Hedge Funds Rank Europe’s Best Equity Analysts

When Charles Winston and his associates on the autos team at Redburn Partners took a bullish stance on Renault in August 2012, it’s safe to say that many of their clients were skeptical. The investment community generally viewed the French automaker’s stock as a perennial laggard.

Investors had tired of the story they had been hearing since 1999, when Renault formed a strategic partnership with Japanese manufacturer Nissan Motor Co. The alliance was supposed to produce huge benefits via economies of scale, but the markets had remained unimpressed. Now, however, Winston and his colleagues were convinced that the partnership was about to deliver on its promise.

In upgrading Renault from neutral to buy, at €35.68, the London-based analysts argued that the case for a share price of €68 — representing a gain of more than 90 percent — was compelling. “Renault’s low valuation has more to do with issues of trust and understanding” by the investment community, Winston wrote, “than [with] its performance.” The company’s strengths included exposure to the sluggish European car market of only about “50 percent of volumes — the same as Volkswagen” as well as large gains in market share in Brazil, Russia and Turkey, he noted. In addition, it had generated free cash flow in nine of the previous 11 years, Winston added, and its fast-growing entry-level car business was expected to earn more than €700 million ($925 million) in profit in 2012. “Renault,” the Redburn team insisted, “has changed substantially over the past decade.”

In the 20 months since the researchers’ upgrade, the market has clearly embraced their view: Renault’s shares closed at €70.15 in late April, just above the team’s price target.

“It was a phenomenal call,” cheers Benjamin Walker, a portfolio manager at the Children’s Investment Fund Management (UK), a hedge fund firm headquartered in London. Winston, he adds, “has the best model for the companies that he follows, and he knows the companies better than his competitors.”

“They were definitely early,” agrees U.K. hedge fund manager Seth Kirkham of Dabroes Management.

The Redburn squad earns only a runner-up spot on the 2014 All-Europe Research Team, Institutional Investor‘s annual ranking of the region’s best sell-side equity analyst teams, but hedge fund managers insist that no one covers the Autos & Auto Parts sector better. Nor is this crew the only one held in higher esteem by hedge funds. To find out which brokerages provide these particular investors with the type of research they find most helpful, Institutional Investor’s Alpha recalculated the results of II‘s 2014 All-Europe Research Team using only the votes cast by hedge fund participants. As was the case last year, two firms tie for first place — but this time around it’s Bank of America Merrill Lynch and J.P. Morgan Cazenove sharing the top spot, bumping last year’s winners, Morgan Stanley and Deutsche Bank, down to third and fourth place, respectively. Rounding out the top five is UBS, which slips one rung.

BofA Merrill leaps from fifth place after doubling its number of positions this year, to 26, while J.P. Morgan jumps from third after its total increases by eight. However, the latter firm claims three times as many first-place teams as the former. In fact, when a value of 4 is assigned to each first-place position, 3 to each second-place position, and so on, J.P. Morgan is the undisputed champ, with a weighted total of 66. Morgan Stanley comes in second when firms are measured by this metric, with a score of 53, followed by BofA Merrill in third, with 49. (See Weighting the Results, opposite page.) Survey results reflect the opinions of nearly 460 hedge fund managers at 232 firms overseeing an estimated $327 billion in European equity assets. The top-ranked teams in each of the 37 sectors that produced publishable results appear in the table on page 41.

Is there something that distinguishes the analysts preferred by hedge funds from those who serve other investors? “It sort of boils down to one thing: competence,” according to Michael Humphries, chief investment officer at Polygon Investment Partners in London. “Sometimes it’s an understanding of the industry. Sometimes it’s being diligent in really looking at a company in more detail than others. And sometimes it’s an understanding of strategy in the sector. There are just too many variables to pin down to anything other than broad competence.”

Which is something that should be in abundant supply in all researchers, counter those on the sell side. “I don’t target hedge funds” over other types of investors, Redburn’s Winston says. “I don’t think the firm does anything differently for them that we don’t do for our long-only clients.”

Mark Stockdale, London-based head of European equity research at UBS, acknowledges that the “growth of hedge funds in number and size has been an established market phenomenon for some time,” but he emphasizes that UBS has never produced published research specifically for this audience. His analysts specialize in providing insights on stocks “that we perceive as relevant to all investors, both hedge funds and long-only.” In recent years, he adds, hedge funds have begun to assume many of the characteristics of traditional investors, as their strategies increasingly “are becoming longer term in their orientation.”

