The All-America Research Team: Hedge Fund Edition

In early January, with shares of Constellation Brands up some 41 percent over the trailing 12 months and far in front of the S&P 500’s 12 percent advance, many Wall Street analysts believed the stock to be fully valued and urged clients to take profits. But not Sunil (Nik) Modi, a sell-side researcher who follows beverage, household and personal care products for RBC Capital Markets. He maintained that the Victor, New York–based producer and importer of beer, premium wines and spirits was “a compelling multiyear investment.” Based largely on an array of strategic moves undertaken by management in Constellation’s beer segment — the rollout of draft versions of Corona and Corona Light, the introduction of canned beer to its product lineup, increased convenience-store distribution and a more aggressive advertising campaign — Modi upgraded the stock from outperform to top pick.

He also noted that the burgeoning cohort of Latino immigrants to the U.S., who have brought with them their fondness for such Mexican labels as Casa Noble tequila and Modelo beer, contributed to his enthusiasm. Along with demographic figures, Modi based his decision on his own instincts and spade work. Not only does the analyst keep abreast of companies by attending a plethora of industry conferences and running regular channel checks across the U.S. with wholesalers, distributors and retailers, he sometimes rides along on delivery trucks and helps deliver cases of beer. “You can’t just sit behind a desk and be a numbers guy,” he insists.

The lessons he has learned in the field have proved valuable. For example, he has seen how sales velocity determines shelf space, particularly with imported beers. The faster six-packs fly off the shelves, he explains, the more space a brand will command in a store. In addition, this hands-on experience gives him a deeper understanding of deliveries and pickups, and the day-to-day concerns of people on the front lines. This not only adds to his knowledge bank, he says, but also has allowed him to build valuable relationships and develop a reliable network of informants. “By engaging in dialogue with folks in the industry, I’m able to stay up to date on the latest trends,” he reports.

It’s an approach that can pay off handsomely. Since Modi’s February upgrade, Constellation’s shares have surged 39 percent, from $97 to $134.80, and bested the broad market by 38 percentage points, through October.

“His call on Constellation has been a great case study of what he does,” says an appreciative portfolio manager at a $7 billion trading and arbitrage fund in New York. “He took the guesswork out of the equation, and we were able to get on the wave.”

Although Modi earns only a runner-up position on the 2015 All-America Research Team, Institutional Investor’s annual ranking of the nation’s top sell-side equity analysts, hedge fund managers insist that no one covers the Beverage, Household & Personal Care Products sector better. Nor is he the only analyst held in higher regard by this type of client. To find out who are their preferred research providers, Institutional Investor’s Alpha recalculated the results of this year’s All-America Research Team using only the votes cast by hedge fund respondents. Bank of America Merrill Lynch tops the roster; its analysts earn a place in 37 of the 59 sectors that produce publishable results. Morgan Stanley is No. 2, with 34 spots, followed by J.P. Morgan, with 32. Rounding out the top five are Deutsche Bank Securities and UBS, with 27 and 22 positions, respectively.

Survey results reflect the opinions of more than 1,200 hedge fund managers at nearly 440 firms overseeing an estimated $1.1 trillion in U.S. equity assets.

The table beginning on page 43 cites the analysts who finish in first, second and third places in each sector, plus runners-up (where applicable).

Few of the hedge fund favorites are as colorful as Modi or likely to spend a busman’s holiday on a beer truck. But this year’s winners have earned their spurs, survey participants say, by delving deeply into their sectors, providing timely forecasts, knowing their companies and channels inside and out, and distinguishing themselves by their creative, original thinking. And, they add, these analysts are frequently gutsy, willing to stand by their research and not pull punches when issuing stock calls that are unpopular.

This is a prized trait for hedge fund investors that can make money by shorting stocks. But many researchers may be reluctant to offend corporate leaders with a negative analysis or even to contradict a client’s opinions. Says a portfolio manager at an $8 billion, multistrategy hedge fund: “I want an analyst who’s willing to debate with clients. I have a real problem with an analyst who says, ‘Sure, I see your point of view.’ An analyst who takes a strong stand is much more valuable to me as an investor.”

Eric Sheridan, No. 1 in Internet on this roster and a runner-up in the broader ranking, worked for 11 years as a hedge fund manager before transferring to the sell side in 2012. Since then the UBS researcher has won kudos for his fortitude and bold calls. “Eric knows what it’s like to go home at night when your portfolio is down by 15 percent,” says a manager at a Greenwich, Connecticut–based multistrategy fund. “He doesn’t make calls lightly; he’s not wishy-washy; and he understands what the stakes are.”

Many investors were taken aback when Sheridan pounded the table on Internet services provider AOL in late March, at $38.91, and set a target price of $54, highlighting the New York–based outfit’s desirable website publishing and advertising technology assets. That prospective 38.8 percent gain was nearly realized in mid-May when U.S. telecommunications giant Verizon Communications agreed to purchase AOL for $4.4 billion, or $50 per share. (The acquisition was completed in June.)

