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Investment view

Among the many jobs I have held in the investment world is that of stock analyst. At the time, I was also a fund manager but the investment house I worked for required all charged with looking after money to contribute to the overall investment process. My sector was engineering, chosen on the premise that I had spent five years working in Birmingham.

My worst call – which in some measure was also my best – was to advise against applying for Jaguar shares at their flotation. I identified the problems that were to force Britain&#39s premier car marque into foreign ownership but failed to anticipate the vast profits to shareholders in the interim.

Investment research is much in the news at present. Following my experience, I confess to having nothing but admiration for analysts. Like fund managers, their successes and failures are published daily in the share price pages of the press. But it seems that an analyst&#39s life is more complex than simply seeking to recommend purchases and sales with reasonable accuracy. They serve many masters, and, in America at least, this potential conflict of interests has led to a massive fine and could reshape the research industry.

In theory, there are two types of research operations – sell-side and buy-side. Sell-side is for external consumption and its principal purpose is to generate revenue as a consequence of the ideas generated. Buy-side may not see the light of day outside the organisation in which it is produced. The aim is to help fund managers reach the best decisions on shaping portfolios. Inevitably, theory and practice are very different.

The problems that have been highlighted in the US relate primarily to the sell-side and to conflict that might exist between the corporate finance activities of an investment bank and other customers for its research product. Analysts are often well paid and are expected to have an independent approach. Yet evidence has emerged that recommendations given may owe more to the desire of the firm employing them to keep corporate clients sweet than to endeavouring to make the right calls on shares. With corporate finance departments typically chipping in a significant proportion of an investment bank&#39s profits, such a desire should not seem unusual. It is the extent to which recommendations are skewed to serve the corporate financiers that has concerned US authorities.

On this side of the Atlantic, the regulator has indicated that there are no plans to demand changes to the way in which analysts operate, although there have been examples of the way in which these conflicts can arise. Terry Smith, now boss of Collins Stewart, was famously castigated by his employer when his book, Accounting for Growth, highlighted the creative methods used by a number of the investment bank&#39s clients. Then there was the example of the analyst pressured into withdrawing a sell recommendation on Maxwell Communications because the company was a client. The analyst circumvented the restriction by saying “can&#39t recommend a purchase” (check the initials his for real thoughts).

It seems likely that the research industry will undergo its own reformation without any pressure from the regulator. An increasing dominance of the market by professional investors now demands a level of resource for fund managers that is unlikely to be satisfied by sell-side research alone, while the disappointing volumes in equity markets, coupled with flat performance and lower levels of corporate activity, is placing significant pressure on investment banks.

For retail investors, it is the independence of the analyst that should first be examined. Then, of course, it will be their ability to get it right more often than wrong. Research is an essential part of the investment management process. I am glad I have the t-shirt. I am happy not to be an analyst today.


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