ON MAY 10, 2007, the U.S. Food and Drug Administration held a nine-hour meeting over potential labeling changes for Aranesp, Amgen’s best-selling drug, used to treat chemotherapy-induced anemia. Restrictions could annihilate sales at the Thousand Oaks, Californiabased biotechnology giant. Early the next morning hedge fund managers were scrambling to determine the impact the meeting would have on the company’s shares, and sell-side analysts were frantically penning notes to their clients. But 300 hedge fund managers and other investors were already deep in discussion of the matter with Bear, Stearns & Co. biotech analyst Mark Schoenebaum, who pointed out that the tighter
restrictions endorsed by the FDA would have reduced U.S. sales of Aranesp by at least $700 million in 2006. Yet he stood behind the outperform rating he had on the stock, which was up 1.4 percent by the end of October. Over the past 18 months, Schoenebaum has thrown together roughly 50 such “Biotech on the Fly” conference calls, which have proven invaluable to his clients.
“Mark is very good at knowing what concerns the Street and detailing the potential outcomes before offering his own view on the most likely outcome,” says Kurt von Emster, manager of Boston-based MPM Capital’s $300 million MPM BioEquities Fund.
By holding conference calls rather than pumping out research, Schoenebaum is able to react to news more quickly and comprehensively than can some of his peers. For hedge fund managers, the calls provide an opportunity not only to listen but also to ask questions -- over the phone or anonymously through e-mail.
It’s this kind of service that keeps Schoenebaum ranked first among biotechnology analysts and helps Bear Stearns rank as the No. 1 sell-side research shop among the hedge fund firms that voted in our sister publication’s All-America Research Team ranking of top U.S. analysts. For a fifth straight year, Alpha recalculated the results from Institutional Investor‘s All-America survey -- which polls a wide spectrum of portfolio managers and buy-side researchers -- using solely the votes from hedge funds. More than 280 hedge fund firms representing more than $800 billion in assets took part in the survey. That includes two thirds of our 2007 Hedge Fund 100 ranking of the world’s biggest single-manager hedge fund firms (Alpha, May 2007).
Bear Stearns tops this year’s ranking with 36 total team positions, up from 25 last year, ending the four-year hegemony of Lehman Brothers. Bear’s ten first-team positions include three new wins, in the Gaming & Lodging, Pharmaceuticals/Major and Telecom Equipment/Wireless sectors.
“We’re always innovating,” says Kay Booth, Bear’s global head of equity research. Among the research initiatives she says the firm has undertaken in the past year or so are expansion of its global research coverage, a new in-house “best practices” Web site for analysts and a podcasting research delivery system -- digital media files distributed online.
As hedge funds have expanded their geographical reach in their search for higher returns, Bear has added roughly 15 new coverage areas, including India and various sectors in Asia, Europe, Latin America and the U.S. The firm has increased its product management team to seven, from one a year ago.
Lehman, which slips to second place this year, experiences declines in both its number of first-team rankings (the firm has ten first-teamers this year, down from 19 in 2006) and runner-up spots. Hedge fund voters award Lehman 31 overall team positions, down from 47 last year. The firm was hurt by the departure of a few star analysts but also suffered from changes to our methodology. Mortgage Finance and Specialty Finance, for example, were combined to create Consumer Finance. (For more information about our methodology, please visit www.alphamagazine.com.) Still, fund managers continue to value Lehman’s strong research culture.
“We’re successful with hedge funds because our analysts are proactive,” says Stuart Linde, the firm’s director of equity research for the Americas. “We ask: ‘What are the lateral impacts?,’ ‘What’s the best way to play a company?,’ and ‘How does it impact its global counterparts?’”
Behind Lehman, JPMorgan Securities drops one notch to No. 3, with 26 positions, followed by Banc of America Securities, Citi and Merrill Lynch in a three-way tie for fourth place, with 21 positions each. Last year, BofA, Bear Stearns, JPMorgan and UBS tied for second, while Citi and Merrill tied for sixth. UBS falls to seventh place this year, with 20 total team positions, down from 25 in 2006. Rounding out the top ten, Goldman, Sachs & Co. finishes at No. 8, and Credit Suisse and Morgan Stanley tie for ninth place.
