Ah, the death of the sell side. It’s a head-turning headline that perennially pops up, in one form or another, in the world of financial journalism. Turns out, rumors of its death have been greatly exaggerated. May Day, Reg FD, the global settlement, the Sturm und Drang of the global financial markets in 2008 and 2009, MiFID II — all have failed to slay the dragon.
“There will always be a sell side,” declares Harvard professor Boris Groysberg, author of Chasing Stars, a book that mines decades of data from Institutional Investor’s All-America Research Team to uncover the true worth of a “star sell-side analyst.”
Investment research, Groysberg declares, has proven to be “an unbelievably adaptive industry” at both the larger banking behemoths and the smaller, more feisty independent firms. The research industry attracts the best and brightest — “enviably smart people” — and it quickly sheds those who don’t measure up. “Average doesn’t make it,” he notes.
And not a single independent research firm would exist absent the sell-side banking firms. As Groysberg points out, although anyone can wake up one morning and decide to open a restaurant, nobody has (or likely ever would have) started an independent research firm from scratch. The bulge-bracket banks, in fact, serve as a farm system for this slice of the investment research industry, training future founders and giving them the access to contacts, the status (via the II rankings), and the moxie to strike out on their own.
There’s one other compelling reason that the sell side survives: The buy side cannot survive without it. The work product of research analysts in investment firms has been characterized as “a mile wide and an inch deep.” The quality of buy-side research does not even approach that of the sell side, asserts Groysberg. “The buy side is more biased, and a nonperforming analyst can hide out for a long time. There’s no independent check on their work. On the sell side, you get flushed out much faster if you are not adding value.”
One interesting correlation that Groysberg discovered in researching his Stars thesis was the connection between analysts leaving to open their own firms — money management firms, hedge funds, consultancies, and research enterprises — and their top rankings in the AART. In fact, he notes, the survival rate of an entrepreneurial pursuit is closely related to the health of the general economy. But after that, a presence on the All-America Research Team is the street cred that counts.
InWall Street Research: Past, Present, and Future, a slim 2013 volume exploring the sell-side industry, Groysberg and Harvard colleague Paul M. Healy recount how the shakeup in sell-side research following the Eliot Spitzer investigation and global settlement was in fact a boon for research analysts looking to set out on their own. The provision that set aside $450 million to fund independent research for distribution to clients of the large banks “breathed life into the independent research market.” The authors identify four analysts — all top-ranked in the AART — who propelled bulge-bracket firms to hang out their own shingles subsequent to the global settlement.
Dana Telsey, a retail analyst at Bear Stearns, and Ivy Zelman, a housing analyst from Credit Suisse, started their eponymous firms in 2006 and 2007, respectively. Then Meredith Whitney departed CIBC Oppenheimer to open up a shop in 2009.
The fourth analyst is Ed Wolfe, who was the All-America Research Team’s No. 1 analyst in Airfreight & Surface Transportation for six consecutive years, up to and including 2008, the year he founded Wolfe Research in the wake of the implosion of Bear Stearns, taking with him six analysts and two assistants. “Research wasn’t pure, and it wasn’t fun,” Wolfe says, explaining why he struck out on his own. That and the demise of his firm, of course.
Today, Whitney is out of the game entirely. But Zelman and Telsey have done well, maintaining their respective single-focus research operations with sidelines in trading, banking, and consulting services. Still, it’s unlikely that Groysberg and Healy could have imagined the level of success Ed Wolfe has been able to achieve.
Wolfe Research is significantly larger than its peers, with 240 employees anticipated by year-end and focused coverage of 575 stocks by 28 lead analysts — of which 16 are currently or recently have been ranked by Institutional Investor. And two Wolfe analysts will make their tenth first-place appearances this year, joining Steven Fleishman and Chris Senyek in the AART Hall of Fame and giving Wolfe greater representation on that elite list than Barclays, Citi, Credit Suisse, or UBS.
Wolfe Research broke into the AART’s top ten research providers for the first time in 2020 and is expected to climb higher in the 2021 All-America Research Team. The firm’s growth and subsequent rise through the ranks have come mainly in the past five years. In its earliest days, Wolfe Research identified itself as a transport research boutique, trading on Ed Wolfe’s expertise and AART recognition. But Wolfe realized that “a one-man shop is not enough insight for the buy side. You have to build sector coverage so that regardless of what cycle you are in, you can be helpful and add value for your clients.”
Ed Wolfe, Jesse Bigelow and Jon Stenzler of Wolfe Research.
