TOP OF THEIR LEAGUE: the brokers who can move markets

When the UBS banking analyst Jonathan Mott released a critical report of Macquarie Group at the height of the global financial crisis, he sailed into a storm of controversy that ended with a grilling from the corporate regulator.

With Macquarie under fire from short-selling hedge funds, Mott's report downgrading his rating and asking pointed questions about the bank's capital position provided fresh ammunition for Macquarie sceptics.

Likewise the Citi analyst Jenny Owen, who raised concerns about the possible breaches of debt covenants at ABC Learning that sparked the beginning of the end for Eddy Groves's listed childcare empire.

Then there's the Merrill Lynch analyst David Errington, a critic of the Foster's expansion into wine from the day Trevor O'Hoy announced the acquisition of the wine company Southcorp. O'Hoy encouraged Errington to take a two-year break. He didn't. The Foster's wine business tanked; O'Hoy resigned.

And earlier this year, the Commonwealth Bank analyst Ben Brownette broke from the pack, flagging concerns about Downer EDI that preceded a big profit downgrade.

They're the big calls that move markets and have raised the ire of companies and their relationships with the brokers that cover them.

The analysts who make them are hired by big banks and broking firms to run the numbers on companies, build relationships with management and ultimately form a recommendation for investors who pay big money to receive their research - buy, hold or sell.

But how is the analyst fraternity viewed by those who pay for its services? And do analysts make the tough calls often enough, or are they an extension of the marketing arm for their banks' lucrative brokerage

businesses?

The latest East Coles Best Broker survey published today in Weekend Business reveals concerns from fund managers about the state of financial research, including a lack of quality and renewed concern over the potential for conflict of interest.

A selection of responses to the survey asking how much professional investors rely on research is typical: We rely on it [research] a bit, which is unfortunate because it has been wrong throughout 2009. Not at all, no value. THEtables have turned in the investment community over the past 20 years.

Back then, it was fund managers whowere poorly paid and analystswho had the upper hand.Now, as 9 per cent of every workers salary flows into the superannuation industry eachweek, an overbrokered investment community is scrambling to get its slice of the ever-growing super pie.

Brokers have product to sell, fund managers have money to invest, analysts have contact with the funds managers. And the perception lingers that analysts are viewed as salesmen for their banks trading desk.

In the wake of corporate failures like RAMS, Babcock&Brown, Allco Finance Group and ABC Learning, investors are even more sceptical about the recommendations of analysts and the relationship their bank has with a company.

Many ask: wherewere the big calls on some of the recent corporate disasters? In fact, therewere notable clangers.

InJanuary 2008, three days before theGold Coast property developerMFSwent into meltdown, aMacquarieEquities analyst,Mark Carew, issued a report with an outperform recommendation and a 12-month shareprice target of $7.15.At the time its shareswere trading at $3.94.Aweek later theywere $1.

The funds managerHughGiddy, from InvestorsMutual, says brokers and funds managers march to different tunes.

The thing that broking analysts dowell is they are very up-to-date in whats going on.

But in termsof a vision of whats going to happen or ability to really tell whats important to a company, thats not always so strong,Giddy says.

Our job as funds manager is to have a vision and so on and the analysts do the legwork.

They go and listen to every conference call, they are very focused on a very narrowset of stocks wherewe look across the market.

DoI pay any attention as to whether theyve got a buy or sell on a stock, not really.

Imjust more interested in background information. Asked if investors need to be sceptical about research,Giddy says: One has to be. He cites the float ofMyer late last year, in which virtually every investment bank was involved in the sale, precluding their research armsfromproviding recommendations.

Not picking on anyone, of the investment banks floatingMyer howmany had a value onMyer of under $3.50? I should think none.

The market has nowhad a fair time to shake out a valuation and the markets not crashed or anything andwere at $3.40.

Theres always that potential. Its your job as a funds manager to be aware that everyone has their own agenda. Their agenda in broking is to make money for themselves, for funds manager to make money for self.

Fund managers achieve that over the long termby delivering good investment performance. Broking is not necessarily correlated to investment performance or good investment idea, its much more linked to underwriting the deals, trading, frequency of trading and size of trading and supporting companies when they want to raise money. But one subtle area where the relationship can play out is in stock coverage. One of the things is that stocks justdont get covered if they dont do any corporate work, its quite interesting, or they give a very narrowcoverage, saysGiddy.

I look at the retail space and look at Metcash versussomeof the other companies that are bigger anddo deals.Metcash never gets a broker to advise them and themarket consistently has holds and sells onMetcash versus their peers, even though theyre cheaper.Whys that?Could it be that theydont generate any deals? Research teams say they are fiercely independent and in any case are separated by Chinese walls fromadvisory work.Many, however, still receive commissions for tradesmadeas a result of their research.

THEEastColes data confirmsthe dominance of the big broking houses in the rankings for analysts. UBS,Macquarie and Goldman Sachs JBWere are the top-ranked houses, withCredit Suisse the bigmover fromeighth to fourth, followed by JPMorgan.

NickColes, whose firmEastColes received 1105 responses from113 institutions representing about $330 billion in domestic equities under management, saysCredit Suisse is making a big push while theCommonwealth Bank, nowin 11th spot, has its eye on a top 10 position next year.

He points to increased competition as a key finding. RBS was unfortunate to lose key analysts toNomura (the head of research at RBS,MikeMorrison, dubbed them the NomuraNine). CLSA has been gradually accumulating personnel, andCBA is making a big push and sits on the fringe of the bulge bracket at 11th. Barclays will be coming soon, which should stir things up even more.

