In defense of the sellside analyst

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The writer is a former global equity strategist at Citigroup

Let me take you back to September 1989. It was my first day at a long-forgotten UK securities firm. The head of stock research asked about my father’s profession – a farmer. Perhaps inevitably, I was assigned to the food production team. It was my job to grab coffee, help spread the load on results-heavy days, prepare stock notes, and analyze industry statistics, much in that order.

My agricultural background was of little help, but I let my boss spend the day calling or meeting with investors. It struck me that, for someone called a research analyst, he didn’t spend much of his time doing research or analysis. Instead, he worked to build and maintain a network between his companies and the investors who owned (or could own) their stock. It was intense work. Its main measure of performance was the annual Extel survey, which polled institutional investors for their favorite analysts. The highest ranked players were those with the widest and deepest networks, not always the ones making the best stock calls. The Institutional Investor magazine survey had similar significance in the United States.

Top tier analysts were coveted for the trading commissions they brought in, but also for their potential to attract lucratives banking investment Business. It was easier for a banker to get the mandate to handle an initial public offering if he had a great industry analyst. “Ranking and banking” was the rallying cry of the late 1990s. This led to inevitable conflicts. Were the analysts paid by investors who wanted an independent view or by companies who wanted a positive case to be brought to market? This has been a tough tightrope to walk, and not everyone has succeeded, leading to significant fines and reforms pioneered by former New York State Attorney General Eliot Spitzer, who sought to separate analyst pay from bank revenues. The decline of sellside research had begun.

Whatever you think of the late 90s model, it backed big budgets and broad coverage of many titles. Some of that coverage may have been conflicted but, in my experience, analysts were far more motivated by Extel’s standing among institutional investors than its popularity among companies.

Then the buyside started to change. The rise of passive funds has reduced the profitability of active fund managers. These pressures have been passed on to the sellside through lower fees. Mifid 2 rules, which separated payments for trade and research, have exacerbated the squeeze. Under the traditional commission-based model, wealth managers paid for sell-side research using client funds. Following Mifid 2 they paid directly with their income. Predictably, these payouts plummeted, a fatal blow to some independent research houses.

Few readers will mourn the decline of sellside analysts and many will criticize the imprecision of their stock recommendations. But that means overlooking a key contrast: On the buying side, performance is everything, while on the sales side, getting the right inventory is only part of the job. Building that network is more important.

I’m not trying to justify the continued survival of my profession. The corporate bond markets appear to function quite well without armies of sellside analysts. I’m not convinced that plans to roll back parts of Mifid 2 will reverse the decline in sell-side research, which was well established before the arrival of the regulation. There has always been value in networks built by top sellside analysts. However, misguided attempts to monetize these networks have resulted in a regulatory crackdown, thereby curtailing future revenue opportunities.

Big banks still employ hundreds of business analysts. Alternative financial support for sellside research could come from prime brokerage, derivatives trading or asset management. Investment banking still pays a large part of the cost. The Spitzer reforms helped safeguard the independence of analysts. But it didn’t stop the interdepartmental subsidy. To quote a CEO of a major bank: “research is a cost of driving affluence to the franchise.” In this day and age it might be difficult to justify selling-side research as a revenue generator. It’s easier to justify as a marketing expense.

Even if the glory days are over, sales company research remains a fulfilling career for the energetic and analytical. It’s a great place to learn how to research companies and build networks—invaluable skills in any profession. I eventually moved on to more macro roles, but I never regret where I started. I hope I made my father proud.