Coordinating research across sectors and asset classes has been one of the driving themes of sell-side research for the past few years. In an effort to leverage their intellectual capital, firms are pushing their analysts to publish joint research reports and sponsor joint conference calls. Lehman’s health care services team, comprising Health Care Technology & Distribution first-teamer Lawrence Marsh, Health Care Facilities second-teamer Adam Feinstein and Managed Care second-teamer Joshua Raskin, hosts joint conference calls and investor trips for clients. The firm’s analysts also use one another’s data as inputs into their company models and to create bigger joint research reports. “We can cover more companies and subsectors than our competitors and get more-detailed information, and that helps generate alpha,” says Feinstein.
Firms have redoubled their efforts to ensure that analysts’ ideas and recommendations are backed by rational assumptions and strong working models. Lehman has made a concerted push during the past year on this front. Linde says the firm’s analysts have gone through every model to make sure that the inputs and assumptions used are correct and still hold. “Model quality is critical in our goal of delivering the best valuation and analytical frameworks for our clients,” he says.
“Hedge funds are continually looking for actionable ideas and proprietary data that will give them an edge over their competitors,” says Gregory Ransom, who became global head of equity research for Banc of America Securities in August. “To deliver on this expectation, you must be able to look across the capital structure of a company -- not just at equities -- to provide your clients with a deeper understanding of how data points and trading in one market can impact other securities prices.”
BofA’s Daniel Oppenheim, who advances from runner-up to No. 2 in the red-hot Homebuilders & Building Products sector, developed a proprietary monthly survey of roughly 4,000 residential real estate agents, sorted by market. The survey, which he says demonstrates a clear correlation between traffic trends and stock prices with a two-month lead time, has helped fund managers identify trade ideas in the subprime mortgage and homebuilding areas. Ransom says BofA is also examining its ratings system with an eye toward adding flexibility to make shorter-term calls than the 12-month time frame on which analysts’ ratings are currently based.
Citi has taken a more multistrategic approach to research. “We are focused on integrating our debt and equity efforts, where such combinations make sense,” says Jonathan Rosenzweig, Citi’s director of U.S. equity research. In September corporate bond analyst Itay Michaeli picked up coverage of automaker and auto-parts-supplier stocks, offering his views on both equity and debt securities in one report.
“In an investment-grade world, a positive equity event could be a negative credit event,” says Michaeli. He adds that growth in the credit-default-swaps market also creates possibilities for investors. “Derivatives are the leading indicator for bonds and equities,” he explains, “and investors want to know what’s going on in those markets.”
Though analysts are restricted to one-year time frames and ratings, clients want short-term color and investment options beyond the traditional buy, sell or hold. Derivatives specialist Mitchell Revsine joined Citi’s equity research team this summer with the mandate to wrap derivatives commentary around sector research. “My job is to come up with tactical options trades that leverage the views of the fundamental analysts,” says Revsine. “It’s a way to monetize intellectual capital.”
The expansion of derivatives research, the collaboration among equity and debt analysts and the globalization of coverage reflect the changing needs of buy-siders as the lines between traditional managers and hedge funds blur. As long-only managers increasingly develop hedge-fund-like products such as 130/30 strategies -- which invest 130 percent long and 30 percent short -- Wall Street firms have had to alter their research accordingly. Says Lehman’s Linde, “About two and a half years ago, the business changed and equity research needed to evolve.”
But it is not necessarily research directors’ efforts to come up with trade ideas that hedge fund managers value most. Of the 12 categories survey respondents were asked to rate, management access, industry knowledge and accessibility/responsiveness are fund managers’ top priorities, in that order; stock selection ranks tenth. “What can be frustrating about the sell side is the number of consensus calls I get,” says one New Yorkbased hedge fund manager. “They add nothing and create a lot of noise. What’s valuable are models and out-of-consensus idea generation.”
Such feedback has not been ignored by Street firms, which have radically decreased the time they devote to maintenance research in favor of efforts to generate new and fresh takes on situations or larger thematic reports covering more than one company or industry.
“We push our analysts to come up with a weekly thought product because the buy side has to know you as a thinker,” says Lehman’s Linde. “The goal is to provide data and information that helps clients generate alpha for their portfolios.”
In the new reality of sell-side research, the job of the analyst is still to have an opinion, and one based on solid modeling. But opinions and intellectual capital aren’t enough. Wall Street firms are seeking new ways to drive revenues around analysts’ work and to come up with trading strategies that can turn ideas into income. Says BofA’s Ransom, “As research directors we have to say, ‘You’ve done excellent research, so how do we monetize it?’”
