Meet the U.S. Analysts That Hedge Funds Rate Highest

Kenneth Usdin, a banks analyst at Jefferies, isn’'t a fortune-teller, but he was spot-on in a recent call just ahead of third-quarter earnings reports from three big U.S. trust companies.

In an October 3 note to clients, the New York-based analyst predicted that Northern Trust Corp., which is headquartered in Chicago, and State Street Corp. of Boston would come up shy of consensus estimates owing to such headwinds as higher costs and weaker fee generation. Sure enough, when the firms reported results later that month, they fell short of Wall Street’s expectations. For Kyle O’Brien, a portfolio manager at Surveyor Capital, a New York-based subsidiary of Chicago’s Citadel, such finely tuned calls are among the chief reasons he counts Usdin among his favorite sell-side analysts. “He’s very tight with his models and estimates,” O’Brien reports.

He also hails Usdin for his idea generation. “We tend to invest in positions where there’s a near-term catalyst, so we’re always looking for the next big thing,” O’Brien explains. “Ken is someone who does a good job at that. He’s one of the few people who will call me and say, ‘What do you think about this?’ And, when I’m testing the waters, he can tell me if I’m on the right track or if there’s a hole in my thesis.”

Usdin ranks third in Banks/Midcaps on this year’s All-America Research Team, but hedge fund managers insist that no one covers the sector better. Nor is he alone in being more highly regarded by this particular audience, whose sell-side research needs often differ from those of traditional investors. To find out which firms provide hedge funds with the guidance they find most valuable, Institutional Investor’s Alpha recalculated the results of II‘s 2013 All-America Research Team using only the votes cast by hedge fund participants. J.P. Morgan climbs from second place in 2012 to first after picking up three more positions, for a total of 42. Last year’s winner, Morgan Stanley, drops only one notch despite losing a whopping eight spots, leaving it with 34 — one more than Bank of America Merrill Lynch, which jumps from No. 6 after adding seven positions.

Deutsche Bank Securities and Barclays also fall one place each, to fourth and fifth, respectively, despite also losing considerable ground among hedge fund participants. The German bank’s total plunges by eight, to 27, while Barclays’s drops by six, to 24. These results reflect the opinions of more than 1,000 individuals from nearly 400 hedge fund firms that collectively manage some $952 billion in U.S. equities.

The table on pages 40 and 41 cites the analysts that hedge fund managers consider the best in their respective sectors. Information about researchers in second and third place, plus a list of runners-up and other survey data, can be found on the web at institutionalinvestor.com.

Some analysts earn top spots on both the broader survey results and this special cut — examples include Christopher Senyek of Wolfe Research, No. 1 in Accounting & Tax Policy, and Ivy Zelman of Zelman & Associates, the reigning champ in Homebuilders & Building Products.

Is there a special breed of analyst whose talents are better suited to serving hedge fund managers seeking the Holy Grail of absolute returns? Judy Hong of Goldman, Sachs & Co., who doesn’t place in the overall ranking but in the estimation of hedge fund participants is No. 1 in Beverages and No. 3 in Tobacco, says no: “We provide value-added research for all types of investors and do not necessarily tailor research to a specific type of client.” However, the New York-based analyst acknowledges that research and stock recommendations in “more complex situations could resonate well with hedge fund managers [that] can also utilize an options strategy to limit the downside.”

The top-ranked researcher in Technology Supply Chain, Brian Alexander of Raymond James & Associates, shares a similar view. “I consider hedge funds to be investors just like mutual funds,” says the St. Petersburg, Florida-based analyst, who ranks third in the broader team. “They all look for somebody who understands the true drivers of a stock’s performance and has experience covering the group.” But there are times, he adds, when “hedge funds are more nimble in taking trading positions.”

Stephen Penwell, Morgan Stanley’s New York-based director of Americas equity research, also downplays differences regarding how analysts serve these two types of investors. “There is no bright line between the needs of hedge fund investors and those of traditional, long-only investors,” he says.

But Brett Hodess, Penwell’s cross-town counterpart at BofA Merrill, begs to differ. “When people [on the sell side] say they don’t do things differently, it’s not true,” he contends. “The analysts who are doing well with hedge funds are good at providing long-term — and also short-term — actionable ideas that investors can execute and use to offset risk.”

Adds Steven Pollard, who leads Americas equity research at Deutsche Bank, “The big difference between hedge funds and long-only funds is that hedge funds can achieve alpha on the short side.” Consequently, he says, those investors are always on the lookout for stock picks where there’s a structural disadvantage or a negative catalyst.

One hedge fund manager, who asks that his name not be published, is quite straightforward. “I want an analyst who’ll identify stocks that are undervalued and overvalued,” he says. “I’m not interested in knowing how many screws there are in a mainframe computer. I’m interested in making money.”

