Well, if this isn’t the very definition of serendipitous, then I don’t know what is.
On Wednesday night I introduced readers to a new series here on Heisenberg Report. That new series is called “Bullsh*t Research.” The dubious distinction of being the first victims went to Goldman for an absurd options strategy and Wells Fargo, for suggesting that “what would Warren Buffett buy?” is a question worth asking.
I prefaced the inaugural edition of “Bullsh*t Research” with the following disclaimer that links to a previous missive in which I explain why I think sellside research is still exceptionally valuable:
I want to preface this by saying that I am squarely in the camp of people who believe that the Street is necessary. I’ll even go a step further and say I am squarely in the camp who believes that Wall Street research is necessary. You can read my full defense of this position in “Have Fun Being Your Own Weatherman: The Argument For Not Firing Wall Street.”
As luck would have it, FT ran a piece on Valentine’s Day by Stuart Kirk, Deutsche Bank’s head of thematic and multi-asset research. Kirk’s post is entitled “Change is coming, but don’t write off investment research.” In it, Stuart explains why we need him. As you can surmise from my piece linked above (“Have Fun Being Your Own Weatherman: The Argument For Not Firing Wall Street”), I agree with almost everything he says.
But you might not.
And furthermore, you might read Kirk’s piece and find yourself wondering whether the product Stuart himself puts out lives up to his own billing.
We’re all about having fun here at Heisenberg Report, so here’s what we’re going to do. We’re going to present Stuart’s defense of the sellside, and then we’re going to present one of Stuart’s latest research notes so you can weigh his arguments against his own product (Note: The research note that follows the FT piece isn’t really indicative of what Kirk is talking about in his defense of sellside investment research. Rather, it’s from a series Kirk writes called “DB 140 Weekender”. So this isn’t an apples-to-apples comparison. But I still think this is an interesting exercise for readers).
Via FT, by Stuart Kirk
Investment research faces the biggest challenge to its business model since Eliot Spitzer, the pugnacious former attorney-general of New York, jammed a mile-high wedge between analysts and bankers 15 years ago. From January, clients must pay for research directly rather than via commission. A horrible shock is predicted as analysts such as me discover what they are really worth. Many say research is in terminal decline regardless.
Such doom and gloom is not shared by the so-called sellside, however – and we are a cynical bunch. We see a bright future where newly unbundled content is king and clients are happy to pay for it. Outsiders are too pessimistic because they do not have the data we do. This is not their fault. Indeed, it is exactly because the economics of research is mixed up with sales and trading that regulators want to untangle the mess so clients can see what they are paying for.
Why are the naysayers wrong? Take readership. Low click-through rates are often cited as a sign of disengagement, but analysts are now encouraged to summarise their ideas into the body of emails so clients do not have to download whole reports. On average, about a third of these emails are opened – a significant number. More encouragingly, openings skyrocket when original work is presented in an attractive way. Our best content is often more widely read than much paid-for financial commentary.
It has also recently been claimed that research must be suffering because headcount is down a 10th since 2012. But that is slightly better than for investment banking overall with an 11 per cent decline, according to Coalition data. New technology has reduced employees in publishing and distribution but areas of importance remain covered. For example, the top eight global research houses analyse the same number of companies they did a decade ago – 3,150 each on average.
The snub that investment research is not valuable is even flakier. Clients fight over meetings with our best analysts and the media ask us for 300 reports a quarter. And, while the sellside’s forecasts are no worse than other professions, analysts are not paid to pick. When I was a portfolio manager in the late 1990s we charged 1 per cent in management fees. Sellside research by contrast costs a fraction as much, around 0.05-0.1 per cent, or to use the industry parlance, 5-10 basis points. That is a bargain given the unrivalled knowledge on offer – not to mention the corporate access, conferences, models, positioning data and much more we throw in as well.
How much of a bargain we cannot prove under a bundled model. But clients tell us how valuable we are, and they tell independent consultants, too. An annual Greenwich Associates survey asks the buyside – the fund managers and other investors – to apportion its commission payments according to the services received. Year after year, the responses show that clients allocate 45 per cent of commissions for research, 35 per cent for execution and 20 per cent for sales.
Sure, research can improve. There is still too much volume versus quality (my department publishes about 50,000 reports a year). We must also be better at embracing technology to make our content easier to use. Some clients have already given up on us, building their own analyst teams instead. But, again, this is not so bad from where we sit. Ironically, large buyside research platforms end up consuming even more sellside content.