Expansion was slow at first. In 2010, AART-ranked quantitative, portfolio strategy, and economics analyst François Trahan joined Wolfe as vice chairman and chief investment strategist; his name was appended to the firm’s until he departed two years later to join former ISI colleagues in forming Cornerstone Macro. (Earlier this year, Trahan opened his own shop, Trahan Macro Research.) In 2013, Wolfe turned over research responsibilities for his sector to Scott Group; he hasn’t covered stocks since. This makes him unique among his independent research firm peers: Virtually all of their founders are still research producers. This is not to say Wolfe is disinterested in the actual process or product of stock research. He regularly reviews reports, mentors associates, and teaches in the firm’s research training programs.
By 2016, Wolfe Research had analysts covering industrials, consumer, macro, and energy. But the real breakout year was 2018, with six analysts joining to broaden research coverage to include financials; technology, media, and telecommunications; and health care. In 2019, just one analyst was brought in, followed in 2020 by five. In 2021, eight more analysts were hired.
Which is exactly why Ed Wolfe bristles at his firm’s being called a “research boutique.”
Says Wolfe, “We are a boutique no longer. We are focused on research relative to banking, trading, prime brokerage, and other sources of revenue that leverage equity research. At Wolfe, research comes first and our analysts’ independence is paramount.”
Ed Wolfe has successfully navigated the shoals of founding and keeping afloat an independent equity research firm, transforming it from a specialized investment boutique into the diversified competitor that it is today. Jon Stenzler, who heads Wolfe Research’s global sales, characterizes the firm as “fiercely independent.” It’s also “determined to put research first by maintaining control of ownership and by creating revenue streams through partnerships with other firms where Wolfe retains 100 percent control of the research to help achieve material trading and banking practices,” he says.
Wolfe compares his firm to ISI (before it was bought by Evercore) and Sanford Bernstein (pre-Alliance). “While there are many great boutique shops doing great work in a sector or two, we are not aware of others that have expanded beyond an original founder’s sectors into new areas,” he explains. “Wolfe is unique and the only firm to successfully do this, we believe, in the past 50 years — other than Bernstein and ISI.”
Wolfe Research presently has 35 institutional equity sales representatives located in eight U.S. cities and London, Paris, and Sydney. It hosts 18 major conferences a year. “Our sales force is the only major sales force still on commission,” its founder notes. “That’s because Wolfe is growing and other firms are not, and therefore can’t motivate people on commission to stay or join them.”
Wolfe has no plans to sell his firm to any organization, believing that the creativity and independence of his analysts’ work would take a backseat to revenue drivers like banking and trading. To keep control of the research product, rather than raising money through ownership stakes, Wolfe has created revenue-share partnerships and alliances with competing bulge-bracket firms, wherein those firms can take advantage of Wolfe’s research and Wolfe can in turn leverage their balance sheets for swaps, derivatives, options, Delta One desks, and capital markets and banking units.
Recruiting is not a problem. “Analysts seek out Wolfe because we give them a unique ability to focus on their franchise [and] grow with more associates, data, and resources as the banks continuously shrink their research spends,” Ed Wolfe says, adding that the firm offers its top analysts a share in its growth through stock, divestiture shares, and revenue splits. “Simply put, our top analysts make more money than they can at the bulge banks, and do it focused on research that they love doing.”
Still, it’s been a tough climate for investment research — “the worst environment you can imagine,” as Wolfe puts it. Knowing what he does now, would he do it all again today?
“One hundred percent I’d do it again,” Wolfe says. “It’s really hard to make money in research, but what I’ve learned over the years is there are a couple of analysts at the large banks who are generating revenue, and people will listen to them whatever they say. The other 95 percent are there to check the box for trading or banking. We have been able to create a brand based on research first, no matter what we do. And more importantly, we get paid for that.”
In anticipation of the release of the 50th All-America Research Team, Institutional Investor posed that same question — “Would you do it again?” — to a number of independent research firm founders. Here’s what they said.
Strategas: Still going strong
In early September, Strategas Research Partners celebrated its 15th year in the business of “independent” macro research. The occasion was marked by the publication of an elegant essay penned by its founder, chief investment strategist Jason DeSena Trennert.
In his piece, Trennert celebrates the resilience of Strategas’s founding partners (only one of the original five has left, and that was amicably), tipping his hat to ISI, the firm where he and his partners cut their milk teeth, and fondly recalling the prediction made by an unidentified bulge-bracket firm strategist who wagered that Strategas wouldn’t last six months.
“The most interesting thing about running an independent research shop these days is not the money,” Trennert insists. “That’s not to say we aren’t profitable. Business has gotten a lot harder over time, but people who really like it know that research is showbiz. If you enjoy talking about the markets and making presentations and talking to investors, it’s endlessly fascinating — and frustrating — but bottom line, there’s a lot less risk in research than there is in running money.” This in spite of the fact that “over the last 15 years, technology and regulation have conspired to make things more complex.”
