Magazine article Financial History

The Fall and Rise of Independent Research

Magazine article Financial History

The Fall and Rise of Independent Research

Article excerpt

There are three teams active at any sporting event: the two competing sides and the officials. Perceived good and bad calls are greeted with boos or cheers, but no one ever actually roots for the refs per se. Still, everyone acknowledges their importance; the game could not be played without their presence. And so it is with the three teams in investing: buyers, sellers and research.

As with the presence of officials, or judges, for that matter, no one would debate their importance. For many decades independent research was the fundamental advantage of any good investor. Early in his career the great investment advisor Benjamin Graham would travel from his offices in New York to Washington, DC, to examine company regulatory filings that were technically public records, but in those days were not available.

But in another, more fraught analogy to sports officials, research is not supposed to take sides, just call offsides or interference or unsportsman-like conduct. History clearly shows that has not always been the case.

Important lessons can be learned from the past three decades, where some notable firms incurred fraud charges while trying to benefit financially, regardless of the investors' success. The case of former equity research analyst Henry Blodget is one example. From Oppenheimer to Merrill Lynch, Blodget operated on his own terms. Amid personal investments in tech stocks, Blodget is considered by many to have betrayed investors for his benefit and is today banned from the securities field for lying in his stock analyses. The research for stock investments requires trust on the part of the investor to believe that revenue and earnings figures are correct, and that the investor will not be deceived.

The complication, says Jack Ablin, Chief Investment Officer for BMO Private Bank (formerly Harris Private Bank, in Chicago), is whether research is considered a service to clients or a business. Neither is a safe designation - if a service there is a temptation to give the clients what they want; if a business, the drive for profit can cloud the picture.

After the exposés and scandals of recent decades, independent research seemed to fall out of favor. Many investment banks and brokerages reduced the size of their research operations, or eliminated them entirely. In some cases the logic was that most investors - retail or institutional - did their own screening online. Now, however, that trend seems to be reversing.

"We see a few more 'sell' recommendations these days than in recent years," says Ablin, "but most recommendations still skew to the 'buy' side." The driver, Ablin suggests, is the revenue model not in research itself, but overall. "Investment banks have come full circle on research. The bulk of their revenues used to come from initial public offerings, so the urge was to support that. Now that area has died down a bit, and the growth business is more advisory, especially for hedge funds."

Those are not necessarily "buy-and-hold" investors, Ablin explains, but rather investors who work both long and short. The result is that sell recommendations are just as useful as investing guides as are buy ratings.

That new reality is in stark contrast to recent decades. In the 1980s and 1990s, as research became more of a commodity, independent research flourished under firms like Donaldson, Lufkin and Jenrette. DLJ (later acquired by Credit Suisse, then Bank of America) recognized the value of research and provided a service in a niche that Wall Street lacked. Today, such research has become an integral part of the sell-side. Yet international regulations around issuing commissions have caused many firms to offer both external and internal research options. Commissions are to be paid independent of trade performance.

As a result, Goldman Sachs introduced its Hudson Street Services, which provides information from external research and offers access to the resources of a small number of external research houses. …

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