Sunday, January 11, 2009

The Equity Research Shortfall

The Equity Research Shortfall

In 2009 many investors will find themselves looking for new sources of equity research. Wall Street firms, crushed by subprime losses, have laid off scores of equity analysts. Goldman Sachs (GS) let go of a dozen analysts covering industries from newspapers to industrial materials in November, and Citigroup (C) said it was dropping coverage of 7% of stocks its analysts once followed. (A Goldman spokesman says the firm has increased the total number of stocks its analysts follow worldwide over the past year.)

And that's after competitors acquired Lehman Brothers (LEH), Merrill Lynch (MER), and Bear Stearns (BCS) and slashed the ranks of their analysts. The total number of senior analysts shrank 40% to 50% over the past year, says Sandford Bragg, CEO of Integrity Research Associates, which tracks analysts from over 1,000 firms for institutional clients. "We've been forecasting consolidation for some time, but we didn't think it would happen so quickly," says Bragg. Even analysts holding top rankings from Institutional Investor magazine and The Wall Street Journal will find themselves looking for work, he adds.

Meanwhile, academic studies haven't shown much value added by analysts' stock picks. The more useful function for investors is being alerted to new developments, whether from tidbits buried in corporate filings or data gathered from multiple companies to discern trends. "Many analysts did know a lot about their industries," says Len Rosenthal, a finance professor at Bentley University in Waltham, Mass., who predicts considerable additional analyst layoffs in 2009. So where to look for new sources of premium investment guidance?

Former Wall Street analysts typically go to work for hedge funds or open boutique research firms, which makes it all but impossible for individual investors to continue reading their reports. At Bear Stearns, Edward Wolfe led the transportation analyst team, top-ranked by Institutional Investor, for almost a decade before opening his own shop last year. Like many of his peers who have gone independent, Wolfe isn't looking for individual investors as clients. Neither is former Credit Suisse Group (CS) housing sector analyst Ivy Zelman, who launched her own company about a year ago. In 2006, in her Wall Street days, Zelman challenged CEO Robert Toll of Toll Brothers (TOL), whom she thought was being overly optimistic, by asking him "which Kool-Aid" he was drinking.

So far there's just one boutique with former top analysts creating a product for individual investors, says Integrity Research's Bragg. Research Edge, in New Haven, employs a half-dozen former top-ranked analysts. The firm was founded in April 2008 by former Carlyle Group hedge fund manager Keith McCullough and started with the same big-client orientation as its competitors. But McCullough decided there might be sufficient interest from high-net-worth investors. Starting in the next few weeks, Research Edge will offer online access to its buy and sell recommendations on stocks and exchange-traded funds at a starting fee of $2,700 a year. Subscribers will also get in-depth reports periodically. "We're trying to offer research without all the compromises and constraints of the old brokerage model," McCullough says. The firm bolstered its reputation with some on-target advice last fall, including a warning for investors to move out of stocks and into cash in September and a recommendation to buy Brazilian stocks in November. (The iShares MSCI Brazil Index Fund (EWZ) gained 25% in the past month.)

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