“AOL was a name that was hated by the Street, yet he saw strategic value,” notes Francis Cueto, director of the media and technology team at Asturias Capital in New York.

Or consider Sheridan’s take-no-prisoners call on Google. In a 70-page report issued in early March, with shares of the Mountain View, California–based search engine trailing the sector by 4.5 percentage points over the prior six-month period, the analyst endeavored to swat away what he called “mounting concerns” about the company’s strength in digital advertising and mobile computing in the face of competition from two of its home-state competitors, Cupertino’s Apple and Facebook of Menlo Park. In making Google his top sector pick, Sheridan argued that its mobile search application was misunderstood and underappreciated.

It didn’t take long for his theory to prove justified. By late October the shares — trading under the name Alphabet following a company reorganization earlier that month — bolted 23.5 percent, from $575.33 to $710.81, and outpaced the sector by 17.3 percentage points. Sheridan remains bullish and recently upped his target price from $750 to $820.

Ivy Zelman, a member of the All-America Research Team Hall of Fame, slips from third place to runner-up in Homebuilders & Building Products in the overall rankings but retains a firm grip on first place with hedge fund voters. “She has tons of industry contacts, whom she regularly polls,” says one New York–based portfolio manager, “so she understands trends and is great at spotting inflection points. She was the first one to tell investors to run for the hills in 2004 and in 2011 and 2012 the first to recommend putting all the chips on the table.”

Another satisfied client maintains that the Zelman & Associates founder led the pack in identifying the emerging strength of the housing markets in California and the Pacific Northwest this year. Her Western survey “picked up a 20 to 25 percent acceleration of the sales pace in January,” he says, and determined that two California-based homebuilders, William Lyon Homes of Newport Beach and Irvine’s CalAtlantic Group, would be beneficiaries. Shares of both stocks (on which Zelman currently has buy ratings) “have been up by 20 percent this year,” he notes.

Accompanying Zelman and her team to Reston, Virginia, for a tour of regional homebuilder NVR in May, this investor says he was impressed by her skills in dealing with a management group that shuns quarterly conference calls and has earned a reputation as being closemouthed. But the executives opened up, leaving the hedge fund manager with a favorable view of a company whose stock is out of favor with many analysts. As soon as he got back to New York, he closed out his short positions in NVR and went long on the stock. “I put in a lot more chips than I took out,” he declares.

In snapping up thousands of shares in the spring, he actually beat Zelman to the punch — she waited until mid-July before upgrading NVR from hold to buy, at $1,421.50, after the company reported robust second-quarter earnings, with net income soaring 37 percent year over year, to $93.4 million. Since then the shares surged 15.2 percent, to $1,637.76, through October.

“NVR is unlike any builder,” Zelman asserts. “They’re more like a manufacturing company. They don’t own land because they don’t like to take on added risk. They have a just-in-time construction strategy that allows for a return on equity that’s huge relative to the industry — and they’re very focused on driving high returns for shareholders.”

Dennis DeBusschere, a portfolio strategist at Evercore ISI, is another sell-side researcher who fares far better among hedge fund managers (No. 1) than among the broader voter universe (runner-up).

“On a daily basis he does a great job of summarizing and digesting benchmarks in a user-friendly fashion, so you know how moves on commodities or interest rates will affect you,” marvels one client. “You get a pretty good idea what will go up and down. He’ll tell you in real time what assets to buy and what to get out of the way of.”

DeBusschere — son of the late Dave DeBusschere, a basketball star on the New York Knicks’ 1969–’70 championship team — says hedge funds “consistently want us to help them navigate complex situations. What we do a very good job of is understanding complex monetary policy, currencies, fixed-income developments, and what that means for stock market and sector performance. They look to us for macro ideas.”

He’s cautioning investors to steer clear of commodities because of weakening global economies, and to underweight utilities owing to interest rate volatility. He urges clients to invest in “a mix of noncommodities cyclicals and defensive stocks” in such sectors as consumer, health care, housing and the Internet. Recommended names include Amazon.com, Coca-Cola Co., Gilead Sciences, Nike, Procter & Gamble Co. and Under Armour.

Fotios Giannakoulis, who joined Morgan Stanley in 2010 as the firm’s lead shipping analyst, scores highest with hedge funds after finishing in second place in the overall ranking. With typically shorter-term horizons than long-only investors, hedge funds are key players in a sector where big swings in both cargo values and nautical distances traveled are constantly changing, he explains. “The shipping space can be highly volatile,” Giannakoulis says. “One day a ship can earn $200,000, and another day that same ship can earn $5,000.”

In such a capricious industry, the researcher’s knowledge of shipping line owners and management teams sets him apart from his competitors, one fund manager attests. “There are a lot of complicated personalities in this space,” this source adds, “so understanding how people react and what risk-management steps they’ll take in a crisis environment can be critical.”

— Paul Sweeney