Wolfe Research’s Senyek specializes in providing just such guidance. His role was expanded earlier this year to include chief investment strategist following the departure of François Trahan (who went on to help launch Cornerstone Macro and is No. 1 in Portfolio Strategy among hedge fund voters and in the broader ranking). In a 219-page report issued in January, for example, Senyek dug deeply into a whole panoply of special situations that, he says, appeal especially to hedge fund investors adopting an event-driven investment style. Chock full of corporate-action plays, Senyek’s research included dissections of spin-offs and divestitures (some at the behest of activist shareholders), mergers and acquisitions, stock buybacks, restructurings, dividend initiations, CEO changes, disappointing initial public offerings and thrift conversions. “Investing in corporate-action ideas has historically produced alpha and is an investment theme we are closely following,” the New York-based strategist wrote.

Among the companies that Senyek determined harbored embedded value were ADT Corp., a provider of commercial and residential security services that is headquartered in Boca Raton, Florida; New York’s CIT Group, a small-business lender, and online brokerage E-Trade Financial Corp.; Paris-based Vivendi, a multinational media and telecommunications company; Van Buren Township, Michigan’s Visteon Corp., a manufacturer and distributor of auto parts; and Sunnyvale, California-based Internet titan Yahoo!

Senyek describes E-Trade as a diamond in the rough. At the start of the year, he notes, Bloomberg reported that only two analysts advised buying the discount brokerage’s shares, 14 rated them hold, and one was encouraging investors to sell them. Thus, Senyek’s endorsement of the stock represented a contrarian view, he points out.

His bullish case was based in part on the end of a low-interest-rate environment; the firm’s renewed focus on its core securities and retirement-investment businesses; and a deferred, net-operating-loss tax asset of $1.3 billion. In addition, he expected the investment community to respond favorably to that month’s appointment of Paul Idzik, Barclays’s former chief operating officer, to the post of CEO. (Idzik is the seventh executive to lead E-Trade since 2007.)

In October the company reported a $47.4 million profit for the third quarter, compared with a loss of $28.6 million for the same period in 2012, and announced that it would sell its G1 Execution Services unit to Bala Cynwyd, Pennsylvania-based Susquehanna International Group, for $75 million, so that E-Trade could “concentrate our time and attention on the core business and our customers,” Idzik said. (The deal is expected to be completed by the end of the first quarter.)

By the end of that month, the shares had soared 71.3 percent, from $9.87 to $16.91, since Senyek’s recommendation.

Hong, of Goldman Sachs, also has an eye for corporate activity likely to unlock value for event-driven hedge funds. In November 2012 she urged investors to buy Dean Foods Co., a Dallas-based manufacturer of dairy products, because she felt it “represented a compelling sum-of-the-parts story” that the market was failing to recognize. Hong cheered the company’s plans to sell assets and use the proceeds to pay down debt.

Since then, Dean Foods has sold its Morningstar Foods division for $1.45 billion and spun off its WhiteWave Foods Co. subsidiary — a move that brought the company another $416 million. The stock bolted 31.6 percent, from $14.82 to $19.50, through October.

Joseph DiMenna, co-founder and head portfolio manager at Zweig-DiMenna Associates, a New York-based hedge fund firm with $2.5 billion in assets under management, says he prizes differentiated, on-the-ground research. He appreciates sell-side analysts “who have a strong sense of why stocks move and what kind of information matters.” In retail, for example, “they walk the malls and see what the layout looks like and how much inventory is on hand,” he says. “If it’s an industry like energy, they might look at how much acreage oil and gas companies own and how much they paid for it.”

And when it comes to coverage of homebuilders, one name stands out from the crowd: Zelman. “Ivy has her finger on the pulse of the industry,” DiMenna says. Investors of all types agree. The analyst has earned a place in the All-America Research Team Hall of Fame, an honor bestowed on those who have garnered at least ten appearances at No. 1 in their sectors in the broader ranking. Zelman has been voted onto that team 20 times — and landed on top 12 times — since her 1994 debut. She has earned a reputation for compiling in-depth, up-to-the-minute information through exhaustive national and regional surveys on such topics as mortgages, public and private homebuilders’ starts, pricing trends, occupancy rates in rental apartments and shopping centers, building-products sales and interest rates. “If you want to know what’s happening, you have to look at all the components,” Zelman says. “It’s a big puzzle.”

This degree of hypervigilance gave Zelman the confidence to declare in a January 2012 report that the housing market had hit bottom and it was time to buy. “Initially, there was a lot of skepticism — no one else out there was saying this,” she recalls. “It was only later that everyone saw strength in the market.” Since the trough, which occurred in October 2011, Zelman’s proprietary homebuilding stock index skyrocketed 240 percent, she reports, through October.

