An article in today's NYT titled "Wall Street's New Harsh Reality" details the increasing downsides to being a sell-side research analyst at an investment bank—among them, the usual suspects: Reg FD, Big Brother-like scrutiny, lower pay, etc.
Last year, when I was still doing buy-side analysis for hedge funds, I wrote two little pieces on the same subject. The first, was a snarky banker-bashing rant (pre-Gawker Gawker) and the second was a fairly straight "sell-side analysis is dead" post. Parts of them still seem relevant and I'm lazy, so I thought I'd reprint them instead of repeating myself.
First, the snarky snarky (edited somewhat for length):
Rambling Commentary on B.S.D.s, Bad-Asses, and Vile Junior Analysts
It is a proved fact that most if not all brokers and traders lead emotionally empty lives, shot through with brittle posturing before others as well as themselves. Often their children don't respect them. - from Spy, circa 1987.
Nick has decided to engage in one of my favorite spectator sports--banker bashing. (Substitute "investment banker" for "brokers and traders" in the quote above, and you have, caeteris paribus, Nick's article.)
First, the obligatory and utterly transparent display of sympathy:
Personally, I take less pleasure in the humbling of the investment bankers. I have too many friends among them.
[I understand the impulse. I, too, have plenty of banker friends--don't we all?
We also have those various friends who may or may not have sold heroin to blind orphans in Tecate as well as those currently under indictment on charges of so-called "egregious" violations of federal statutes regarding the sale of small arms to well-meaning diamond smugglers in Sub-Saharan Africa. (After all, what's a little jail time if not the cost of doing business?) And deep in the cavernous recessess of our Rolodexes, we all certainly have a third-world dictator or two.
Investment bankers are par for the course, really. Can't live *with* 'em; can't sue 'em into oblivion.]
In the interest of full-disclosure, I do have a few i-banker friends who are charming people that I love dearly. I fear, however, that as my friends are fairly normal and well-adjusted, their respective employers will shortly expel them for not fitting the "banker mold."
He continues,
But it was always a mystery to me why they were paid quite so much more than people of equal ability, if not the appetite for such a soul-destroying environment.
Oh, I know all the arguments. The securities industry is a winner-takes-all market, like the movie industry, in which it is worthwhile for companies to reward lavishly their best talent, because the best talent wins all the business. And there were the crumbs, an explanation borrowed from Bonfire of the Vanities, in which the hero explains to his daughter how brokers take discreet crumbs, but of gargantuan loaves.
It's appropriate that Nick reference Wolfe's Bonfire, as many of the bankers I know perceive it less as social satire than a how-to book. Junior analysts aspire to be Big Swinging Dicks ("BSDs") and Masters of their respective Universes.
Some, amusingly, think themselves already there. Of those, some have had the audacity and the idiocy to refer to themselves quite seriously as "bad-asses." Within earshot of me.
Note to those people:
Let's put things into perspective. These guys are bad-asses. They speak several languages, can run for days carrying heavy loads without sleep, freefall out of planes, blow things up, chase terrorists, and can probably build small vacation houses out of toothpicks, a few alkaline batteries, and dental floss. You, by comparison, punch numbers into spreadsheets. On a really exciting day you get to use an aggressive discount rate. You are not a bad-ass.
If, for the sake of argument, we agree that the real life BSDs--the guys that actually get the deals--are bad-asses, *you* are still not the bad-ass. You're the guy that carries the pitchbook for the bad-ass.
But perhaps I'm being unfair. The junior analysts can't help it. The culture reinforces the arrogance. Bulge bracket banks spend all day abusing their junior analysts then reward them with gargantuan paychecks, dinners at chic restaurants, car services, and a variety of other desirable perqs. This allows the junior analyst to less-painfully weather the abuse from his superiors by affording him the luxury of being equally condescending and abusive to less well-paid peers.
On a less elevated level, no one is shedding tears, because investment bankers can still be insufferable. "Those still in employment are so used to bigging themselves up to colleagues and superiors, that they're unable to switch this off over dinner," says a friend who momentarily forgot her rule about dining with bankers. "They still suffer badly from busy-itis: I'm so busy, blah, blah, blah. Which is just dull."
Nick asked me this morning if I had ever dated an i-banker. Once, I replied. A long time ago. "By mistake," I should have added.
It's not even the arrogance that kills me. (That would be hypocritical.) It's the fact that it's absolutely impossible to have a conversation about anything but banking (how exhilarating it is) or money (how much they're making.) If they had any other interests before, the bank has effectively lobotomized them--poor bastards. Spending time with anything besides the interests of the bank is considered both adulterous and blasphemous.
