After a series of royal scandals, Britain’s Queen Elizabeth II took to calling 1992 an “annus horribilis” — Latin for a year that wasn’t so hot.
No one would argue that equity markets around the globe didn’t have a horrible year too — in 2008 — but which of the sell-side firms in developed Europe did the best job of offering timely research of true value to hedge fund managers? None other than Banc of America Securities–Merrill Lynch, according to Alpha’s ranking of the top firms in Europe, based on our annual sell-side survey of hedge fund managers.
[Click on All-Europe Research Team -- Hedge Funds Only, to view the Leaderboard and Leading Analyst Rankings]
Merrill Lynch, of course, had its own annus horribilis in 2008. Then-CEO John Thain had little choice but to sell the troubled investment bank to Bank of America Corp. last fall after credit markets froze and equity markets tanked. Known today as Banc of America Securities–Merrill Lynch, the firm’s research group claims the No. 1 spot, with 21 ranked teams, rising from No. 2 a year ago.
In our separate Europe, Middle East & Africa emerging-markets ranking, BofA–Merrill Lynch grabs second place, with two team positions, behind Renaissance Capital. The Moscow-based firm, which captured the top spot in the EMEA survey for the first time a year ago, retains its title, with a remarkable eight No. 1 teams this year.
To identify the research analysts who outshone their rivals when it came to servicing hedge funds in 2008, Alpha turned to its sister publication, Institutional Investor. For a sixth straight year, we recalculated the results of II’s All-Europe and Emerging EMEA research team surveys, using votes only from hedge funds. The broader surveys — which appeared, respectively, in the February and March international editions of II — also include votes from pension funds, mutual funds and other traditional asset managers.
BofA–Merrill Lynch climbs to the top of Alpha’s developed Europe ranking — despite the turbulent markets and its own extensive internal problems — in part because its analysts were well positioned to make short-term calls, courtesy of the firm’s “most and least preferred” program, initiated by London-based media analyst Julien Roch toward the end of 2006 and rolled out departmentwide in 2007. Under the system, analysts from 15 sectors are asked to pick what they believe will be the five best and worst stocks in their industries over the following 30 days.
“It helps identify strong conviction calls on shorter time frames,” explains Simon Greenwell, the firm’s London-based head of equity research for Europe, the Middle East and Africa.
“A lot of hedge funds like to be market neutral, and we’re giving them a market-neutral product,” adds Michael Harris, BofA–Merrill Lynch’s London-based head of emerging-equities research. “We’re saying what we like, but we’re also saying what stocks you want to avoid.”
In mid-January, Harris and his team published their first “Istambulletin” of this year, with 12-month picks for the best and worst choices among Turkish stocks. Their report included the following pair trades: Türkiye Garanti Bankasi (“plenty of upside”) versus Asya Katilim Bankasi (“not expensive but enough risk”) and conglomerate Haci Ömer Sabanci Holding (“the extent of the discount should allow for outperformance”) versus its larger rival Koç Holding (“current valuation fairly generous”).
With a full year’s most-and-least performance under its belt, the firm says that its choices in two sectors did exceptionally well: Business services was up 86.57 percent in 2008, and the real estate segment of the program was up 61.70 percent, according to a BofA–Merrill Lynch spokesman. Ten sector selections had positive results, and five were negative. (The firm declines to release specific numbers or to divulge an aggregate figure.)
UBS, which is tied with J.P. Morgan Securities for No. 2 in the ranking, introduced a similar series of reports at the beginning of 2008 from its 25 teams that cover developed Europe. Published under the heading “Preferences,” UBS’s buy-and-sell calls delivered an aggregate net return of 12 percent on the year, says Nicholas Pink, the firm’s London-based head of European equity research. Pink would not disclose the results for individual sectors, though he insists that “our best teams would match Merrill Lynch, and the majority outperformed.” Pink says that UBS is considering whether to expand the strategy to its emerging-markets coverage.
The UBS product is different in small ways from BofA–Merrill Lynch’s. Each analyst team makes three to five picks per sector on “least-preferred” and “most-preferred” stocks. Pink says some sectors are combined to ensure that there is a large enough universe of stocks. Typically, the selections expire after 30 to 60 days, he adds, though some picks remained in the portfolio for all of 2008. The departmentwide list has about 100 stocks on it.
Both BofA–Merrill Lynch and UBS have instituted new policies in response to the increasingly volatile — and sour — markets. The big change came at Merrill Lynch in June 2008 from an edict that required at least 20 percent of the stocks followed by analysts to be rated as underperform. Once the new policy went into effect, analysts became more aggressive in officially questioning the value of stocks, and the percentage of equities rated underperform increased to as much as 30 percent. The mandate gave the firm’s analysts “much more license to identify some of the weaker names,” says EMEA research head Greenwell, explaining that when Merrill Lynch had its old buy/sell/neutral system, less than 10 percent of its stocks were rated as sell.
“It got analysts off the fence, and the timing was fortuitous,” adds emerging-markets research head Harris, noting that Merrill already had price targets on its buys but that the firm added them to its neutrals and underperforms as well.
UBS, meanwhile, has put more of an emphasis on aligning its top-down macro view with analysts’ bottom-up earnings estimates. For instance, last fall, when the European Commission predicted the economy in the European Union would “grind to a standstill in 2009,” with GDP growth of 0.1 percent for the euro zone, UBS executives believed the outlook was actually even grimmer. Starting on November 14 and continuing over the next two weeks, UBS put out a series of reports under the banner “Black Skies,” in which the bank said it was “looking for a deeper recession.” UBS cut earnings estimates for the fourth quarter of 2008 and all of 2009 for about 200 nonfinancial companies — about one quarter of the equities it follows in developed Europe — in the belief that the credit crunch would eventually strangle the real economy, not just the financial sector. “I would not claim we foresaw the scale of the downturn,” Pink says. “Almost everyone was surprised by it. But we did work hard to ensure that our analysts’ earnings estimates were as realistic as possible.”
