| Clockwise from top: Melanie Flouquet, Laurent Favre, Pinar Ergun, Andrew Baum and Christian Kern |
Pinar Ergun, who heads the two-person team covering household and personal care products at Bank of America Merrill Lynch in London, saw just cause to pound the table on Reckitt Benckiser Group early last year, at 4,962.44 pence. The U.K.-based manufacturer of such home and hygiene products as Calgon, Clearasil and Lysol “made a strategic decision to accelerate investment into consumer health, where there had been very strong growth,” she explains. “We said this would speed up their earnings momentum.”
The next month the company unveiled a cost-cutting program, dubbed Supercharge, designed to streamline operations and save up to £150 million ($219 million) a year. Declaring that the effort would make Reckitt more agile and efficient, the analysts raised their price target from 5,600 pence to 6,500 pence and added the stock to the firm’s list of best research ideas for 2015.
That proved to be the right move. In February 2016 management reported that sales last year rose 6 percent, to £8.87 billion — well ahead of consensus expectations of 5.3 percent — with the greatest gains in its consumer health division, where revenue surged 14 percent on a like-for-like basis, to £2.94 billion.
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The BofA Merrill analysts raised their target again, this time to 7,350 pence. By mid-April the stock had soared 35.7 percent, to 6,735 pence, since their reiteration, besting the U.K. broad market by 37.9 percentage points.
“We were one of the first to dive deeply into [Reckitt’s] transformation,” Ergun notes, “and we’re still one of the biggest bulls.”
This duo captures third place in Household & Personal Care Products on the 2016 All-Europe Research Team, Institutional Investor’s annual ranking of the region’s best sell-side equity analysts, but hedge fund managers insist that no one covers the sector better. Nor is this the only crew held in higher regard by this particular type of client. To find out who are their preferred research providers, Institutional Investor’s Alpha recalculated the results of this year’s All-Europe Research Team using only the votes cast by hedge fund respondents. BofA Merrill leads this lineup; its analysts earn a place in 27 of the 32 sectors that produced publishable results. Morgan Stanley is No. 2, with 24 spots, followed by J.P. Morgan Cazenove, with 21. Rounding out the top five are UBS and Deutsche Bank, respectively, with 16 and 11 positions.
Survey results reflect the opinions of more than 550 hedge fund managers at some 267 firms that collectively oversee an estimated $408 billion in European equity assets.
“No one hedge fund is the same as another,” observes Simon Greenwell, BofA Merrill’s head of Europe, Middle East and Africa equity research. Nonetheless, these money managers have a common desire for “a clear message, high conviction and investible ideas,” he says. “They want analysts to have a broader understanding of why they like an idea, and there’s less interest in intrasector value.”
His analysts are required to maintain underperform or sell ratings on 20 percent of the stocks under their coverage. “We want them to not only find the best buy ideas, but also to question the universe of stocks with a different mind-set,” Greenwell explains.
Hedge funds are also more likely to appreciate comprehensive reports that explore an industry or an important trend from top to bottom, he adds. Case in point: “The Robot Revolution,” a 303-page treatise his firm published in November.
In anticipating what is projected to be a $153 billion industry by 2020, the white paper discusses the socioeconomic implications of the expanded use of robots and artificial intelligence. “We are facing a paradigm shift that will change the way we live and work,” declares the report, asserting that in ten years “every house in the U.S. and Japan will own personal robots.”
Christian Kern, head of European equity research at J.P. Morgan Cazenove, reports that hedge funds often have more flexibility than traditional institutional investors. “They can invest globally. They’re open to different asset classes and have more appetite to short stocks,” he explains. “And they can invest in equity derivatives rather than the underlying stocks.”
One call that won the admiration of hedge fund investors, he says, was the cautious turn on European shares taken in late November by Mislav Matejka and his associates, who capture first place in Equity Strategy in this ranking and in the broader All-Europe Research Team survey. Weaknesses in oil and commodities prices as well as concerns about possible currency devaluation in China prompted the London-based analysts to “reduce our equities overweight in a balanced portfolio to a minimal one, the lowest we have had since the current upcycle started,” they wrote. “The long period of indiscriminately buying any dip might be coming to an end.”
On January 4, a sharp sell-off in China coupled with plunging oil prices sent the Stoxx Europe 600 Index tumbling 2.5 percent.
“That was a very practical example of a successful call we made that materialized within a relatively short time,” Kern attests.
