For the complete 2002 All-Europe Research Team results please go to the Research & Rankings section of this site.
Following a horrid summer for European stocks, HSBC Investment Bank last September took the unprecedented step of ordering its 400 analysts worldwide to begin issuing as many sell recommendations as buy advisories. Concerned that investors had lost faith in the integrity of brokerage firm analysis, global research director Mark Brown also forbid the analysts to put holds on stocks unless they expected the shares to move less than 5 percent in either direction in the ensuing 12 months.
There was more. The researchers were told that they would have to rank stocks within any given sector from most to least promising. And to reinforce the message that its analysts, sole intent was to select the best-performing shares, HSBC put down its own money. The firm publicly unveiled a E53.1 million ($50 million) fund it had created in January to invest in its best research ideas and said that it would institute an annual performance review of all its stock picks. No other investment bank had taken such radical steps to put itself back in institutional investors, good graces.
Roughly six months later Brown considers the campaign a success. Less than 5 percent of all HSBC recommendations are now holds, down from 38 percent last summer. Buys and sells are roughly equal at about 5 percent, and the remaining recommendations are split almost evenly between accumulate and reduce. And, by the bye, HSBC's fund managed to end 2001 up 15 percent.
"We,ve forced our analysts to clearly take a stand," says Brown. "They can no longer hide behind hold ratings."
Perhaps, but he hasn,t quite persuaded many investment managers, who remain skeptical that researchers can satisfy their diverse and demanding constituencies while still generating first-rate analysis. "What HSBC did is a move in the right direction," says Stuart Gilmartin, a money manager at E252 billion SG Asset Management in London. "But the most reliable ideas come from our own team, and nothing is likely to change that opinion." Investment banks still produce "very few sell recommendations, even the obvious sells," says Alexander Zavratsky, an analyst in London with Fidelity Investments, which handles E49 billion in European equity assets.
HSBC's directives were, at least in part, a public relations exercise, but their boldness points up the severity of the brokerage firms, problem. For several years investors have grown increasingly upset with securities analysts, convinced that they had abandoned fundamental, independent research in favor of more lucrative investment banking assignments. But in 2001, with markets plummeting and the volume of IPO and M&A transactions suddenly sliced in half, analysts needed their core clients -- institutional investors -- more than ever. As Leslie Manookian, head of both the European portfolio management and in-house research teams at E473 billion-in-assets Alliance Capital in London, puts it: "IPO entry is not the key now. It's trading ideas that are key."
Brown was not alone in trying to address investors, concerns. Merrill Lynch and Morgan Stanley, for example, have forbidden analysts from owning stock in the companies they cover; they and other firms are making a bigger effort to disclose banking relationships. Merrill and Citigroup/Schroder Salomon Smith Barney are among the firms that now review their ratios of buys to sells, to ensure that they,re presenting a balanced view. Merrill,s European sell recommendations have risen to 7 percent of stocks covered from 1 percent about a year ago.
The ostensible shift toward fundamental research reflects a more practical fact of life: a wretched market. Following a 2 percent decline in 2000, European stocks dropped 22 percent last year, with technology shares down a sickening 42.5 percent in the worst overall stock market performance since 1990. There were no sovereign safe havens. Although Nokia Corp.-dependent Finland offered the worst country returns, -34.2 percent, the German market fell 19.8 percent, France declined 21.97 percent, and the U.K. slumped 16.15 percent.
The collapse wreaked havoc in equity-related deal making. Share issuance fell to E103.1 billion, from a record E229.2 billion in 2000. European IPOs dropped by 65 percent, to E35.1 billion, according to Thomson Financial. M&A activity, largely driven by soaring equity prices in recent years, plunged from
E1.89 trillion to E850.1 billion in 2001, according to Dealogic.
Deal making -- and the market -- also suffered from an adverse regulatory environment. Last year the European Union's competition czar, Mario Monti, scuttled unions between French electronic and electrical equipment makers Schneider Electric and Legrand, Sweden's packaging company Tetra Laval Group and French packing-equipment maker Sidel and the Netherland's SCA Mölnlycke Holding, a unit of Swedish papermaker and packager Svenska Cellulosa, and the Metsä Tissue unit of Finnish rival Metsä-Serla Corp., among several others. "It's hard to pinpoint why this is happening," says François Gouws, UBS Warburg's head of pan-European equity research, "but a regulatory tightening" of this sort naturally inhibits deal making and undermines stock prices.
All of this bad news has hit close to home. Companies almost everywhere have lowered bonuses, and layoffs in the research departments of some firms hit about 10 percent in the past year, estimates one London-based recruitment specialist. Many of these reductions, says the recruiter, have come in the once high-flying technology, media and telecommunications, or TMT, area.