Moelis are here, too, now.Morgan Stanley still doesnt seem to be making much of an impression even after manyyears with a reasonably large team (albeit smaller than the others) and are anchored at 10th. Among other results, asked howmuch they rely on research, 32 of 43 respondents played downits significance in their investment decisions, saying they relied on it only a bit. Just five said a lot.

Asked to identify the greatest challenges facing the broking industry as it attempts to meet the demandsof institutional investors, funds managers nominated increased competition, a spreading of resources so thin that quality falls, and conflicts of interest.More than half want research unbundled fromtrading desks to ensureno conflict of interest.

Notably, the big three investment banks  UBS,Macquarie andGoldman  also top the survey for dealing and equity capital markets.

Survey respondents said they expected more investors to seek direct market access in the future, cutting out brokers while they also see the commissions paid falling.

But their concerns about competition and quality are dominant themes: Toomanybrokers, not enough good analysts and the industry needs to be consolidated to improve analyst quality and better the brokerage pool.

WHILE often critical of analyst performance, fund managers keep buying the research as a staple of their information diet and every morning a sizeable datadumplands in their inbox to tempt their investment strategy. As one fund manager whoresponded to the survey notes: Everyone has their favourite research brokers for different sectors, [research is] very important. Someanalysts help with access to company management, opening doors to meet with management because their bank is the house broker. It makes the talent pool attractive to banks and in the wake of the global financial crisis and the negative impact on bonuses, there has been a noticeable pick-up inmovement of analysts between banks.

The pick of the croparepowerful players in their sector with their recommendations often market-moving. So what are the top-ranked analysts fromthe latest results thinking?

STRATEGY Macquaries Tanya Branwhite andNeale Goldston-Morris fill the top two rankings in strategy.

We both come froma stock background, Branwhite tells theHerald. We think very muchmore about our research and our analysis froma stock perspective. The macroenvironment is still very important butwe always, I think, look primarily froma stock perspective and then put that within the context of macro. I think a lot of our competitors are from[an] economic background and dont have those insights into the stock sides. Branwhite and her team delighted subscribers by correctly calling the top of the market just a fewweeks before it turned inMarch.

But she has also published provocative research about the outlook for the economy.

I suppose the theme thatweve really been talking to a lot to clients and thats got longertermramifications, we started writing research a year ago about the prospect of a different economic, macro-economic outlook more akin to whatwe saw in the 70s and 80s, this idea of the shorter, sharper cycle.

Weve continued to develop that theme  thats got somepretty significant implications around things like howare stocks valued, how do you value growth, whats [an] appropriate P/E rating for a stock in that sort of environment and the implications for returns . . . that, I think, has been verywell received. Branwhite has concerns about company outlook statements in the upcoming reporting season. Weve saidwe think the 2011 numbers are a little bit too high, she says, highlighting banks as a likely area to moderate expectations. Imnot so sure that the earnings growth expectations into next year will be met. I think credit growth is going to be a lot lower than whats expected. BANKS Amongthe banking analysts, renewal over the past few years has seen top-rankers likeBrian Johnson, ex-JPMorgan, andJeffEmmanuel, ex-UBS,move on.UBSs JonathanMott tops the pile. We became bullishon banks inMay last year, which coincided with theUSbank stress tests. Luckilywe caught that rally.We remained positive onthe banksupuntilApril this year. Priceswere a bit overdone,he says.

He remains cautious about the outlook.

There are still a number of headwinds facing the banks. Wholesale funding costs remain elevated and access to those markets is challenging; deposit growth is slowing; funding costs are continuing to rise. This is going to put a lot of pressure on margins and force banks to keep repricing their mortgage books outside theReserveBank cycle just to stand still. So revenue growth will be subdued for the next while.We are also entering a period of re-regulation globally and the banks will need to hold more capital and liquidity. RETAIL Inthe retail sector, the top-ranked analyst ShaunCousins, fromJPMorgan,madecalls on Billabong andWesfarmers that paid off for investors.Nowhes concerned about earnings.

We recently downgraded consumer discretionary to underweight basedon a concern that earnings forecastswere too high for fiscal 2011 andwe think the reporting season will have cautious and softcommentary and that the consumer will remain restrained forsome time rather than enjoying a rapid recovery as we no longer cycle fiscal stimulus,he says.

MEDIA TheGoldman Sachs JBWere analyst Christian Guerra was a standout in the survey, topping two sectors  media and telecommunications.

Covering a sector like media, its dependent on the economy so you need to make sure youre in tune with the economic teams view there.Whenwewere cautious on the economywe made five downgrades to our market forecasts.Wewere negative on a few stocks including FairfaxMedia and Ten. But then inMay 2009we decided being negative was no longer appropriate andwewent neutral.We thenwent positive in September whenwe thought the outlook was looking brighter. Since thenweve called pretty aggressively that the ad market recovery is happening and thats driven our stock calls.

Right now,we are really bullish on the advertisingmarket, andwe have been since September.We have already put through two admarket upgrades andwe think the risk is still to the upside. Leading the charge in terms of the admarket recovery is online, metropolitan free-to-airTVandoutdoor.Media stocks should have apretty good reporting season. Guerra doesnt include publishers in the category to enjoy the recovery to the same extent. Newspapers have underperformed that recovery.Newspaper ads are going up but are not growing as fast as the overall ad market.

BUY, HOLD, SELL THE TOP-RANKED ANALYSTS

2010 OVERALL

RESEARCH RESULT

1. UBS

2. Macquarie

3. Goldman Sachs JBWere

SOURCE: EAST COLES