Does providing research make sense for bank shareholders, though? Consider that in the past decade every investment bank has reviewed its operations and made tough decisions, including closing entire business lines. Yet not one has ceased doing investment research. That is because every part of a bank benefits from research, either directly or indirectly. Traders see that commissions are two times higher when a stock is covered by an analyst. Bankers know the success rate of getting on a deal is five times greater. Plus, we do everything from giving speeches at wealth management conferences to providing briefings for senior management. It is also nice that we do not require capital.
Research has always generated revenues, if it is sometimes hard to see. That is about to change and with luck these revenues will soar. We know from data on readership, meeting requests and phone calls that demand for research more than doubles during periods of uncertainty such as Brexit or Donald Trump’s election victory. And the sellside has suffered alongside active management as the dispersion of total returns declined after the crisis – the world was too boring, too uniform. Expect a renaissance in research now things are hotting up again.
Via Deutsche Bank, by Stuart Kirk dated February 13 (so the day before the above ran in FT)
Macro US economy — Are facts about to get in the way of a good story? The US economy is meant to be doing winningly. Both the Atlanta and New York Fed nowcasts for first quarter growth are nudging three per cent. The composite ISM and PMIs have hit a one-year high. Consumer sentiment has rocketed up in recent months. As has small business optimism. However one group seemingly immune to the pervasive cheerfulness are those curmudgeonly financiers. The senior loan officer’s survey this week reported an unexpected sharp tightening in credit conditions, presaging a downturn in credit growth, especially in consumer lending. This disappointing survey follows already soggy bank lending — with December registering the first month-on-month contraction in bank loans since the 2013 taper tantrum. If the US economy is to stay on script, bankers must read the chapter on “animal spirits” too.
Strategy Promise v policy — Some say equities have been too hasty in pricing in Trump promises. Not so. Take corporate tax reform. Cutting the headline rate from 35 to 25 per cent, for instance, would increase S&P 500 earnings per share by $10. However, if this was driving the stock rally, sectors with higher effective tax rates would have gained the most. Instead, relative sector performance since the election bears no correlation with effective tax rates. Similarly, the market doesn’t seem too worried about losing interest tax deductibility, a measure likely to lower S&P 500 earnings per share by $3. Indeed, a basket of the top-50 highest versus lowest interest expense stocks is back to pre-election levels. President Trump announced yesterday that significant tax changes would be unveiled in the next 2-3 weeks. Investors seemingly want to see evidence before they start to believe.
Stocks BP — With a dividend yield pushing an ex-crisis high of seven per cent, shareholders understandably fear a cut at BP. After all, the oil major’s dividend payment last year was $4.6bn while free cash flow was negative. Hence why investors cut five per cent from BP’s stock price after this week’s fourth-quarter results revealed a five per cent planned increase in capital spending this year and a one-tenth rise in the company’s breakeven oil price — on top of underwhelming profits. But that does not mean a dividend cut is imminent. BP is geared at just 27 per cent and more capex should help boost production by one-third by 2020. Most of this new production is gas so it will not plug the 8m barrel per day global supply gap in 2020. That may have to wait for higher oil prices.
Finance Bank regulation — After Janet Yellen was told last week to cease international banking discussions until the new administration decides on its financial regulation agenda, some would-be rules may soon be scrapped. Chief among these is the output floor. This specifies that an individual bank’s assessment of an asset’s risk weighting cannot be lower than a certain proportion of the regulator’s standard model. The discrepancies can be wide. For example, higher default rates in the US mean American banks tend to allocate mortgages a 35 per cent risk weighting, triple the level of European banks. That means an output floor would have a disproportionate impact on the continent’s banks. A muted 65 per cent floor would impact half of European banks and increase their minimum capital requirements by 20 per cent, double the hit for Japanese banks and quadruple that for American banks.
Digestif Tequila competition — This week the world’s biggest tequila maker with 30 per cent volume share, Jose Cuervo, raised almost $800m in an initial public offering. Here are seven facts about tequila. (1) Tequila is a type of mezcal made in five Mexican states from the blue agave plant (2) True tequilas contain a moth larva (3) America and Mexico account for 85 per cent of global consumption (4) July 24th is National Tequila Day (5) Over the past decade volume growth has been fastest in Turkey (6) Tequila can be manufactured into diamonds (7) Patron — a rival maker to Jose Cuervo with eight per cent of global volumes but 18 per cent of revenues — was co-founded by that bearded, ponytailed bloke of Paul Mitchell hair care fame.