Simon Greenwell, who in June became director of research for Europe, the Middle East and Africa at BofA Merrill in London, underscores the importance of hedge funds — “it’s a key client segment that we’re very anxious to build relationships with,” he says — but trying to anticipate their needs is challenging, to say the least. “No two hedge funds or investment managers are the same,” Greenwell observes. “A particular hedge fund can have widely varying wants and needs, such as asking the research team to look at financials one month and industrials the next.” Organizations that wish to serve this market must be nimble and excel at multitasking, he adds.

“Hedge funds can go long or short. They’re not constrained by national boundaries, or by U.S. stock exchanges or European bourses, or confined to indexes — and their mandates are much more flexible as to products,” Greenwell says. “They use leverage a lot more and are more demanding. We’d be the first to admit we’ve got a lot of work to do to get better at serving this group of clients.”

BofA Merrill researchers publish 12-month stock calls for investors based on long-term structural stories, he adds, and since 2012 have also been producing ten high-conviction stock calls — seven long and three short — on a quarterly basis. These recommendations “are largely aimed at investors like hedge funds with shorter time horizons. Unlike the longer-term calls, there’s a lot of focus around news flow,” Greenwell says, which frequently is “the catalyst to material movement in stock prices.”

In addition, the firm has produced a number of primers that provide in-depth research on a particular market or theme. Recent reports have investigated such topics as banks in Southern Europe, cloud computing, India and industrial automation.

One recent volume that hedge funds greeted warmly, Greenwell says, is “Safer World,” a 133-page study published in mid-February on global safety and security. “It may sound trite,” the report commences, “but it’s not safe out there. Every year 2.3 million people are killed at work, 1.3 million lose their lives in road accidents, and 15,000-plus die in terrorist attacks. Globalization is driving the need for safety and posing new challenges — from emerging-markets growth to outsourcing, the food-supply chain, a degrading environment and new diseases.”

The review looks at scores of companies involved in safety and security while delving into 80 stock plays that reflect the “safer world” theme across eight sectors: autos; commercial and residential property; cybersecurity; homeland defense; life sciences; oil and gas; testing, inspection and certification; and the workplace. By 2020, the report states, the global market for the wares of companies operating in these areas will top $1.5 trillion.

Take the area of cybersecurity. Roughly 91 percent of U.S. companies were subjected to cyberattacks in 2013, according to Moscow-based multinational Internet security firm Kaspersky Lab, costing a tidy $11.5 billion. The analysts’ work includes an assessment of companies offering solutions to beat back cyber threats to businesses, with buy recommendations on such well-known Silicon Valley stalwarts as Cisco Systems and Juniper Networks. But the report also recommends less familiar names like Qihoo 360 Technology Co., a Chinese Internet and mobile security concern listed on the New York Stock Exchange, and Splunk, a San Francisco–based developer of software that provides real-time operational intelligence.

Although an increasing number of hedge fund managers are taking a longer view, they still appreciate out-of-consensus reporting that alerts them to opportunities in the near term. They say one of the best providers of this type of research is Citi’s Ronit Ghose, who leads the Banks team that claims a runner-up spot in the broader ranking but is No. 1 in the eyes of hedge fund voters. “He’s a thought leader,” declares one loyalist. “He was one of the first to downgrade HSBC. That was telling.”

While the Street remained almost uniformly bullish on HSBC Holdings, Ghose and his associates lowered their rating on the bank from buy to neutral in February, at 624.06 pence. “It was a consensus-long stock,” the London-based team leader says. “But I was concerned that earnings and dividends forecasts were too high because of worries around lower earnings from China and Latin America as well as the more conservative regulatory policies in the U.K. regarding higher capital requirements.”

The shares slid to 591.80p in mid-March before starting to recover, closing April at 604.10p, for a loss of 3.2 percent that trailed the sector by 1.6 percentage points.

This was not the first time that the Citi team had shown itself to be a successful outlier. In late July 2012, for example, the researchers issued a bullish call touting the financial services sectors in Benelux, France and the Nordic Countries. It was a sharp break from the generally pessimistic sentiment expressed by the bulk of European analysts.