It peaked in May, she adds, before starting to slide as money managers began to worry about comments from the Federal Reserve concerning potential reductions to its $85 billion-a-month bond-purchase program. Interest rates spiked, and homebuilders got clobbered; the index has tumbled 24 percent since mid-May.

In a note to clients in early October, Zelman lowered her forecast for fourth-quarter housing orders by 8 percent but stressed that this setback is only temporary. Owing to “the strong underlying foundation of demographic trends,” she says, residential construction should jump 20 to 25 percent next year. The analyst retains buy ratings on 13 of 15 publicly traded homebuilders she covers.

Zelman’s candor and confidence appeal to people like Ricky Sandler, founder and chief investment officer at Eminence Capital, a $4.5 billion hedge fund headquartered in New York. “Don’t tell me what management says or what the Street’s consensus is,” he says. “I want independent thoughts and opinions.”

Gutsy calls also characterize the work of Edward Garlich Jr.‘s group at Guggenheim Securities, which according to hedge fund managers is tops in Washington Research. Throughout the course of last year’s presidential campaigns the team insisted that President Obama would be reelected — news that wasn’t exactly welcomed by the firm’s 3,500 clients, many of whom were hoping that Republican challenger Mitt Romney would emerge victorious. Nonetheless, “we stayed the course all the way through the campaign,” says Garlich, whose Washington-based crew is No. 2 in the overall ranking.

More recently, Capitol Hill analyst Christopher Krueger “was one of the first people to say that the government would shut down in October, but that we would not go past the debt ceiling,” Garlich reports. Krueger also projected in July that Fed vice chairwoman Janet Yellen would be nominated to replace her boss, Ben Bernanke. That was two months before Lawrence Summers, the president’s former economic adviser and a front-runner for the position, withdrew his name from consideration. The Yellen forecast “was early, it was definite, and it turned out to be right,” Garlich says.

Those are exactly the adjectives that best describe the calls hedge fund managers appreciate most, observes BofA Merrill’s Hodess. “Most of the big mutual funds won’t buy on short notice, but frequently hedge funds will act,” he notes.

By doing good for hedge funds clients, sell-side analysts can do well, adds Deutsche Bank’s Pollard. Lacking a large complement of research staff, he says, most funds typically outsource much of their research needs to the larger brokerages. “They’ll pay for high-quality research and sales services and for the best execution,” the New York-based research director says. “Hedge funds make terrific clients.”

Determining Hedge Funds’ Top U.S. Equity Analysts

To determine hedge funds’ favorite U.S. sell-side equity analysts, Institutional Investor’s Alpha retabulated the results of the 2013 All-America Research Team survey, which II published in its October editions, counting only votes cast by hedge fund personnel.

To select the members of the 42nd annual All-America Research Team, II started by sending questionnaires covering eight categories and 65 investment sectors to the directors of research and the chief investment officers of major money management firms. It also contacted institutional investors from client lists submitted by Wall Street research directors and sent questionnaires to analysts and portfolio managers at many top institutions.

Rankings were determined strictly by using numerical scores. Votes for each analyst were weighted based on the size of the institution responding and the place it awarded to that analyst (first, second, third or fourth). For research sectors where team efforts are the norm — Equity-Linked Strategies, Real Estate Investment Trusts and Washington Research — II combined the votes for all the analysts covering a sector at each firm. Teams and individuals were designated runners-up when their scores fell within 35 percent of the third-teamers’ scores.

Analysts must be certified pursuant to Regulation AC to be recognized as winners or team leaders in all Research sectors; no such restriction applies to the sectors in the Economics & Strategy category. Analysts who changed firms after July 2, 2013, are cited at their previous organizations. Voters must meet eligibility requirements, and winners must achieve a minimum vote count. All ballots are subject to review by II’s Research Operations Group, and final results may be inspected by an independent auditor.

The identities of the survey respondents and the institutions that employ them are kept confidential to ensure their continuing cooperation. II tapped opinions of more than 1,000 hedge fund managers at nearly 400 firms overseeing an estimated $952 billion in U.S. equity assets; the views of this group are reflected in Alpha’s list of top analysts.

This response was sufficient to publish complete results (first through third places) in 62 sectors. Accounting & Tax Policy and Alternative Energy fielded only first and second places, and no analyst in Natural Gas met the minimum vote requirement.

This ranking was compiled by Associate Research Editor Denise Hoguet under the guidance of Senior Research Editor Tucker Ewing and Director of Research Thomas W. Johnson.