The irony that Strategas was established two years before the (unforeseen by its partners) global financial and European debt crises is not lost on its founders; yet the fall of Bear Stearns turned out to be a defining moment, resulting in the enduring lesson that offering “insight in the midst of crisis” is the true mission of Strategas. That’s because “independent firms can and still do say things that large publicly traded institutions can’t,” Trennert says.
He does point out that the market for macro research is a bit crowded these days, with Cornerstone (the second significant ISI offshoot); Dennis DeBusschere’s 22V Research, which just opened in 2021; Renaissance Macro, helmed by AART Hall of Famer Jeff deGraaf; MacroMavens, run by yet another ISI alum, Stephanie Pomboy; the aforementioned Trahan Macro; and Wolfe Research all sharing the playing field these days. But would Trennert do it again? Sure he would.
Zelman: Well sheltered
Cleveland-based Ivy Zelman — the first of the four former Wall Street analysts singled out in Wall Street Research for striking out on her own — opened Zelman & Associates in 2007, trading on her personal Rolodex and a high level of confidence that she could make it as an independent housing research analyst. Today the firm has 25 employees, with 12 analysts covering 55 stocks in nine sectors, all in the housing space. But wait! Technically speaking, the firm is no longer “independent.” In July 2021, it was acquired by Walker & Dunlop, a commercial real estate finance company based in Bethesda, Maryland. Zelman is universally admired for her ability to produce quality research and her finesse in running a successful firm. “Ivy Zelman has done an incredible job,” points out a peer at another firm. “When you have a one-industry focus, you’re held hostage to that industry. If housing stocks go out of favor, you’re going to have to scramble.”
Zelman ventured out on her own following a 15-year career first at Salomon Brothers and then at Credit Suisse. She shares the primary motivation for starting her own firm in her recently published memoir, Gimme Shelter. “We had several reasons for leaving Credit Suisse, but the primary catalyst was the unique opportunity we had on our hands with our proprietary research,” she writes. “We knew we could monetize the network we had built around it by hanging our own shingle at a higher level than Credit Suisse was willing to match.”
Zelman started preparing to make the move in late 2005; one of her early advisers urged her to take the time and trouble to get a broker-dealer license. “As a Wall Street analyst, I never really thought about how I would get paid out on my own,” she recalls. “I was confident that I could attract clients but naïve about how I would get paid.” If she had realized this, she says, it might have scared her off.
“The icing on the cake was when trading commissions went from eight cents to basically zero,” Zelman explains, and to be sure, MiFID II “killed a few people, but it also forced transparency and made the buy side be more decisive about their actions.”
Would Zelman do it again, knowing what she now knows, in today’s environment? “Yes,” she says. “It’s really about the individual and your presence in your sector. The real driving force is having a platform to differentiate your research for your clients. And then having a collaborative, loyal team is essential as well.”
Webber Research & Advisory: Sweet smell of success
J. Michael Webber Jr.’s energy-focused boutique, Webber Research & Advisory, is one of the newest kids on the block; it was founded in 2019, just months before the pandemic broke out. The firm offers research and technical consulting services but has no trading function. Currently, it has six energy engineers supporting the research side.
Michael Webber had been the No. 1–ranked Shipping analyst in the AART over five years, from 2015 to 2019 — not to mention the glam cover boy for the October 2015 issue of Institutional Investor.
Would he do in 2021 what he did back in the fall of 2019?
“Yes,” he says unequivocally. “I took the red pill” — a reference to The Matrix — “and the notion of plugging back into the machine is incredibly foreign at this point.” This is not to say that he doesn’t harbor fond memories of his stints at Wells Fargo and Deutsche Bank, Webber admits. He’s found that “the challenges and rewards associated with building an independent shop are just so unique,” he says. “It requires a different level of commercial creativity and adaptability, and you are basically working without a net.” The bottom line: “Once you’ve had some success under those conditions, and control of your own equity, it’s hard to imagine ever giving that up.”
MoffettNathanson: Taking the plunge
MoffettNathanson is one of two firms founded in 2013 that were profiled in an article on independent research in that year’s AART issue (the other was Cornerstone Macro). Craig Moffett and Michael Nathanson between them had snagged 26 appearances on the AART from 2004 to 2012 for their coverage of cable & satellite, entertainment, media, publishing & advertising, and telecommunications services.
When they opened the doors to MoffettNathanson, Moffett says, “we knew that the old model was broken. We thought we could make a better research mousetrap, one that would bring us closer to the needs of our clients by focusing 100 percent of our energies on the research process and dispensing with everything else, like trading execution.” The way they did this was by creating a subscription-based research operation.
