personal Care Products). Engineering & Construction and Technical Software were eliminated. We also renamed some categories for clarity: Leisure Products/Leisure Time became Leisure; Photography and Electronic Imaging was rechristened Imaging Technology; S&Ls and GSEs was renamed Mortgage Finance. We also added IT consulting to Computer Services.

The identities of the survey respondents and the institutions that employ them are kept confidential to ensure their continuing cooperation. The opinions of more than 2,500 individuals -- representing approximately 90 percent of the 100 largest U.S. equity managers, as well as more than 300 other key money management firms -- were tapped.

Our reporters spent weeks on the phone with voters to learn more about the analysts they had selected. In addition, many of the winners were contacted to clarify points their clients raised, to confirm certain stock prices and to get their own assessments of the year gone by.

Here, then, is our ranking of the best brokerage firm analysts in 82 investment areas, along with synopses of what makes these individuals stand out from the crowd. It was compiled by Institutional Investor staff under the direction of Senior Editors Carolyn Sargent and Jane B. Kenney with Assistant Editors Sivert Hagen, Erika Ihara and Curtis Yoshioka. Sargent wrote the introduction; Contributing Editors Pam Abramowitz, Andrew Bloomenthal, Jeanne Burke, Mary D’Ambrosio, Mary Dubas, John Hintze, Suzanne Lorge, Ben Mattlin, Ellen James Martin, Scott McMurray, Giles Peel and Melanie Waddell wrote or edited the sector reports that follow.

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