With independence, ex-bank analysts find, comes freedom to make sell calls on investments

PUBLISHED : Tuesday, 08 October, 2013, 12:03pm
UPDATED : Tuesday, 08 October, 2013, 10:47pm

After 27 years working for investment banks and hedge funds, Hong Kong-based equity research analyst Paul Schulte decided it was time to fly solo.

Carrying a résumé littered with big names like Nomura and CCB International – the overseas investment banking arm of China Construction Bank – and several others, some of which no longer exist, Schulte wished he had gone independent sooner.

The independent research industry has started to gain a foothold in Asia. It is already relatively mature in the West thanks to regulations enacted in the last decade in the United States to end the conflicts of interest between banks and analysts.

Now, a growing number of analysts are trying their luck as independents, selling knowledge and expertise picking stocks, as investment banks have cut back on research departments in the wake of the global financial crisis.

“We are in a very different world,” Schulte, a 48-year-old American, said in an interview in an office space in Hong Kong that he shares with other companies.

“In the last four years, if you don’t see that the research game in investment banks is over, then you are just a fool,” said the ex-Lehman Brothers executive.

Banks were and continue to be under pressure because of shrinking trading volumes, thinning client lists and regulatory changes restricting their proprietary trading activities.

As a result, there were fewer jobs and less pay in research units, and less chance of career advancement. It became a recipe for disillusionment, raising questions about professional values and quality of life for Schulte.

“When you are inside an institution, there are fundamental conflicts of interest. Let’s not pretend there is any independence going on whatsoever,” said Schulte, who has sovereign wealth fund CIC and hedge fund Fortress among his clients.

“Some people just don’t feel comfortable any more working for financial institutions.”

When you are inside an institution, there are fundamental conflicts of interest. Let’s not pretend there is any independence going on
Independent analyst Paul Schulte

These days he is unafraid to make a lot more sell recommendations than he ever did working for banks. Nearly half of his calls are “sells” now, as compared with less than a tenth that the teams he led at banks regularly issued.

Schulte, who also teaches at the University of Science and Technology in Hong Kong, is among a growing number of independent analysts challenging the overly optimistic ratings that the sell-side analysts often give to the companies they cover.

Critics have long said that research analysts working for banks were too soft on companies, while independent analysts can be more cold-eyed and ready to issue sell calls, helping clients to short or stay away from struggling companies.

Top analysts, who just a few years ago took home US$1 million-plus, have become increasingly unaffordable and left banks to set up on their own.

The inroads made in Asia by independents are modest, and few are profitable, but the growth is evident.

Commissions paid to the independent research industry in Asia have risen 40 per cent to US$200 million since 2009, according to Integrity Research Associates, a consultancy.

By comparison, global equity commissions, which are mainly paid to investment banks, fell 21 per cent to US$27.7 billion.

In April, Schulte joined the platform of IND-X Securities (Asia), a marketing and support firm for independent analysts, and founded his own research service.

Hong Kong-based IND-X has marketing and support relationships with more than 30 independent research providers, focusing mainly on Asia and emerging markets. It estimates there are roughly 40 such independent firms operating in Asia.

Some analysts in the region have built up more than a decade of experience, command a following among fund managers and are ready to take the risk of striking out on their own.

The funds industry itself is maturing. As the ranks of experienced analysts shrink at banks owing to cost pressures, senior portfolio managers are likely to consider subscribing to independent research firms started by top analysts.

“These are sort of grizzled analysts, who are disillusioned, highly sceptical, do not want to work for big investment banks, and they have seen a number of cycles – and that’s what people pay for,” said Gillem Tulloch, founder of independent research firm Forensic Asia.

Independent research firms charge between US$10,000 and US$100,000 per year in subscription fees in Asia.

To keep costs down, they share resources, often hosting meetings at Starbucks rather than in the boardroom.

They face challenges such as persuading Asian fund managers, who are used to getting support from the sell side, to pay for research.

Louis Vincent Gave, chief executive of a 60-man team at Gavekal, said one of the main challenges is also from the rise of passive funds and exchange-traded funds that require no research to invest and are getting more popular globally.

These are sort of grizzled analysts, who are disillusioned, highly sceptical, do not want to work for big investment banks, and they have seen a number of cycles – and that’s what people pay for
Gillem Tulloch, founder, Forensic Asia

“I don’t think we are going to see a wholesale migration of the research function from banks to the independent research space,” said Tim Condon, managing director and head of Asian research at ING in Singapore.

“There is definitely room for them, but they will be at the fringes. Research is free at the banks and comes packaged with other benefits for the buy side.”

Banks help funds execute trades and arrange corporate access. While technology is making execution less of an advantage, banks continue to rule when it comes to connecting fund managers with companies using their investment banking relationships.

It’s tough for the independent analysts to match that, but they say clients do not expect corporate access from them but value and pay for research and opinion.

“As the funds industry moves towards unbundling of services such as corporate access, research or investment banking deals, independent research firms are likely to gain,” Tulloch said.

They are already benefiting from the cuts at research units of banks, hiring talent at lower cost. The long-term lure includes the possibility that investment banks may buy some of the independent firms to bring back talent.

Staying put in the shrinking world of investment bank research units would carry its own risks.

“As an analyst, whether you like it or not, you are tied to the bottom line, and if you are not perceived to be contributing to the bottom line, you are suspect,” Schulte said.