I have a Mr Miquel on the line. He is not very happy.” My first ever piece of investment research had just been published and until I received that chilling call from him one morning in 1979, I had never spoken to the senior partner of Fielding Newson Smith, the broking firm where I worked.
That was about to change, for Raymond Miquel, the feisty chief executive of Arthur Bell, then the UK’s market leader in Scotch whisky, had taken great exception to a report I had written recommending that shareholders sell shares in his company.
The senior partner stood by me, telling Mr Miquel that analysts’ obligations were to investors not to the companies they wrote about. And he remained supportive, even when the share price rose steadily. In those days, the risk to my career was a bad stock call, not a grumpy CEO. The arrival in January of new European markets rules, known as Mifid II, prompts me to wonder whether the status of sellside investment research is about to turn full circle.
The senior partner stood by me all those years ago because like most broking firms — there were a few exceptions — Fielding Newson Smith’s biggest clients were fund managers rather than the corporates in whose shares they dealt. The analysts’ job was unequivocally to provide institutions with objective research. But after Big Bang, the stock exchange reforms of 1986, broking firms were absorbed into banks. Lucrative banking relationships became an attractive adjunct to dealing for investors, and sellside analysts now had another audience to consider.
Big Bang and a bull market led to a boom in capital markets activity in which analysts were used to attract corporate finance business. They became highly paid and famous, and during the internet bubble of the late 1990s they acted as secret agents promoting their investment banking departments’ new issues.
This was exposed by New York State Attorney General Eliot Spitzer after the dotcom crash of 2000, leading to tighter regulation and a wave of independent research boutiques. Integrated banks and brokers were required to separate research from investment banking and to restrict analysts’ participation in corporate finance pitches and roadshows.
The legal and compliance departments have become more intrusive in the daily life of analysts, and conflicts of interest at the integrated firms are managed better.
However, sellside research in the investment banks is not yet a transparent profession. Aside from the inevitable suspicion that analysts temper their views about stocks where there is a corporate relationship, no one knows the value investors place on research since it is often bundled up with trading costs. Because these are passed on to end investors such as pension fund contributors and mutual fund savers, fund managers have not had to think too hard about the value they put on sellside research and brokers do not know the monetary worth of their research departments.
However, Mifid II will require fund managers to pay banks and brokers directly for research instead of combining the cost with execution charges. The price of research and whether the fund manager or end investor picks up the bill is still to be resolved, but amid the fog of unintended consequences the one certainty is that both sides will look more closely at the economics of research.
This might lead investment managers in the UK and Europe to decide that they can do without it altogether, but this is unlikely. External research helps to establish context and consensus, particularly for smaller capitalised stocks. Analysts with a deep knowledge of the companies they follow and an understanding of how to apply it will be valued by active investors — but there will not be room for many. Alongside them will be a cadre of well-regarded specialists following smaller companies and a rump of junior analysts producing data-driven research. There will be a market for research but it could be very small.
Although a smaller and less expensive industry seems inevitable, Mifid II could complete the post-Spitzer rehabilitation of sellside research as a reputable occupation. Fund managers and investors paying hard cash will drive up quality and be less tolerant of those speaking with forked tongues. Analysts, like the companies they follow, will be working to transparent market forces.
All of this has the potential to restore prestige and status to a profession that long ago lost integrity and a clear sense of purpose. For those presently involved it is a small consolation; for those that survive, it is a prize worth seeking.