The Value of Vetting

We see it in all sectors, professions, and projects: A vetting process for identifying value. Whether it’s the A&R guys who find us the best bands; the headhunters that find us the best executives; or the search engines that finds us the best information – we are a society that has come to value the processes that fast-track us to top results.

We’re learning the same is true for StreetBrains and its vetting process for qualifying the analysts we add to our brand. To give a rough idea, 400+ analysts have been through StreetBrains vetting process in the past 8 months. However, we have only launched 10 of those as brands. Our purpose has always been that we want to represent great insights and analysis, so we’ve been extremely selective in bringing on new brands who offer insights that cannot be found anywhere else. But we’ve learned from several clients recently that the value of our vetting process is actually much bigger than that.

A recent study by the Noble Group – a UK investment bank – found that financial directors of AIM (Alternative Investment Market) listed companies had a very low awareness of independent research.

The findings show:

75% of respondents could not name an independent research company.

58% did not even try to name an independent research company.

17% thought they could name one but named a broker or an information service rather than an independent research company.

Only 24% could name an independent research company.

Part of the problem with even the best of the best independent analysts is that most clients don’t have the time to go out and seek out and assess the quality of every independent researcher they come across. In theory, they like the idea of using independent research…but, where to find them? We’re hearing more and more often that firms find this ‘discovery’ process to be a daunting task.

By bringing a variety of analyst brands onto one platform after a stringent vetting process, StreetBrains is able to cut an enormous amount of ‘vetting’ time out for the client. That client is now able to focus on finding tradable insights, rather than trying to assess credibility, writing style, or brand focus. In essence, we bring the mountain to Mohammed.

The Noble survey also found that 84% of the surveyed AIM financial directors think that broker research is biased.

While this comes as no surprise to us, it underscores the importance of increasing the awareness and visibility of truly independent analysts. (Truly being the operative word…but that’s a topic for another day!)

Bottom line: if the objective insights of independent analysts can be more easily accessed, it seems that their insights would be welcomed by clients who are clamoring for non-biased research.

The End of Pollyanna Propaganda?

It almost pains us to ‘pile-on’ with yet another blow to Wall Street’s favorite punching bags, but let’s be honest, they’ve brought this upon themselves.

In yet another story this week that bullies research analysts about their collective incompetence (to make the distinction, we are referring to the 'mouthpieces' at big firms who are payed to spew rhetoric, not analysts who are independent and conflict-free), Geoff Colvin, writing for Fortune, brought us ‘Analysts in Fantasyland.’ To excerpt from the painfully accurate account delivered in Geoff’s story:

Maybe Wall Street analysts are more honest and less compromised than they were pre-SarbOx, but recent events show that they're still awful at their most important job: predicting bad news. They haven't lost their habit of falling in love with the companies they cover and refusing to face unpleasant realities until everyone else has already done so. Now, eight years after they were inflating the bubble, we again have to question whether analysts do retail investors any good.

The latest evidence: Analysts have only just discovered that corporate profits in the fourth quarter aren't going to be nearly as strong as they had supposed a month or two ago. The consensus view going into the quarter was that S&P 500 profits would go up 12 percent to 15 percent, a large jump coming on top of the 20 percent rise in last year's fourth quarter. In light of the credit crunch, the housing collapse, and the towering price of oil, that forecast seemed highly - one might say insanely -optimistic. This it proved to be, but only after the quarter began did the consensus view finally lurch into the real world. Their growth forecast is now about 1.5 percent and still falling.

It has been obvious for many months that profit growth would have to slow way down simply because it couldn't continue at recent rates. Profits have been rising sharply the past few years, which makes sense after the hole they fell into in 2001 and 2002. But by early this year they had grown to 12 percent of GDP, way above their historical average of 9 percent. Analysts knew all this, and in case they didn't, various commentators (including Fortune's Shawn Tully) were insistently pointing it out. But the analysts, ever hopeful, chose to believe that U.S. companies would perform magic.

Although their hand was somewhat forced, in-house analysts are finally able to call it like they see it (as long as they talk ONLY about what has already occurred/is occurring). Perhaps it’s better late than never? Could the days of Pollyanna Propaganda be over?

We doubt it, but at least they’re not denying the sky is blue….for now.

Wall Street Swarmed With McFlys

For those of you who remember the 80’s classic, ‘Back to the Future’, I’m sure you’ll agree – George McFly is the most spineless character in cinematic history.