Determining exactly what qualities, attributes and skills appeal most to hedge fund managers is more art than science, but it does appear that those who finish at the top of this roster have a distinguishing feature — a certain je ne sais quoi — that’s perhaps less appreciated by the overall investment community. Take Melanie Flouquet, for instance, the leader of J.P. Morgan Cazenove’s top-ranked team in Luxury Goods. Before joining the bank she spent four years auditing telecommunications companies for global accounting firm KPMG. Such skills are eminently transferable to her current work, she maintains, particularly on earnings calls for which she constructs her own models.
“I like numbers,” the crew chief says. “They tell the story.”
Flouquet and her colleagues often take bold stands with unwavering confidence. Consider their bullish call on Denmark’s Pandora. In mid-April 2014 they reiterated an overweight call on the jewelry manufacturer’s shares, at 338.56 Danish kroner, on the grounds that a series of steps the company was taking — expanding into new territories, moving deeper into emerging markets and instituting online sales in the U.K. — would likely double annual sales.
Two years later the stock is up more than 152 percent, to Dkr855, and ahead of the sector by a mind-boggling 151.4 percentage points. The researchers, who work out of London, remain bullish, with a price target of Dkr1,130.
Citi’s Andrew Baum, who oversees the No. 1 team in Pharmaceuticals, also has experience that informs his current position: he’s an Oxford University–trained physician. “In the U.S. the vast majority of hedge funds that trade pharmaceuticals stocks have dedicated analysts or portfolio managers with biomedical backgrounds, unlike many [European Union] health care investors,” he notes. “In addition, U.S. hedge funds have extensive budgets allowing them to attend medical conferences. I am more likely to get into the real weeds of a science-specific conversation over a particular drug mechanism with someone who works at a hedge fund in New York than with a long-only investor in Europe.”
A welter of complex forces can influence the stock prices of pharmaceuticals manufacturers, he points out. These include not only the efficacy of drugs in the pipeline and their potential approval by regulatory bodies, but also competition from generics and an array of legal issues pertaining to patent infringement. To help companies come to terms with many of these concerns, Baum and his teammates published a 64-page study in February 2015 with the ominous title “Biosimilars: Real, Dangerous, Coming Soon.”
The report warns that biosimilars — drugs that are virtual clones of existing products — are “more competitive than the market appreciates” and that, over the next ten years, their developers could capture more than $110 billion from established players. The balance sheets of Amgen and Pfizer, both of which are based in the U.S., and Switzerland’s Novartis could all be at risk, the analysts contend.
The CV of Laurent Favre, whose BofA Merrill squad leads the lineup in Chemicals, includes work experience that few sell-siders can boast: he spent several months at Millennium Management in London before returning to the brokerage in 2014. Working for a global hedge fund, he says, gave him an appreciation of putting money at risk every day. “It was very useful, invaluable and challenging — in a good sense,” the London-based researcher says.
He also developed a keen understanding of how important it is to the buy side that calls be definitive. One complaint that hedge fund managers often voice, he says, is that sell-side analysts will make a neutral call only to insist they were actually bearish if it blows up. “It can be a bit more difficult with a company’s management to be negative,” Favre affirms, “but my clients appreciate that I don’t hide behind neutral ratings.”
He will be the first to tell you that taking a strong stand isn’t always easy. Throughout last year, for example, Favre and his associates had an underperform rating on Germany’s BASF, the world’s largest chemicals manufacturer (as measured by annual sales). They believed that the company would suffer a double whammy from softening demand and a surplus in the supply of key products, particularly oil field chemicals. They set a target price of €70 when the shares were trading above €85, making the case that BASF’s cash flow would come in below consensus forecasts and that the decline in earnings per share would accelerate.
However, because of a weaker euro and the quantitative easing policies set by the European Central Bank, he says, BASF was judged to be a winner by the market — so much so that, his critical report notwithstanding, the stock climbed as high as €89.92 in April 2015. “The share price was going up every day,” he says, “which was painful.” Nonetheless, the analysts stood their ground, even lowering their price objective to €65.
In February the company reported that net income had tumbled 22.7 percent year over year, to €3.99 billion ($4.36 billion), and earnings per share slid from €5.61 to €4.34. By mid-April the stock had fallen to €65.51, down nearly 26 percent from its 52-week high.
While the team is pleased to be vindicated, Favre insists the greater satisfaction comes from serving clients. “They pay your bills,” he says, “so you should have strong convictions.”
