The Future of Equity Research NIRI Rocky

The Future of Equity Research – NIRI Rocky MountainsPresentation Notes: 

The Future of Equity Research – NIRI Rocky Mountains Presentation Notes Mukul Gulati Vice President, Content Products and Strategy Reuters Research

Recent Trends in Sell Side Research: 

Recent Trends in Sell Side Research Increased regulatory pressure resulting from the Sarbanes-Oxley Act and the Spitzer settlements Separation from investment banking departments is resulting in serious cost pressure on sell side departments and companies are being forced to cut costs

Recent Trends in Sell Side Research: 

Recent Trends in Sell Side Research Companies are cutting coverage – 20% decrease in company coverage. Mostly small caps are being cut Coverage for large cap stocks has not dropped Fewer star analysts and outsized compensation packages Firms looking at innovative ways to cut costs, especially for junior analyst work Offshoring – India, Philippines etc. Technology Rationalization etc. Partnering with quantitative data providers CSFB acquired a company called Holt to bolster small cap coverage Holt specializes in a quantitatively driven model to predict ‘economic earnings’

Independent Research: 

Independent Research The Spitzer- SEC settlement requires the 10 firms to provide research from three independent research providers as part of their research reports These firms are required to spend a $100M on independent research and investor education Scramble for the settlement dollars So far, a lot of quantity, not enough quality Few high quality exceptions – Bernstein, Argus etc Very few are included in the consensus Firms are finding it hard to find to build a successful business model

Buy Side Trends: 

Buy Side Trends Small hedge funds are increasing in number rapidly Approx. 8000 hedge funds in the United States and growing fast A significant number are involved in equities trading Popular with investors Hedge funds can go both long and short and hence be market neutral – market neutral funds are particularly attractive in down markets Hedge funds can deploy leverage for outsized returns Downside – LTCM etc Popular with star money managers Compensation structure – fund managers typically keep 20% of the profits in addition to a management fee

Quantitative Trading: 

Quantitative Trading A majority of the hedge funds are small, therefore, they do not have access to in house analysts and sell side research This forces some of these funds to set up quantitative trading strategies Some of quant trading is performed by hedge funds, others by proprietary trading desks of Wall Street firms Some hedge funds are being funded by Wall Street firms Quant strategies Using computers to identify patterns in stock price behavior Technical (price and volume driven) Fundamental (estimate revisions, growth etc.)

Statistical Arbitrage and Systems Trading: 

Statistical Arbitrage and Systems Trading A lot of quantitative strategies are executed by humans, some by computer systems 40% of the volume on the NYSE and 25% of the NASDAQ is driven by systems trading Statistical Arbitrage example – pairs trading – GM and Ford This will result in more unexplained or ‘random’ stock price behavior Ultimately it will result in more efficient markets, and minimizes price volatility, as all available information is captured in the stock price immediately

Is Sell Side Equity Research Dead?: 

Is Sell Side Equity Research Dead? Not at all, but a period of serious consolidation is coming for Wall Street Research departments High grade qualitative company and industry research will continue to be a source of competitive advantage for sell side firms Despite all the recent criticism and some egregious behavior from a few analysis, the sell side research community plays a valuable role in the asset allocation process and keeps management teams honest Computers can read numbers but still cannot efficiently process factors such as the quality of the management strategies Big Buy side institutions will continue to use sell side research, in addition to their own analysts, money flow toward quantitative research will continue to increase Quantitative strategies will continue to rely on sell side estimates

Other Trends: 

Other Trends Since Regulation FD, Earnings Pre-announcements have replaced Earnings Surprises as the single most important event in stock price changes The absolute level of recommendations has no correlation with the stock price, changes in recommendation do Increased focus on non EPS measures – Revenues, EBITDA, Same Store Sales etc.

Other Trends: 

Other Trends Consolidation on Wall Street will result in fewer analysts More unexplained and ‘random’ behavior in your stock price Earnings Guidance Companies which provide earnings guidance tend to have a lower standard deviation of analyst estimates, or dispersion around the mean The Street likes stability Surprises on earnings guidance or historical reporting will continue to result in stock price volatility My advice – disclose information when you have a certain degree of confidence Increased pressure from the investment community for detailed disclosure A complex set of factors will drive stock prices – not just EPS Companies with more transparent and fuller disclosures will be rewarded