Sadly, it seems that McFly has cloned himself a thousand times over, and his spawn have infiltrated Wall Street in the form of research analysts.

In Scott Patterson’s ‘Ahead of the Tape’ column in today’s Wall Street Journal, he pulls the lid off of Wall Street research in his story titled, ‘Analysts Botch Profit Forecasts on Home Turf.’ (click here for full story.)

While the entire article goes on to point out conflict-ridden research coming out of the Street, particularly in the wake of the subprime mess, one quote in particular stuck with us.

Paul Hickey, co-founder of Bespoke Investment Group is quoted in the article, saying, “You often see brokerage companies giving their peer companies the benefit of the doubt, so they don’t get in this shooting match.”

What is it exactly that has stripped Wall Street analysts of their backbone? Fear of being fired? Perhaps. But that exists for all employees, no? Even full out whistleblowers out there in the past 5-10 years have stood up to ‘The Man’ and been rewarded, so the fears of these analysts to issue negative or contrarian reporters seems unfounded. Yet Wall Street analysts seem to cower in their corners, doing as they're told, content to simply keep their heads down, collect their paychecks, and pray they aren’t asked to become a profit center. McFlys.

With only 7% ‘Sell’ ratings on the year, and with all of the Biffs out there pointing the bullying finger in their direction, in-house analysts are going to have a tough go in ’08. Independent analysts have a tremendous opportunity to make inroads with players on the prowl for valuable research.

Appropriately, here’s the dialogue from a scene between Biff (the bully) and McFly (the spineless wuss):

Biff Tannen: And uh, where's my reports?

George McFly: Uh, well, I haven't finished those up yet, but you know I... I figured since they weren't due till...

Biff Tannen: Hello? Hello? Anybody home? Huh? Think, McFly. Think! I gotta have time to get 'em retyped. Do you realize what would happen if I hand in my reports in your handwriting? I'll get fired. You wouldn't want that to happen, would ya? Would ya?
George McFly: Of course not, Biff. I wouldn't want that to happen. Now, look. I'll finish those reports on up tonight and I'll run 'em on over first thing tomorrow. All right?

We Called It

As previously mentioned, every couple of weeks we will be highlighting some of the big calls made by StreetBrains’ portfolio of independent analysts.

Remember: StreetBrains provides conflict-free research – the analysts do not hold positions in the stocks they cover, and are not affiliated to any investment banking outfits. Period.

Below are some of our calls:

• Boo-hoo, Mickey - PatternWatch put the squeeze on Walt Disney (DIS) this past Friday, when they pointed to technicals and fundamentals that supported shorting this stock. Click here to read ‘Mouse Trapped’ by Carrie Coolidge from the 12.24.07 issue of Forbes, now on newsstands.

• Known best for great pairing ideas, Gotham Research recently was up 15% on a Bob Evans (BOBE) (long) / Brinker (EAT) (short) pairing. They worked their magic again when they closed out up 11% on a Commerce Bancorp (CBH)/Bancolumbia (CIB) play last week.

• Photizo Group continues to cultivate their contrarian calls by putting a BUY rating on Xerox (XRX) this past week.

• Coming from very different sector perspectives, both Sterling Account and inMotion issued BUY ratings on Schlumberger (SLB) recently. Perhaps they’re on to something….

Fund Fees: What are you paying for?

It’s probably safe to say that anyone with money to put into a hedge fund doesn’t mind paying a high percentage management fee as long as you’re getting a phenomenal return. It all comes down to value.

Same goes for Manhattan real estate – if a broker shows you your dream townhouse, but you have to pay a 20% broker fee, you wouldn’t blink. You’d be ecstatic that you could stop sifting through all of the unsuitable apartments, and the value of finding what you’re looking for would justify the expense attached to finding it.

In both of these scenarios, the ends justify the means. Unfortunately, for less risky investments, the returns are not high enough to eliminate the question:

What are you paying for?

In the case of mutual funds and pension funds, which, by design, are not typically risky investments, of course the rewards are not usually as exponential as might come from a hedge fund investment. Yet, they have more hidden fees attached to them than Paris has boy-toys. The lack of transparency in fund administrator services and 12b-1 fees as well as management fees, loads, expense ratios, turnover rate, taxes…goes on and on.

(Is your head spinning yet?)

The unbundling initiative that is being largely lead by the independent investment research world would likely help alleviate some of these incurred costs, while also putting money back in the pocket of the Portfolio Managers (PM).