That's not to say that the sky is falling. The total market cap of European Union members, stocks fell in 2001 to E11.32 trillion from E11.85 trillion in 2000, but longer term the trend is exceptionally strong: Financial services consultant Freeman & Co. calculates that market caps are still up 66 percent since 1997. And Europe's much-discussed new equity culture remains alive. Joining a host of its neighbors, Germany, Europe's biggest economy, last year passed major pension reforms that will permit employees to allocate some of their savings for stock purchases. The country also launched important tax changes that will, at long last, allow big companies such as Deutsche Bank, DaimlerChrysler, Allianz and others to start unwinding their cross-shareholdings. The hope of investors is that they will use the money to pursue their corporate strategies more aggressively and with greater sensitivity to shareholders.
Last year also saw the continued resurgence of European banking giants, which is reflected in the results of Institutional Investor's 17th annual All-Europe Research Team. In 2001 Credit Suisse First Boston, following a large-scale restructuring of its research department, jumped from fourth to first. This year its Swiss rival UBS Warburg treks a similar path, soaring from fourth to the top spot, nudging CSFB into second. The number of UBS team members skyrocketed from 31 to 46. Right behind the Swiss universal banks stands the German version, Deutsche Bank, in third. Also gaining ground: Citigroup/SSSB, advancing to fourth from sixth. Two of the U.S. research titans of the bull market, Merrill Lynch and Morgan Stanley, lose ground. Merrill, second a year ago, falls to fifth place, losing ten team positions. Morgan Stanley, which finished second as recently as two years ago, slides to sixth this year from fifth in 2001.
The rising popularity of research produced by European houses isn,t lost on money managers, who associate some of the excesses of the bull market with the U.S. firms. "Some brokers pushed too far down the investment banking road, and fund managers have grown pretty cynical of analysts who get paid more for deal generation than for independent research," says Rupert Carnegie, head of research and strategy at the E147 billion Henderson Global Investors in London. "It was a very real issue for some of the New York houses, and they are now backpedaling."
Not surprisingly, researchers are scrambling to tighten their relationships with fund managers. Many research firms are trying to service clients better by viewing European stocks from a global perspective, a goal that gained urgency in 2001 as all of the world's economies began a synchronized descent. "Last year proved that the markets are globally linked," says Timothy Huddart, director for European, Middle East and Africa research at Merrill Lynch. "Putting stocks and regions in a global context" is vital, says Nimrod Schwarzmann, head of European research at Deutsche Bank. "Everyone is desperately trying to do this, in part because of the globalization effects on the client side." Adds Al Jackson, CSFB's global research head: "You either go global or pack your bags and go home. It's what clients want."
Broad thematic decisions about sectors have become more important than ever. In the past few years, the most important discussions among Henderson's portfolio managers have been whether to be "in or out of TMT." Given Europe's growing legion of international competitors in these areas -- ranging from Deutsche Telekom to Vodafone Group, Vivendi Universal and Nokia -- it,s impossible to be an astute stock picker without reviewing global market data and trends. Are these companies superior to NTT DoCoMo, AT&T Corp. or China Mobile? Henderson set up its own group nine years ago to assess global sectors and themes and has only recently begun to see the sell-side firms catching up. "There is progress, and channels of communication at the brokerage firms have begun to open," says Carnegie, who thinks that much work remains to be done. (In keeping with the trend of reviewing sectors more broadly, II this year has eliminated distinct U.K. industry categories and is only ranking analysts in industry sectors across all of Europe. We have retained country categories to highlight particularly strong local research and continue to monitor the best macro researchers.)
As always, there's no shortage of suggestions from the buy side on what's needed. Steven Ho, a buy-side analyst at J.P. Morgan Fleming Asset Management in London, which runs £40 billion ($58 billion) in European equities, would love to see more cross-border fundamental analysis -- such as a comparison of operating margins for competitors across jurisdictions -- as well as sensitivity analysis models that can be adjusted for currency, interest rate, inflation and other macroeconomic assumptions.
Research directors agree that their rapid transition, in less than a decade, from country-specific analysis to pan-European sector comparisons to global research hasn,t proceeded seamlessly. Newly christened global research directors too often have been simply coordinators who glommed local research and turned it into worldwide research pieces. Often the New York- or London-based research chief continued to be responsible for local coverage.
In addition to putting European research into a global context, brokerage firms need to find other ways to make their research stand out from the crowd. "On earnings days I never pick up the phone," says Fidelity's Zavratsky. "I have 50 people calling me, telling me whether earnings will be up or down. It's really quite awful. You can overlay most reports, and they say the same thing."
