It was January 2011, and markets were rallying around the globe, driven by optimism that the U.S. and European economies were on the rebound. One rising stock was Janus Capital Group Inc. (JNS), the Denver-based asset management firm.
Investors were betting that Janus, with its lineup of growth-oriented mutual funds, would benefit from the surge. JPMorgan Chase & Co. (JPM) analyst Kenneth Worthington disagreed.
Sifting through Janus’s funds, he saw that returns had begun to taper off about six months earlier, Bloomberg Markets magazine reports in its August issue. Worse, the firm had recently instituted so-called performance fees on a half dozen of its funds, meaning that the funds pay fees to Janus Capital, their “adviser,” based on performance against their benchmarks. When fund performance lags, those fees decline, hitting profits.
“Performance collapses, earnings collapse, the stock collapses” was the scenario that Worthington says he saw.
The JPMorgan analyst put a sell recommendation on Janus on Jan. 7, 2011, when shares were trading at $13.45. The stock rose as high as $14.54 in February before nose-diving, finishing the year at $6.31.
“It was one of the worst-performing stocks in the S&P 500 last year, and we caught it all,” Worthington says.
Janus shares, since upgraded to a hold by Worthington, closed at $7.20 on July 11.
Worthington’s sell call on Janus helped make him the top U.S. stock picker of brokerage and asset management firms, according to a ranking of U.S. stock analysts by consulting firm Greenwich Associates in association with Bloomberg Markets.
JPMorgan, under Americas equity research head Noelle Grainger, scored the largest number of highly ranked analysts, making it the No. 1 firm in U.S. equities research. Bank of America was No. 2, followed by Morgan Stanley. (MS)
To compile the ranking, Stamford, Connecticut-based Greenwich Associates surveyed 980 buy-side analysts at 216 investment management firms, mutual funds, hedge funds, pensions and insurers. The analysts were asked to name the Wall Street research teams they considered their most important sources of advice on investments in 58 industries. Those were winnowed to 35 to ensure a statistically significant number of responses.
The answers were then weighted by the amount of trading commissions each buy-side firm paid out to banks and brokerages -- $30 million on average, or a total of $5.6 billion. A vote for an analyst by a firm that paid $20 million in commissions was thus given twice the weight of a firm that paid $10 million.
Wall Street research directors say it’s harder than ever to earn money from the kinds of calls that Worthington made. Ever since the credit crisis began to unfold in 2007, markets have been driven by macroeconomic events that have little to do with single-stock fundamental research.
Nearly 70 percent of a typical stock’s performance is determined by forces linked to macroeconomic shifts rather than issues specific to a company, such as earnings or management changes, according to Morgan Stanley research completed in early May. That compares with just 33 percent in 2005.
“It’s a heck of a lot harder to make money on a stock-specific basis in the short term,” says Stephen Penwell, director of North American equity research at Morgan Stanley. “You’ve got to identify secular trends.”
Bank and brokerage research directors say they’re confident they can cut through the macro forces that are driving markets to come up with useful investment advice.
“The decline of Wall Street research is vastly overblown,” JPMorgan’s Grainger says. “There continues to be a demand for high-quality talent. Investors still want to know what is going on in an industry.”
So analysts today are more focused on churning out exhaustive studies of trends and industries, with colleagues on several continents providing insights.
“We’re in the business of connecting the dots,” says David Bleustein, Zurich-based UBS AG (UBSN)’s head of U.S. equities research. “We can tell you how a longshoremen’s strike in Australia is likely to affect a U.S. coal company.”
Earlier this year, for example, Zurich-based Credit Suisse Group AG (CSGN), which is tied at No. 4 among the top-ranked firms, issued its Emerging Consumer Survey Databook 2012, a 179-page tome compiled with pollster Nielsen Holdings NV. (NLSN) It surveyed nearly 14,500 people in Brazil, Russia and six other emerging markets on everything from their credit card debt to their perfume expenditures.
54 Percent Return
“You’ve got to be an investigator now,” says Stefano Natella, Credit Suisse’s co-head of securities research and analytics.
The databook shows that 24 percent of Brazilians surveyed who had after-tax monthly income of 8,151 to 11,410 reais ($4,002 to $5,602) and who had purchased jewelry in the past three to 12 months had bought foreign brands. Portfolio manager Catherine Wood at AllianceBernstein Holding LP (AB), which managed $400 billion as of May 31, says such surveys help her refine her investment themes. In this case, it reinforced her thesis that expanding wealth in emerging markets was benefiting luxury goods purveyors Cie. Financiere Richemont SA, L’Oreal SA (OR) and LVMH Moet Hennessy Louis Vuitton SA. (MC)
“When we move into a macro-driven environment, thematic long-term investing outperforms,” she says. “We’re looking for global themes that are disruptive and cut across economic sectors.”
Bank of America application and systems software analyst Kash Rangan, who tied for No. 3 in that category of the ranking, is using deep-dive research to pick out groups of companies that are profiting from global technology trends. He co-authored a four-part series of reports totaling 586 pages that mapped out the dynamics of cloud computing and the companies likely to benefit from it.
In May 2010, Rangan’s team used the research to make a dozen stock recommendations -- including Amazon.com Inc. (AMZN) and Salesforce.com Inc. (CRM) -- that generated a 54 percent return over 12 months. The Nasdaq Composite Index (CCMP) rose 33 percent during the same period.
“You want to identify the theme that can make money for clients and then you want to identify the companies that are most leveraged to that theme,” Rangan says.
John Pitzer, the Credit Suisse semiconductor analyst who is tied for No. 1 in that category, harnessed the firm’s proprietary database of 3,200 suppliers and customers to assess the likely impact of Japan’s March 2011 earthquake and Fukushima Dai-Ichi nuclear-power-plant disaster.