This required a significant leap of faith. “We couldn’t be sure it would work,” recalls Moffett. “There really weren’t many subscription-based research services out there to which one could point as a proof of concept. Eight years later, the need is the same, and it’s still all about the research.”
He concludes, “Thankfully, clients have appreciated the simplicity of the business model as much as we have, and subscription-based research models are no longer a novelty.” Today the firm supports eight analysts and six research associates, still committed to covering media and telecommunications. Recently, three senior analysts were added to cover the payments, processes, and IT services sector.
Would they do it again, knowing all that has transpired in the investment research world in the past nine years?
“Sure,” says Nathanson. “If anything, the decision is even easier to make today. Independent research firms have now been widely embraced, and new payment models that no longer require firms to own a trading desk are commonplace. In 2013, we made the call that we would be successful in this transition and be able to change buy-side perceptions. Now, with the industry structures in place, we wouldn’t hesitate to go at it again.”
Sidoti & Company: Where’s the beef?
In the penultimate chapter in their 2013 book, Groysberg and Healy profile several firms in the investment research space, including Merrill Lynch, Credit Suisse, and Sanford C. Bernstein. They also take a look at two then-independent firms, Leerink Swan (the firm was acquired by SVB Financial Group in January 2019 and is now called SVB Leerink) and Sidoti & Company, founded in 1999. Sidoti is a firm that focuses on micro- and small-cap stocks, sidestepping direct competition with the bulge bracket and, in fact, with most of the independent research universe as well.
Peter Sidoti has had to retool, rethink, and reformat his business over the 22 years he’s been at it. He professes he is mystified about how other independent firms are staying afloat. “To me, it’s wildly interesting” to think about how these firms are making money, he says. “This whole model is so distorted. There is a basic misunderstanding by 99 percent of the world who think analysts make money by picking stocks that will go up.”
Sidoti publishes research on more than 200 equities, predominantly with market capitalizations ranging from $50 million to $4 billion across industries. That research is distributed to about 500 institutional investors.
Ten years ago, Sidoti disclosed to Groysberg and Healy that 98 percent of his firm’s revenues came from commissions, with three quarters generated by his own trading desk and the rest by commission-sharing agreements with larger brokerage firms.
Today the firm deploys a company-sponsored research program. This is the direction Sidoti believes all independent firms will take in time. “Our Paid-For research product has been successful for two reasons,” he explains. “First, our clients know us and trust that we aren’t going to blow things up, and second, we put in bells and whistles by creating a separate independent board. We were worried about adverse selection, but it’s actually turned out to be positive selection.”
Sidoti also does something now that wouldn’t have washed five years ago, which is to charge companies for presenting at the seven conferences he stages annually.
Thus, Sidoti & Company is still afloat, though the past few years have admittedly been rough. “I love the research game,” Sidoti says. “I really do. I love picking stocks, but we’ve had to restructure our business drastically, and it isn’t fun. We’ve gone from 80 analysts down to 17. But we’ve turned the corner now and are back on track, looking forward to the years ahead.”
He adds, “If you can find me an independent model that works and is going to continue going forward, I’d love to know what it is. There’s so much pressure on trading costs, and the regulations get worse and worse every year.”
Would he start his firm in 2021 knowing what he knows now?
“No, no, no, and no,” Sidoti says.
Longbow: Maybe, maybe not
Longbow Research, founded in 2003, is the first of several firms that sprang from Cleveland-based FTN Midwest Research, which folded in 2010 following a failed deal for it to be acquired by Point Capital Partners. Other offshoots include Cleveland Research (started in 2006) and Northcoast Research (established in 2009). A fourth firm, Wedge Partners, is now part of Rosenblatt Securities. Longbow’s six analysts today cover nine sectors in the industrials, consumer, and tech arenas.
Longbow’s founder and senior analyst, David MacGregor, is on the fence about whether he’d do it all over again in today’s marketplace. Over the past 25 years, he’s witnessed how asset managers have built up their own analytical tools and staffing, yet he vigorously maintains that “analysis” and “research” are distinct. “There’s no shortage of people who can build an earnings model,” MacGregor says, noting that business schools are churning them out, “but real research is still a scarce element in the investment management process. The value of what we contribute through our work is identifying a firm fix on the underlying fundamental development.”
Additionally, most buy-side portfolio managers don’t have the opportunity to get to know companies well enough to perceive if managements are leading them to fallacious conclusions. “This happens a lot,” MacGregor insists.
Absent the baggage carried by research analysts in investment banks, MacGregor asserts that his value-add is the ability to write candidly about what he sees in the marketplace in terms of volume, price, and competition. But the field today is so crowded, he’s not sure of the impact he could make if he came into the game right now.
“The ability to be skeptical and then verify the validity of this skepticism through good fundamental research at the end of the day is what we have to offer,” MacGregor concludes.