Complaints like Zavratsky's are common among investors who would much prefer a single great trading idea or a nugget of information to another explanation of that morning's news. Everyone wants an information edge, and the investment banks are trying hard to provide it. "In general, the trend is moving away from maintenance research like following earnings releases. It's a must to differentiate yourself," says London-based Caroline Bault, head of European research at Commerzbank Securities.
One beneficiary of these demands: local brokerage houses, a group many had given up for dead only a couple of years ago. These regionals, specializing in a particular country or industry and usually operating without a big investment banking arm, can offer valuable insights not available from global investment banks.
Sarah Caygill, a Geneva-based investment manager, says she often relies on French brokerage firm CAI Cheuvreux, in both France and Nordic countries. "We do a lot of fundamental number-crunching work ourselves but would never put
on a position, especially not a short, without talking to a local broker," says Caygill, who co-heads Doyle Caygill Capital, which advises White Mountain European Fund, a new,
E13.5 million long-short hedge fund. "Where houses such as Cheuvreux are invaluable is providing insight into what the market mood is. Even if your fundamental view is right, it makes no sense to fight the market."
Although they can,t always provide the best local color, bigger firms can offer customized -- or bespoke -- research. Driving this trend are European hedge funds, which grew from E32 billion under management in 1999 to E51 billion in 2000 and which were estimated to have ballooned another 62 percent last year, to E82.4 billion, according to a Goldman Sachs study. Because this group trades so frequently (their portfolios often turn over 25 times in a single year), they are voracious consumers of trading ideas. And they,re willing to pay for a specific study on a particular company or trend, or for an original data run. Hedge funds also tend to make decisions rapidly, allowing banks to build relationships and earn commissions faster, notes Bault.
"If 2000 was the year of technology funds, 2001 was the year of different kinds of specialist funds, with different kinds of specific mandates," says Merrill's Huddart.
Some see hyperactive hedge funds as the investment banks, largest research marketplace for the future. Stuart Fowler, head of U.K. equities at E294 billion Axa Investment Managers in London, believes that brokerage firms will in time concentrate their efforts less on firms like his with large teams of in-house analysts, and more on the smaller, privately held hedge funds that need a steady stream of new ideas. "For the brokers, the honey pot has moved on," he says.
Indeed, some bigger portfolio managers prefer their in-house efforts to customized work. Henderson's Carnegie, who has commissioned some proprietary research, says: "My experiments have not been terribly successful. Though I suspect, as both sides get more used to that way of operating, it may improve."
Nor does bespoke research replace relationships. As Deutsche Bank's Schwarzmann says: "Buy-siders won,t always buy a stock because it's a good idea. They need to know the analyst. What is his thinking? How has his thinking evolved? What is the context of this recommendation? What changed, to change his mind?"
This year Institutional Investor for the first time asked investors to incorporate trustworthiness in their ranking of the most important attributes of a successful equity analyst. It ranks as the second most important characteristic -- just behind industry or country knowledge and well ahead of such traditional benchmarks as stock picking and earnings estimates -- of the 14 attributes evaluated.
No surprise, then, that many investment banks are eagerly trying to build long-term, trusting relationships again. J.P. Morgan has increased the number of its seminars that teach buy-siders how to conduct fundamental research. And Paul Gibbs, a 20-year bank veteran and head of the firm's valuation policy committee, discussed valuation theories with nearly 700 investors in 2001, far more than ever before. Money managers that have over the past few years built their research departments as aggressively as brokerage firms have suffer from some of the same ills as the investment banks. "Broadly speaking, the quality of research has gone down. I think equity research has been de-skilled because training has lagged growth," says Peter Houghton, J.P. Morgan's head of equity research for Europe, the Middle East and Africa.
Sponsoring these training seminars is also a logical alternative research service, because investors express less and less desire for written research. "As buy-side research groups have grown, demand has decreased for written research, but demand for raw data and corporate access has increased," Houghton says. In response, J.P. Morgan, which is one of the few firms in London adding staff, plans in 2002 to double the number of conferences, customized data reports and one-on-one meetings it arranges between investors and corporate management. "It's a fairly economical way to add value," he says.
The relationship between analysts and portfolio managers may not be perfect, but buy-siders do maintain a favorable opinion of most European research, according to a survey that II conducted as part of its polling for the All-Europe Research Team. Nearly 27 percent of the respondents say that the quality of European equity research improved in the past year, while 22 percent say that it has declined. The vast majority of respondents, 81 percent, say that they are "somewhat satisfied" with European brokerage house research. The remaining voters are split about evenly between "very satisfied" with the researchers, efforts and "not at all satisfied." To put the European results in context, nearly 40 percent of those surveyed during the polling for the All-America Research Team (Institutional Investor, October 2001) thought that the quality of U.S. research had deteriorated over the previous 12 months.
For the complete 2002 All-Europe Research Team results please go to the Research & Rankings section of this site.