Rupak Ghose is an advisor to fintech companies and a former financial research analyst.
When I joined Credit Suisse First Boston in the summer of 1999, I knew where the action was: equity research. Yes, really.
There were legendary telecommunications analyst Jack Grubman at Salomon and Internet analysts Mary Meeker at Morgan Stanley and Henry Blodget at Merrill Lynch, each feted in the media and taking home tens of millions of dollars a year. They were the gods of the market, not traders or buyers. I was therefore excited to become a Media Equity Research Analyst at CSFB.
As the dotcom bubble raged, the CSFB cowboys focused on technology by hiring Frank Quattrone and his merry band. He was seen as a home run to take on such a huge revenue generator. CSFB gave Quattrone the autonomy he craved, including having stock research analysts report on him.
Two decades after the Eliot Spitzer deal that rocked the investment research business, there are four reasons why it is still shrinking in size and credibility: dwindling information advantage, new entrants, margin pressure in secondary stocks in cash and a dwindling customer base.
Let’s start with a declining information advantage. In the movie Wall Streetthe corporate raider Gordon Gecko says: “Come on, tell me something I don’t know. It’s my birthday, man, surprise me. Bud Fox responds with inside information about a lawsuit at the airline where his father works. RegFD’s disclosure requirements in 2000 initiated a push to prevent the selective disclosure of information by companies, and sell-side compliance has since been strengthened significantly.
Management teams are more careful about what they say and access to them is more limited than it was then. The sales-side’s waning influence means the days of CFOs chasing analysts for their time are long over. This creates an uncomfortable competition among analysts to get into the good books of the companies they cover with softball questions and conference call statements like “Great quarter, guys!”
Downgrade a stock to “sell” and the investment bankers may not be able to get you fired (at least not immediately), but you are likely to lose management access. This takes you to the same final destination as the dole line, albeit more slowly than in the past.
That’s because a large part of the value proposition for analysts these days is to take groups of investors on roadshows to visit public and private companies or access their expert contact base. But companies have expanded their investor relations teams to take the lead on management roadshows, and in the age of disaggregated research, why spend a fortune on sellside research when you can simply tap into one of many networks of experts?
However, technology, not regulation, is what has flattened the research world. Sellside’s analysts – constantly monitored by an army in compliance departments – are surprisingly poor at wading through online noise to extract relevant signals about their actions.
With so much corporate insight, expert analysis, and rich media circulating for free on social media, the bar for sellside content to overcome is much higher. The proliferation of blogs by both amateurs and ex-savvy sellside and buyside strategists at much lower price points is another deflationary drag on research spending.
As for the sellside’s continued lack of negative valuations, dedicated short-selling research firms like Muddy Waters and Hindenburg have jumped into the breach. Some media outlets that are trying to protect their moats have expanded significantly into investigative journalism (a subscription to FT to read Wirecard report by Dan McCrum was much cheaper and more valuable than the research reports produced by the sales side).
The third is the evaporation of the profitability of sellside cash equity businesses. Most of the revenues and profits are generated by equity derivatives and prime brokerage. Cash equity fee rates plummeted in equity trading and market share was given over to high-frequency trading firms. Algorithms don’t need to talk to stock research analysts.
Fourth (and intertwined with all of the above factors) is the shrinking client base for sellside equity research.
Just a decade ago, large wealth managers like Fidelity would have topped research client lists, generating massive amounts of revenue through trading fees explicitly tied to research content. But the number of large long-only asset managers consuming and paying for sellside content has plummeted, making analysts increasingly dependent on a small number of multi-strategy hedge funds.
The irony of all these developments is that equity research analysts are now working more than ever for investment banking. Although payments are now indirect and spread across many parts of the bank, the percentage of a cash stock research and sales department’s cost base covered by fees on the buy side is lower than ever.
And whatever happens on the regulatory front, it’s hard to see how anything will change significantly. The era of star analysts died years ago and will not come back.
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