Say what?

That’s right. The guy making you money, should make good money. No one disagrees with that statement. His management fee – if he’s made you 30% this year - is a non-issue. The part that should be called to question is – what other fees are you paying that are unjustified, or being billed to you for unused or under utilized resources?

Like that $150 gym membership you pay each month to have access to something you don’t use – at some point it’s time to reassess the fees you pay and ask: What exactly am I paying for?

Bundled research – the research provided as an ‘add on’ to execution - falls into that camp. This research is often redundant, lacking of value, and gets as much use as your dormant gym membership. Yet it continues to be purchased because it is as common practice in the industry.

Part of the reason this cycle has yet to be broken is that PMs fear unbundling would create more work for them. Though it may take some work on the front end to seek out the top providers for execution and research, respectively – the pay off on the back end of having insightful, actionable research on one hand, and best execution on the other would alleviate headaches for both PMs as well as investors.

The clock is already ticking for PMs to jump on the unbundling bandwagon. Regulators are taking a look at how unbundling can help paint a much clearer picture of incurred fund fees and now it’s only a matter of time before requirements are enacted here in the US as they have been in the UK.

Unbundling could potentially revolutionize the way that funds do business, and bring in some serious revenue for those who embrace it. In a business where being late to the game can cost you everything, we think we will continue to see firms jump on board the unbundling bandwagon.

DeCommoditizing Investment Research

In the brilliant book, Mavericks at Work (a must read) – there’s a great quote from Vernon Hill at Commerce Bank who says:

“We’ve shown that you can decommoditize a commodity business. Nobody needs another me-too bank.”

The notion of decommoditization is one that the investment research world should take to heart. The lack of insight and value in most investment research has become appalling. When the biggest difference to be found in ten research reports is a 2 cent discrepancy in target price, it’s safe to say that research has become a commodity. But how can analysts change the playing field?

Realistically, it’s not easy for in-house analysts. They are all talking to the same sources as their competitors and learning the same information at the same time (thanks to SarbOx, RegFD and other regs). They all have a mandate to cover specific companies, and truthfully – they really aren’t there to be creative and see/analyze outside of the box. This is a necessary tool, and not one to be undervalued. But is it necessary for firms to have this research from more than one source?

The answer, of course, is no. But big firms – for CYA reasons – need to have in-house analysts dedicated to the companies that their firm invests in. Makes sense. They can’t rely on outside analysts for that. But why would they pay another firm to receive the same research they produce in-house?

Right now, it’s simply because in most cases, they get the research ‘for free.’
(READ: they get it for 3 cents a share as a tack on to their execution pricing.) So why pay for MORE research in addition to that research?

Many firms are starting to understand why. They’re asking themselves what the value is in the commoditized research they currently pay for through their execution, and they’re recognizing how little new information they are accessing. This is leading to a trend in unbundling for some in the industry. It’s possible that decommoditization has already begun. But can it continue?

We believe it can. The feedback StreetBrains gets from clients is that straight forward research is important, but so is insightful, objective analysis. Value is the name of the game – and if indie research providers can step their game up and provide new insights and niche material to their clients, rather than duplicating what firms are already doing in-house or receiving as an execution add-on, decommoditization of this valuable product will occur.

On Wall Street, Sell = Salmonella

If you read Dana Cimilluca’s story in yesterday’s Wall Street Journal titled, “Research Analysts: Best-Paid Concierges?” (click here for story) and thought, “That’s just absurd!” - you’re with us.

In the independent research world, we tackle this issue on a daily basis. Some independent research providers pride themselves on their abilities to set up company management meetings for their clients. In fairness to them – in many cases, this is what clients want. We are constantly surprised at the interest and desire amongst our hedge fund and bulge bracket firm clients to have such meetings. Not to suggest that company management doesn’t have anything insightful to say – but when have you ever been to a company meeting where the company provided insights into how they are falling short or worse - failing?

What is the true value of these meetings? And more importantly, are they really worth paying commission pricing for? Are there actually companies out there who are unwilling to sit down and meet with hedge funds and other institutional investors without a middle man (analyst) being involved? Wouldn’t it be much more simple and cost effective for these high powered investors to go directly to company management and arrange a meeting?