Having worked on a few mergers and acquisitions as an independent analyst, I know first-hand that M&A transactions are about as exhilarating as a trip to the dentist for a root canal. Only the truly masochistic or delusional would enjoy the bureaucratic blizzard of redundant paperwork that is a corporate merger.
And the guys that tell you it's all about the thrill of the deal? The tough negotiations? If they're junior analysts, I doubt it. They don't get within a 100 miles of the negotiations, and the extent of their real deal exposure consists of fetching coffee for the attorneys that are frantically hammering together the trainwreck of a term sheet. Unless they're referring to voyeuristic pleasures, they're the boasts of those struggling to maintain necessary illusions.
Allison Pearson's new book, I Don't Know How She Does It, was recently slammed by a Salon reviewer because it was completely unrealistic. The lead character, a hedge fund manager, claims that she loves her job because "I love the blood rush when the stocks I took a punt on deliver the goods. I get a kick out of being one of the handful of women in the Club Lounge at the airport ... Most of all I love the work: the synapse-snapping satisfaction of being good at it, of being in control when the rest of life seems such an awful mess." This in an industry where, as the reviewer points out, most people readily admit they're in it for the money.
If the lead character were a junior analyst, however, that quote wouldn't be out of place. There's a bit of reluctance at that level to admit that the job basically sucks, and that if one weren't paid small fortunes to do it, one would likely be somewhere else, doing something different.
Now that the small fortunes are diminishing, it would presumably make sense to assume that not only are these delusions crumbling, but the egos are shrinking as well. Not necessarily the case. Even with the pay cuts and ever-smaller bonuses, the junior analysts are still at the top of the financial food chain relative to peers their age, and that tends to be the standard by which they measure themselves. When that changes--and it may, as the market gets worse--the junior banker crowd will have to face the not-so-sexy reality of what they actually do 70 or 80-plus hours a week.
The second, more boring, but perhaps more useful post:
Why Sell-Side Analysis Is Dead
Largely because I'm a buy-side analyst and I rather enjoy looking snobbily down my nose at the sell-side people and making grandiose proclamations about why they're all going to be jobless in a few years.
Kidding, kidding.
Sort of.
I *do* think that sell-side analysis (as we know it now) will eventually be made obsolete by recent securities regulations, the commoditization of basic security analysis, and the expanding array of widely available financial tools and data. :
In December of 1999, the S.E.C. proposed the implementation of Regulation Fair Disclosure, ("Reg FD" - implemented in 2000) which, in plain English, prohibits selective disclosure of insider information. In plainer English, this means that the CEO of a public company can no longer give a sell-side analyst any material information about the company that hasn't been publicly disclosed. (A bit oversimplified, but that's the gist of it.) Prior to the implementation of Reg FD, part of the value of sell-side analysis was that the analyst had more information about the company than the average investor. The analyst had this information largely because he or she typically had better and more frequent access to management. Management, in return, had a fairly significant incentive to talk to analysts because their reports generated awareness about the company, and functioned as a de facto marketing channel even when the analyst's recommendations were unfavorable.
Today, management isn't allowed to tell a sell-side analyst anything they haven't already told the public. *You* theoretically have access to the same information as the analyst. A sell-side analyst can't give me any material information about the company that I can't, with a little effort, get myself. If sell-side analysis was considered "marketing" before, it's even more the case now.
Another factor in the devaluation of sell-side analysis is increased public awareness about the relationship between sales/trading and banking at bulge bracket firms, and saturation media coverage on the penetrability of the supposed Chinese Wall between the two. Even when the analysis is fundamentally sound, its credibility is undermined by the conflict of interest (both real and perceived) between banking and retail. Throw in a few widely circulated Henry Blodget emails about Buy-rated stock being essentially worthless and you have a very cynical retail client base that isn't likely to take your rating system or your analysis seriously.
To be fair, I use sell-side reports to get historical data points on companies I'm screening. The quant side of basic security analysis is fairly unambiguous, and when an analyst calculates a liquidity ratio from historical data, it's not like they can really get it wrong. (Technically, they can, but they'd be out of a job.) I do believe, however, that sell-side reports have little or no predictive value, except for the fact that a widely publicized and aggressive upgrade or downgrade can be a self-fulfilling prophecy. I heard a high-yield guy mention a New York statute against fortune telling a few weeks ago, and I can't find it, but I'd imagine it has some implications for setting price-targets based on pro forma models for which the variable assumptions are largely subjective.
