• Embed Doc
  • Copy Link
  • Readcast
  • Collections
  • CommentGo Back
 
BY JOHN RUBINO
question is haunting WallStreet. Actually, a lot of ques-tions are haunting WallStreet, but the one causingthe most immediate angst is: Are thesell side’s problems cyclical or secular?The answer holds the key to thou-sands of careers. So let’s begin at thebeginning, which, for our purposes, is theearly 1970s. Back then, equity tradingcommissions were fixed, meaning thatwhen Fidelity Magellan wanted to buy achunk of IBM, it had to pay the same 20or so cents per share, whether it executedits trades through Merrill or Bear Stearns. Which firm got the business depended onwhich analysts did the best job of keepingPeter Lynch and company up to speed,and the winning analysts got a cut of theresulting commissions.This cushy setup ended with 1975’sBig Bang, when trading commissionswere deregulated. Active buy-side firmswere suddenly able to demand volumediscounts on their trades, and the sellside’s income stream began to evapo-rate. But just as the commission droughtwas becoming critical, investmentbanking rode to the rescue. The 1990sbull market was in full swing, IPOswere booming, and the bankers haddiscovered that offering influential,guaranteed-favorable research coveragewas a great way to attract new business.They invited analysts to the IPO party,and by the late ’90s, “companies feltthat [favorable coverage] was part of what they were paying for when theysigned up with an investment bank,”says Warren Isabelle, president of Iron-wood Capital Management.This changed the goals and thenature of sell-side research. An All-American ranking from
InstitutionalInvestor 
magazine was crucial as itimplied to corporate customers that ananalyst’s research was widely followed.Rating banking clients’ shares a buywas mandatory as favorable coverage waspart of the package. And travel — neces-sary to build relationships with moneymanagers and banking clients — becamenon-stop. “I spent 80 percent of my timetraveling,” recalls Jonathan Ziegler, aformer Deutsche Bank analyst now withresearch house JM Dutton.Public companies, meanwhile, dis-covered that they could manage theircoverage by “guiding” selected analyststo the proper insights on upcoming earn-ings reports. The analysts with the bestaccess got a cut not just of trading com-missions but of the much larger bankingfees. Pay packages for rock-star analystssoared into the millions of dollars.Then it all fell apart. Tech stocksimploded, the IPO pipeline dried up,and the regulators imposed a panoplyof new rules: Public companies mustnow release the same information to allanalysts at the same time (per the USSecurities and Exchange Commission’sRegulation Fair Disclosure (Reg FD)).Each research report must include achart showing the analyst’s past recom-mendations and the ensuing price action.Most damaging of all, analysts can nolonger be paid for their contributions tothe banking deal flow.The sell side, as a result, finds itself with temporarily lower trading volumes(which always leads to mass layoffs inany event), still-falling commission rates,a loss of exclusive access to companymanagements, and no more investmentbanking fees. So the answer to thecyclical/secular question appears to be“a little of each.” Some aspects of thesell side’s good old days will return whenthe next bull market sends trading vol-umes soaring. Some, like investmentbanking fees, are gone forever. Thus, the
 Analyst
future appears to hold the following:
Fewer analysts.
Demand for sell-side analysts will, as always, depend onstock prices and trading volumes. Butunder the new regulatory regime,another 1990s-style hiring boom isunlikely. Think of that decade as anaberration and tomorrow’s more modeststaffing levels as a reversion to the mean.
Reduced coverage of small andmid-cap stocks.
Most bulge-bracketfirms [leading investment banks] willmaintain coverage of large caps becauseMicrosoft and IBM generate enoughtrading volume to make it worthwhile(and the buy side will continue to cravethe expertise that a full-service researchoperation can bring to bear on majorcompanies). Not so for small caps, how-ever. A stock that trades 100,000 sharesa day at an average commission of 2cents a share generates a paltryUS$400,000 over a typical year’s 200trading days. That doesn’t come closeto what it costs a bulge-bracket firm tomaintain coverage. So the biggest play-ers have been abandoning small andmid-cap stocks.According to First Call,only about half the companies with mar-ket caps below US$500 million are nowfollowed by sell-side analysts.
Increased responsibilities and/orlower pay.
 Work loads are rising asremaining analysts take on some of thecompanies of their recently departedcolleagues. Yet the average bulge-bracketanalyst with five years of experiencewill probably earn around US$650,000
 AGENDA
The State of the Sell Side
How cyclical and secular issues are affecting business
CFAMAGAZINE
NOV-DEC 2003
46
KEY POINTS
•Sell-side employment levels are atleast partially cyclical, and shouldrebound during the next bull market.•The major investment banks will con-tinue to cover large cap stocks.•Independent research boutiques willcontinue to proliferate.•The sell side will return to its roots,with more pure research and less mar-keting. Stock picking will become farmore important.•The really big money is now on thebuy side.
      P      R      O      F      E      S      S      I      O      N      A      L      P      R      A      C      T      I      C      E
A
of 00

Leave a Comment

You must be to leave a comment.
Submit
Characters: ...
You must be to leave a comment.
Submit
Characters: ...