I received the following article from Singapore on sell side and buy side analysts. At the end I have added a posting on the same topic.
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Fund managers value honest and independent analyst reports that offer a different viewpoint. But they feel that such reports are few and far between.
Of course, underscoring that assessment is what they perceive to be a potential conflict of interest between sell-side research and stockbroking arms housed within a brokerage firm.
One fund manager who declined to be named says that 'sell' calls are as important to him as 'buy' calls. But he feels that very often, some brokers tend to issue only 'buy' calls and no 'sell' calls.
'I still see many reports which are done for marketing purposes. That is, they are written to get new businesses rather than present the true picture of the targeted companies,' he adds. 'There is still a lack of real independent research out there.'
The fund manager, who is with an Australian private equity firm, says that he values regular, continual coverage on stocks rather than 'ad-hoc' coverage.
One criticism about the industry has been a lack of research continuity for underperforming stocks where 'sell' calls are warranted, as it is the 'buy' calls that drive equity team sales at these brokerages.
A case in point is OSIM International, which was a magnet for analysts in its early years of sterling growth. But after it started reporting losses following its acquisition of US retailer Brookstone in 2005, analysts stopped covering the stock. Coverage of the stock has returned recently after OSIM staged a turnaround in earnings by writing off its Brookstone investment last year.
'These days, the large financial institutions have underwriting, proprietary trading and stock-broking businesses. Which is a larger profit centre?' asks Wong Kok Hoi, chairman and chief investment officer of APS Asset Management. 'They say they have China walls but frankly I am not sure how thick the walls are.'
But on balance, the unwillingness of users to pay for the research also has a part to play for the quality of sell-side research, Mr Wong adds. On a positive note, he believes that sell-side research has improved over the years.
Fund managers typically have large in-house research teams to meet specific research needs. The difference between sell-side research and buy-side research is who pays for them.
Sell-side research is often funded by the stockbroking business and its recommendations are directed across the general mass of the brokerage clients.
Buy-side research is paid for by the funds' clients, and recommendations are based on how well the investment meets the fund's investment strategy and portfolio.
Fund managers say they generally use sell-side research to gain new insights or investment ideas, obtain a third-party view, or to know more about new companies.
Hugh Young, managing director of Aberdeen Asset Management Asia, says he typically seeks out sell-side research for specific industry expertise that Aberdeen does not possess in-house. But he laments that there has been much rehash in research reports on what company management says.
'It's useful for people who don't have time to read the full management report. We do a lot of research in-house, so we can only blame ourselves when we get things wrong.'
Since short-term estimates or assumptions of the analysts are quickly priced into the market before fund managers could act on them profitably, fund managers often look out for the long-term views of the analysts.
'As long-term investors, we naturally would like to know the intrinsic value of a company,' Mr Wong says. 'Hence, we appreciate analysts' work on the long-term value of a company which, among others, must at least include long-term growth prospects of the industry and the company business franchise, including its durability.
'We also like to know what they think of the integrity and competence of management and appreciate those who can help flesh out the quirks among the fine print in the annual accounts,' he adds.
'We have always found it productive to speak with analysts who know management well, truly understand the business franchise's strengths and limitations, the company's competitors, etc.'
Sunday, August 09, 2009
Buy Side Vs Sell Side Analysts
An example of a buy side analysts team (and its a big team) locally would be the analysts at Public Mutual. These recommendations by buy side analysts, made exclusively for the benefit of the fund that pays for them, are not available to anyone outside the fund. If a fund employs a good analyst, it does not want competing funds to have access to the same advice. A buy-side analyst's success or talent is gauged by the number of profitable recommendations he or she makes to the fund. In most cases, top buy side analysts end up as their in-house fund managers. This is usually why many of the traditional fund mangers positions are not advertised - they have instituted a hoard of analysts clamoring for those positions.
The buy-side differs from the sell-side in three main ways: they follow more stocks (30-40), they write very brief reports (generally one or two pages), and their research is only distributed to the fund's managers.
Buy-side analysts can cover more stocks than sell-side analysts because they have access to all the sell-side research. They also have the opportunity to attend industry conferences, hosted by sell-side firms. During these conferences, the managements of several companies in a sector present why they are a better investment. After gathering this information, buy-side analysts summarize their case in a brief report that also contains an earnings forecast. These reports are only distributed to the fund's managers.
The sell-side provides research and conferences to the buy-side in the hope that the buy-side will let them execute the large trades that the funds make when they act on the recommendation provided by the sell-side. Having access to the sell-side's primary research and the ability to attend industry conferences allows the buy-side analyst to follow many more stocks than a sell-side analyst. To compensate the firm for this information, the funds will buy and sell stocks with the brokerage firms that provide the best information.
You would think that a buy side analyst recommendation would perform better than a sell side because the former only has to please one client, while the latter may be "forced" to generate new ideas or do flip-flops in order to generate trades / commissions. The buy side is paid by the fund management house itself, hence just one client to please or piss off. The sell side is paid by the brokers, which means you can be praised or pilloried or pile-driven by many clients of the firm.
In a 2008 study by Boris Groysberg, Paul Healy and Craig Chapman for the CFA Institute in the Financial Analysts Journal Vol. 64, they looked at buy-side and sell-side earnings forecasts from 1997-2004. The conclusion was that buy-side analysts made more optimistic and less accurate forecasts than their counterparts on the sell-side. The performance differences appear to be partially explained by the buy-side firm's greater retention of poorly performing analysts and by differences in the performance benchmarks used to evaluate buy-side and sell-side analysts.
In a new study by professors from Harvard Business School and the University of North Carolina, they found that shares chosen by sell-side analysts performed more than 3x better than those selected by the buy-side analysts (1997-2004 as well). The findings are a surprise because buy-side forecasters have none of the conflicts with investment banking units like the sell-side.
A probable explanation is that sell-side research is published while buy-side is not. The fact that it circulates spurs competition, comparisons, scrutiny, and maybe even get recognised when "best of awards" come around. It is also fair to assume that buy-side analysts have a much much less of a chance to be fired, retrenched or replaced than sell-side, and for that reason as well sell-side analysts make much more money.
The results were culled from over 12,000 analysts at brokerages and 340 buy-side institutions. Buy-side "buy calls" generate an annual market adjusted return of 2.3% while sell-siders generate an 8.1% return average. This would really beg the question why fund management firms would continue to fund these buy-side research? One main benefit is to cover those stocks that generally do not appear on the radar of the sell-side analysts. Sell-siders can only reasonably cover big stocks as those are the ones that generate the commissions. Buy-side may need to discover more of the smaller companies.
In my view, the sell-side analysts will always know the companies and the senior management of the companies covered better than the buy-side analysts. Now that there is a stricter and hardier Chinese wall between research / sales / investment banking, it will make sell-side research have a bit more integrity and reliability.
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