As a former analyst for a major investment bank, a prominent hedge fund manager fondly recalls what he considers the glory days of sell-side research.
In the 1980s, when this hedge fund manager worked on the sell-side, he remembers getting on the phone with a company’s chief financial officer, who would read him the firm’s balance sheet. “I had information people cared about and before the buyside got it,” he says.
In those days, most companies did not provide nearly the volume of detail they now share when they release earnings – and Wall Street analysts were viewed as having the inside scoop on the companies they covered.
Today, this is not necessarily the case. Technology has made information more of a commodity, available to everyone at the same time. New rules enacted in the United States after the dot-com bubble burst at the turn of the millennium have established clear walls between the sell side’s research and investment banking departments. And public companies have been barred from selectively disclosing material information to analysts.
“There has been a decline in the sell side,” the hedge fund manager says. “Both technology and regulatory changes impacted that.”
One executive from a multibillion dollar multistrategy fund opines that “basis sell-side analysis is of less interest to hedge funds these days.”
That’s not to say hedge funds no longer value sell-side research. In fact, they still remain prominent clients of Wall Street research departments, if the latest All-America Research Team survey is any indication. Out of the 3,900 investment professionals who participated in the 2018 ranking of Wall Street’s best equity analysts, just under a third worked at hedge fund firms.
These hedge fund professionals stuck by their favorite research providers, ranking their top four firms in the same order as last year: JPMorgan Chase & Co. topped the AART: Hedge Fund Cut, followed by Morgan Stanley in second place, Bank of America Merrill Lynch in third, and Evercore ISI in fourth.
Although in fourth place overall, Evercore boasted the most first team positions, with 12 analysts and analyst teams chosen by hedge funds as the best in their given sector.
The firms which seemed to lose the most hedge fund favor were UBS, which slipped from fifth place to seventh place, and Deutsche Bank, which plummeted from No. 8 to No. 14.
In general, these research providers are viewed by hedge funds as part of a larger research mosaic – something to supplement, not replace, the work their own analysts do in house. Hedge funds executives interviewed by II said, for instance, that they wouldn’t necessarily act on an analyst’s stock picks.
“We don’t use them for idea generation,” stresses the portfolio manager of a multi-billion dollar long-short firm. Another hedge fund manager bemoans that fewer analysts do the kind of legwork that used to be valued, such as visiting suppliers and conducting industry surveys.
While hedge fund managers say it is nice to see the target price raised on a stock they already own, such ratings do not impact their decision to buy the stock, hold it, or add to the position. One prominent manager emphasizes it is his analyst’s job to come up with the ideas and listen to earnings calls.
Still, quality sell-side research can be a good starting point for hedge fund analysts. One manager says his method for getting up to speed on a potential new investment includes acquiring as many research reports as he can get his hands on.
“I think the sell-side analysts who understand the specific capital structure of a company in relation to the overall business are of a lot of interest to hedge funds,” adds an executive from a multibillion dollar multistrategy fund. One long-short manager, for instance, says his firm uses sell-side research to help model an investment’s financials.
But where the sell side is perceived to provide the most value to hedge funds is through corporate access – the meetings with corporate executives, field trips to see firm operations, and non-deal roadshows organized by sell-side firms on behalf of buy-side investors.
“We can meet 10 managements in two days,” says one hedge fund manager of sell-side conferences. “This is hard to do otherwise.”
As another hedge fund executive adds, “We tell analysts they are facilitators of corporate access.”
Still, the very best sell-side analysts can also provide new and differentiated insights into the companies and industries they cover.
“A great sell-side analyst uncovers something the rest of the market is missing or what the rest of the market hasn’t seen,” says one executive at a major hedge fund firm.
One manager likes to see analysts who cover, say, 10 companies very well, as opposed to offering a breadth of coverage that spans 50 or so companies. Another hedge fund executive looks for analysts who follow not only his or her list of public companies but also their privately held competitors, to provide a fuller picture of the industry.
In the end, however, most managers say this is what they are paying their own internal analysts to do. Says one portfolio manager at a sizable long-short firm: “With their more concentrated books, hedge funds should know their positions better.”