“Since the financial crisis, everyone thought that to look smart in European financial stocks, all you had to do was to be bearish,” Ghose observes. But the Citi researchers perceived that banks in the regions they had targeted were poised to benefit from “the tailwind of healthy [local] economies.”

In analyzing the Nordic banks, for example, Ghose employed the novel strategy of comparing them with similar institutions in Australia and Canada. All three banking systems share what he calls “plain vanilla” operations. “They are relatively simple, domestically focused business models, unlike the U.K. or French banks, which have more geographically dispersed, international and complicated business models.” Nordic firms, like those in Australia and Canada, operate in a banking system that allows a “more oligopolistic structure,” he adds, with just a few major players dominating the market, unlike the “more diverse system operating in other countries.”

Ghose’s deep dive also revealed that the Nordic banks were generally superior in efficiency, as measured by cost to income and profit per employee, to Canada’s financial institutions and “in line with the Australian banks,” he reports. Yet the Nordics were trading at lower price-to-earnings and price-to-net-asset-value ratios. Those stocks have gained 0.8 percent and outpaced the sector by 2.4 percentage points since the analysts’ recommendation, through April 2014.

They upgraded Denmark’s Danske Bank from neutral to buy in March 2013, at 104.84 Danish kroner and with a target price of Dkr140, on the belief that “the market is not giving Danske the benefit of an improving provision cycle, potential for capital returns, tightening credit spreads and the positive risk-premium impact that should follow,” the researchers wrote. “Danske offers the highest total return of the Nordic banks over the next three years. In an optimistic scenario total return could exceed 100 percent by 2015.”

In January they reiterated their recommendation and raised their target price to Dkr150. The Citi troupe believed that CEO Thomas Borgen, who replaced Eivind Kolding in September, and other newly appointed members of the executive team would implement changes that would boost the bank’s stock performance.

“We did like the new management’s vision, particularly their focusing on returns,” Ghose affirms. Danske’s shares have bolted 45 percent, to Dkr152, and bested the sector by 23.3 percentage points, through April.

“It’s been the best-performing bank in the Nordic region and one of the better-performing banks in Europe outside of Southern Europe,” Ghose says.

Investors are impressed. “One of his key calls was that Danske would outperform its peers — and he was right,” says one. “A lot of people had forgotten about the bank, and it was being overlooked, but Ronit explained its attractions and what [management] wanted to do. He was instrumental in waking the market up.”

Portfolio managers heap similar praise on Gregor Kuglitsch, who captains the UBS team that finishes first in Building & Construction (and is a runner-up in the broader ranking). “Although all hedge funds and long-only investors pursue different strategies, hedge funds often look for short-term trends while keeping an eye on longer-term fundamentals,” he notes.

The London-based analysts are championed for their unbridled support of Help to Buy, initially presented by the U.K. government as a three-year, £3.5 billion ($5.3 billion) scheme to provide financial assistance and mortgage guarantees, primarily for first-time homebuyers. Allocated funds will support the purchase of some 74,000 homes. The program allows qualified participants to buy an eligible property for a cash deposit of 5 percent, a mortgage of 75 percent and a low-interest government loan of 20 percent. Critics argued that the government involvement would inflate a housing price bubble destined to burst, while advocates insisted that it would spur new construction and help people climb the first rung of the property ladder.

Within a week of the program’s unveiling, in March 2013, Kuglitsch and his colleagues issued buy ratings on all seven U.K. homebuilders they cover, with high-conviction calls on Bellway, Redrow and Taylor Wimpey on the belief that these three would enjoy the most upside. At the time, Bellway’s stock was trading at 1,188.19p. One year later, with the shares above 1,650p, they pounded the table, telling investors that the company was still undervalued relative to its peers. By late April the price had slipped back to 1,439p amid a general market rout triggered by a sell-off of technology stocks. But the team remains bullish, with a target price of 2,030p.

Redrow’s stock soared 53.5 percent, from 186.76p to 286.60p, while Taylor Wimpey shares jumped from 87.91p to 105.10p, for a gain of 19.6 percent through April. During the same period the sector advanced by 13.8 percent.

In its first year of operation, Help to Buy aided more than 27,000 households in the purchase of a new home, the U.K. government reported in late April. Although originally intended to last only through 2016, the program has been extended until 2020 — with an additional £6 billion commitment from the government — chancellor of the Exchequer George Osborne announced in March. a