"The Catering Business"

We affectionately refer to our research counterparts who focus on company management luncheon schmooze sessions as ‘The Catering Business.” In the catering business approach to research, an analyst issuing a SELL (GASP!) recommendation on the host company is the equivalent of serving up salmonella to the black-tie crowd at Cipriani.

Besides the fact that regulatory rules won’t allow for companies to really open up in these meetings, does any party involved really expect an analyst to offer up an objective, insightful, potentially critical report after a company has played host to interested investors?

If so, we respectively contend these people reside in FantasyLand.

Since access to companies is important to analysts’ abilities to do their jobs, it’s no wonder sell recommendations this year have dropped to 7% (according to WSJ story). Our question is, why would anyone want such conflict-ridden research, let alone pay for it? Do these people still have Jack Grubman on speed-dial?

Isn’t it about time that analysts band together and raise the bar for objective research? Isn’t it up to analysts to manage companies’ expectations about what a company meeting entitles them to? It should be a chance for them to be heard – not an automatic guarantee of a buy rating.

Analysts should take a page from journalists and recognize that their job is to provide objective and insightful perspectives – not make friends. Fears of being stonewalled, bruised egos, and negative market impacts should not have any impact on the integrity of an analyst’s research.

StreetBrains believes analysts should leave the catering to Cipriani, and focus on writing insightful, objective research.

Rejecting Researchecution

Just as Hollywood’s got Brangelina and TomKat, Wall Street has Researchecution: a hybrid coupling that seemed like a good idea once upon a time, but ultimately has the shelf-life of canned fruit.


The days of Researchecution – the ‘bundling’ of research and execution costs - are very close to numbered here in the US, and are already a thing of the past in the UK. Increasingly more Wall Street firms are asking themselves why they continue to bundle these services, and the case for client commission arrangements (CCAs; commission sharing agreements/CSAs; soft dollar arrangements, etc, etc.) to aid ease of payment for a la carte research - while enabling best execution pricing - is gaining traction. However, this isn’t the first divorce that some on Wall Street have been reluctant to embrace.

Not long ago, you may recall the painful breakup of investment bankers from their beloved research desk counterparts. Although research had been a supportive and loyal partner, investment bankers abused the relationship, and eventually divorce ensued.

The same separation is imminent for research and execution. The issue of transparency over what monies pay for execution vs. what monies pay for research will eventually come center stage – whether it be on a regulatory level, or internally at firms as they struggle to justify all spending in the current volatile market.

The questions that firms are starting to ask themselves are: “What are the benefits to unbundling research from execution? Will it save my firm money? Is it necessary? If so, why has the SEC not implemented a rule requiring unbundling? What advantage will it provide? Will it cost me more in compliance?"

Integrity Research’s blog on Sunday offers a ‘state of the union’ for the current environment for CCAs. At StreetBrains, we’ve been having these same discussions with clients and potential clients as well. The landscape for CCAs is still somewhat uncharted territory and some firms are hesitant to jump on the CCA bandwagon. However, an increasing amount seem to see the value and advantages to unbundling.

To answer the questions above:

1) The benefits of unbundling research from execution are many. First, you will be able to ensure you are getting best execution pricing (since you won’t be ‘factoring in’ research costs.) Second, you can pay solely for research you want and use, rather than being bombarded with research you neither want nor need. You can establish relationships solely with those research providers you value and trust. Third, unbundling research costs from execution costs make for more transparent bookkeeping – and although there is no rule that currently requires that level of transparency, the likelihood of such a rule coming about is imminent.
2) There is little research out there thus far showing whether or not unbundling saves money. What we do know is that unbundling helps firms to more accurately assess the value of their research purchases, so they are able to adjust spending accordingly. Although the cost savings are still unclear, what is clear is that unbundling provides a clearer picture to assess what you are paying for. In a market environment where purse strings are tightening, the ability to pinpoint the cost: value ratio is of utmost importance.
3) Although there is no rule currently requiring research to be unbundled from execution pricing, such a rule is likely to come – and soon. So, using CCAs would seem (and does seem, to many of our clients) to be a no-brainer – stay ahead of the regulatory curve; get a clearer picture of what your firm is spending its money on; and pay for what you value. (best execution, and great research.) Additionally, unbundling improves transparency without adding to compliance costs.

Many more firms are beginning to understand the implicit value of unbundling, and are looking to independent research providers such as StreetBrains as they divorce Researchecution. To learn more, please visit our complete “Myths and Facts” page that helps dispel some common myths about paying for independent investment research.