The availability of free analytical tools and financial data on the Internet is a catalyst for the democratization of security analysis, and as traditional consumers of sell-side analysis learn how to do it themselves, the demand for commercially produced research decreases. The basics aren't rocket science. Most people are reasonably capable of learning them. In this respect, sell-side analysis adds value for lazy people, but there are no real barriers to entry for people that want to learn how to do it. That's not to say that all of finance is like that, but if you want to know when to buy or sell your stock on a fundamental basis, you can easily learn to do it yourself.
To address the obvious question, buy-side analysis is also affected by many of these things. I *do* expect the industry to shrink on my side of the fence as well, but because buy-side analysts are responsible for allocation decisions and frequently have to go beyond the usual Graham-and-Dodd types of analysis, I think they'll have a little more immunity to these kinds of systemic changes. If you're evaluating fairly sophisticated hedging strategies, for example, it's not likely that your job can be performed by a guy with access to Yahoo Finance, EDGAR, and some free time.
All of this said, I don't think that sell-side analysis will cease to exist completely; only that it will be more overtly recognized as The Marketing Department for retail firms.
[From my former blog. Post dated February 7, 2002]
Why Sell-Side Analysis Is Dead
Largely because I'm a buy-side analyst and I rather enjoy looking snobbily down my nose at the sell-side people and making grandiose proclamations about why they're all going to be jobless in a few years.
Just kidding.
Sort of.
I *do* think that sell-side analysis (as we know it now) will eventually be made obsolete by recent securities regulations, the commoditization of basic security analysis, and the expanding array of widely available financial tools and data. :
In December of 1999, the S.E.C. proposed the implementation of Regulation Fair Disclosure, ("Reg FD" - implemented in 2000) which, in plain English, prohibits selective disclosure of insider information. In plainer English, this means that the CEO of a public company can no longer give a sell-side analyst any material information about the company that hasn't been publicly disclosed. (A bit oversimplified, but that's the gist of it.) Prior to the implementation of Reg FD, part of the value of sell-side analysis was that the analyst had more information about the company than the average investor. The analyst had this information largely because he or she typically had better and more frequent access to management. Management, in return, had a fairly significant incentive to talk to analysts because their reports generated awareness about the company, and functioned as a de facto marketing channel even when the analyst's recommendations were unfavorable.
Today, management isn't allowed to tell a sell-side analyst anything they haven't already told the public. *You* theoretically have access to the same information as the analyst. A sell-side analyst can't give me any material information about the company that I can't, with a little effort, get myself. If sell-side analysis was considered "marketing" before, it's even more the case now.
Another factor in the devaluation of sell-side analysis is increased public awareness about the relationship between sales/trading and banking at bulge bracket firms, and saturation media coverage on the penetrability of the supposed Chinese Wall between the two. Even when the analysis is fundamentally sound, its credibility is undermined by the conflict of interest (both real and perceived) between banking and retail. Throw in a few widely circulated Henry Blodget emails about Buy-rated stock being essentially worthless and you have a very cynical retail client base that isn't likely to take your rating system or your analysis seriously.
To be fair, I use sell-side reports to get historical data points on companies I'm screening. The quant side of basic security analysis is fairly unambiguous, and when an analyst calculates a liquidity ratio from historical data, it's not like they can really get it wrong. (Technically, they can, but they'd be out of a job.) I do believe, however, that sell-side reports have little or no predictive value, except for the fact that a widely publicized and aggressive upgrade or downgrade can be a self-fulfilling prophecy. I heard a high-yield guy mention a New York statute against fortune telling a few weeks ago, and I can't find it, but I'd imagine it has some implications for setting price-targets based on pro forma models for which the variable assumptions are largely subjective.
The availability of free analytical tools and financial data on the Internet is a catalyst for the democratization of security analysis, and as traditional consumers of sell-side analysis learn how to do it themselves, the demand for commercially produced research decreases. The basics aren't rocket science. Most people are reasonably capable of learning them. In this respect, sell-side analysis adds value for lazy people, but there are no real barriers to entry for people that want to learn how to do it. That's not to say that all of finance is like that, but if you want to know when to buy or sell your stock on a fundamental basis, you can easily learn to do it yourself.
To address the obvious question, buy-side analysis is also affected by many of these things. I *do* expect the industry to shrink on my side of the fence as well, but because buy-side analysts are responsible for allocation decisions and frequently have to go beyond the usual Graham-and-Dodd types of analysis, I think they'll have a little more immunity to these kinds of systemic changes. If you're evaluating fairly sophisticated hedging strategies, for example, it's not likely that your job can be performed by a guy with access to Yahoo Finance, EDGAR, and some free time.
All of this said, I don't think that sell-side analysis will cease to exist completely; only that it will be more overtly recognized as The Marketing Department for retail firms.