One Credit Suisse report, by London-based Richard Kersley, head of global equity research product, focused on Shin-Etsu Chemical Co., whose sidelined plant in the Fukushima prefecture made 22 percent of the global supply of 300-millimeter silicon wafers used by companies such as Intel Corp. (INTC) and Micron Technology Inc. (MU)
Pitzer maintained his buy recommendations on the two chip companies after concluding that any supply disruptions wouldn’t be sufficient to impact their earnings. From March 17, 2011, the date of Kersley’s report, to July 11, Intel stock returned 32.9 percent while Micron lost 39.2 percent.
At the end of the day, it’s buy-side portfolio managers who pick stocks.
Lache has a track record of prescient against-the-grain calls. In April 2010, investors were driving down the price of auto parts maker Johnson Controls Inc. (JCI) on the theory that the worsening euro-zone economic outlook would hit its earnings; the Milwaukee-based company derived a third of its revenue from Europe.
Lache saw it differently. He judged that JCI’s battery unit would profit from the signing of a new contract with Wal-Mart Stores Inc. He also saw signs of a rebound in Johnson Controls’ auto interior and building controls divisions. He upgraded the $31.20 stock to a buy on May 6, 2010, with a $36 price target. Shares bottomed at $25.90 in early June before rebounding to $39 on Dec. 7, when Lache downgraded it to a hold.
“We’re trying to be contrarian,” he says. “That’s how you make money in this part of the market.”
Credit Suisse’s Thomas Gallagher, who tied for the No. 1 spot in Greenwich Associates’ life and health insurance category, made a nuanced call when, on July 14, 2010, he upgraded Des Moines, Iowa-based Principal Financial Group Inc. (PFG), an insurance and asset management firm, to a buy from hold.
His rationale: In a declining stock market, the company, which has a big 401(k) retirement plan business, should hold up better than its peers because those saving for retirement tend to do so regardless of market gyrations.
Principal was also cheap. Using a common valuation metric, Gallagher calculated that it could be liquidated at 1.6 times the price at which it was trading, half the multiple of rival Radnor, Pennsylvania-based Lincoln National Corp. (LNC) Investors agreed: Shares returned more than 30 percent during the next six months, to $33.07 on Jan. 5, 2011, before Gallagher downgraded them again to hold.
Proprietary data can help an analyst make those kinds of calls. In January 2011, Morgan Stanley restaurant analyst John Glass commissioned a survey of 1,500 coffee buyers, personally writing the questions. Seattle-based Starbucks (SBUX) Corp. had recently disclosed that it was interested in the single-serving, packaged-coffee market.
“The key question was, ‘Does single-serve coffee cannibalize your visits to Starbucks coffee shops?’” Glass says.
Few respondents said it did.
Based on that and other responses, Glass concluded that Starbucks would quickly garner 30 percent of the fast-growing, $3 billion single-serve market and that the new product could help push up earnings growth to as much as 20 percent. He put a buy on the stock at $33.12 with a $40 target price.
Three days later, after Starbucks announced plans to partner with Waterbury, Vermont-based Green Mountain Coffee Roasters Inc. (GMCR) in the single-serve market, shares jumped to $37.97. The stock traded at $52.16 on July 11.
Even as analysts work to make themselves indispensable to investors, their world is shrinking. Investors are trading less these days, which reduces commissions. Average daily trading volume peaked at more than 12.3 billion shares in March 2009 and fell to 6.6 billion by March 2012, according to New York-based Rosenblatt Securities Inc. Asset managers, including hedge funds, will pay an estimated $13.3 billion in U.S. equity commissions in 2012, down from $17.5 billion in 2009, according to Tabb Group LLC, a New York-based capital markets consultancy.
The rise of exchange-traded funds has further reduced the need for researchers. ETFs comprised 14.9 percent of stock market volume in 2011, up from 4.6 percent in 2005, according to Rosenblatt. Big ETFs, like index funds, have little use for research and generate much lower trading commissions, often using electronic networks.
“That’s going to be a challenge for our business,” says Jonathan Rosenzweig, Citigroup Inc. (C)’s Americas equity research director. “The fact is that passive investing continues to grow.”
As the prominence of researchers has diminished, so has their pay. It’s off 20 percent since 2007 to an average of $500,000 for midlevel analysts, according to Alan Johnson, managing director of compensation consulting firm Johnson Associates Inc.
The superstar analyst of the 1990s bringing home millions of dollars a year is gone, partly as a result of 2003 settlements with then-New York Attorney General Eliot Spitzer and other regulators that walled off analysts from their firms’ investment-banking divisions. Senior-level researchers today get two-thirds of their pay in deferred stock awards. Before 2007, just a third of their pay was deferred.
One growing and unheralded role analysts play is in connecting their buy-side clients to managers of the companies they cover through meetings, conferences and field trips. In one recent high-end excursion, an analyst signed up 15 top clients, chartered a plane and took off to meet with executives at half a dozen companies in the course of a few days. One buy-side firm paid the analyst more than $100,000 in trading commissions for the trip.
The face-to-face meetings are the latest offering by an industry hurt by a poorly kept Wall Street secret: Its traditional buy-sell-hold recommendations get scant heed from investors.
“The upgrades and downgrades are secondary,” Credit Suisse life insurance analyst Gallagher says. “It’s much more about finding relevant information, being helpful in explaining issues that are important over a multiyear period.”
In short, the analysts who do find favor with investors are those who manage to grind out good investment ideas even in equity markets that are governed by fear, correlation and aversion to risk.
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