The analysts’ instincts were right. On January 19 the EC lowered its GDP forecast, projecting a 1.9 percent drop for 2009, which would be the first contraction in the euro zone’s ten-year history. Four days later UBS published a report in which its London-based analysts cut their dividend forecasts for 110 companies in developed Europe as a result of deteriorating macroeconomics and the need for companies to conserve cash.
J.P. Morgan Securities makes a sizable move in the ranking, jumping from No. 5 to tie UBS at No. 2, with 17 analyst team positions. The research group benefited from parent JPMorgan Chase & Co.’s May purchase of Bear Stearns Cos., adding five analysts through the acquisition: Jonathan Dann and Maurice Patrick, in telecommunications; Alexandra Hauber, in pharmaceuticals; Nico Dil, in capital goods; and Timothy Nollen, in media. J.P. Morgan’s research arm in London has been hiring analysts and expanding its equities coverage since the summer of 2006, when José Linares, head of equity research for Asia and Europe, returned there from Hong Kong (where he had been the head of Asia-Pacific equity research). His assignment in London, in his words, was “to improve the performance of the department,” and he seems to have done that. Last year J.P. Morgan had just ten ranked teams.
Morgan Stanley, which slips in this year’s ranking from No. 1 a year ago to fourth place, has been taking a longer-term tack. The firm is issuing reports that look out as far as 2012 and name the 20 European and 50 global stocks its analysts believe will be the winners once the current crisis has passed.
“The idea is to take a step back and extend the normal investment horizon from six-to-12 months to three years,” explains Rupert Jones, the firm’s London-based head of research. Because Morgan Stanley’s long-only equity funds must by definition own stock, he says analysts are “focusing on fundamental research and the depth of research, rather than reading short-term market movements.”
Many of the best-ranked firms have pushed forward with plans to expand their on-site presence in emerging markets, in spite of the global recession and the retreat on almost all fronts.
Renaissance Capital continues to increase its coverage of sub-Saharan Africa, adding four analysts to bring its head count covering that region to nine, with four based in Lagos, Nigeria — its African headquarters — two in Zimbabwe and one in Kenya (the other two are in London). Most are country-specific analysts, but one is a bigger-picture economist and one is a bank analyst, says Renaissance head of equity research Alexander Burgansky, who leads the firm’s top-ranked EMEA Oil & Gas team.
“Where there’s a lot of opportunity and few competitors, that’s exactly the kind of region we like,” says Roland Nash, chief strategist at Renaissance and leader of the top-ranked Equity Strategy/Emerging EMEA Markets team. “Who else can provide road shows in Lagos?”
Nash also leads Renaissance’s Russia research team, which is ranked No. 1 for a fifth straight year. “During the turmoil of 2008, I found the conference calls organized by Roland to be extremely useful,” offers one of the hedge fund managers surveyed, citing a conference call on which Colin Powell, the former U.S. secretary of State, was one of the experts who spoke on the delicate subject of Russia’s August invasion of Georgia. Nash tells Alpha that Powell was “quite constructive — he gave people some hope that things could improve.”
BofA–Merrill Lynch has also increased its local presence in emerging markets this year. Emerging-markets research head Harris says the bank is in the process of increasing its universe of coverage to 179 emerging-markets stocks, from 109 a year ago, explaining that, despite the sell-off in the latter part of 2008, it has become important to be on-site because “increasingly, you’ve got a local client base, and a global client base that travels often to the country.”
Last year Harris’s group hired Moscow-based Eduard Faritov from Renaissance to cover infrastructure in Russia and brought aboard David Danilowitz from J.P. Morgan to follow banking from its Johannesburg office. BofA–Merrill Lynch has also been expanding its office in Dubai since the middle of 2007, an effort that has been led by analyst Stephen Pettyfer, whose team is ranked second in EMEA Telecommunications.
UBS, which is tied for No. 3 in the emerging EMEA ranking with Deutsche Bank and Troika Dialog, hired Dmitry Vinogradov from Citigroup to be co-head of its Moscow office with Alexei Morozov, bringing its head count in the Russian capital to five senior analysts and one economist. The big Swiss bank also hired John-Paul Crutchley from Merrill Lynch to co-head its London-based banking team, replacing Stephen Andrews, who relocated to Dubai, where UBS now has two analysts covering banking and on-site construction and real estate.
The newest top-firm entry in the Dubai market is J.P. Morgan, which opened a research office there on January 25 under the supervision of Christian Kern, a former telecom analyst at Lehman Brothers.
“Dubai has become a hub,” says research head Linares, adding that the bank is planning to transfer Naresh Bilandani — a member of the emerging-markets banking team in London — to Dubai to cover real estate and diversified industrials. Joining Bilandani will be Muneeza Hasan, a senior analyst currently based in Karachi, Pakistan.
“Our ambition is to cover 30 to 40 [Dubai] stocks this year,” Linares says.
Alpha’s list of top analysts includes seven who lead first-place teams for the first time: Andrew Stott (Chemicals) of BofA–Merrill Lynch; Gerardus Vos (Technology/Software) of Citi; Rodney Whitehead (Retailing/General) of Deutsche Bank; Erik Bloomquist (Tobacco) and Duncan Russell (Insurance) of J.P. Morgan; and Martin Allen (Property) and Bruce Hamilton (Specialty & Other Finance) of Morgan Stanley.
Anyone who excelled did so in difficult circumstances, notes London-based Russell, who joined J.P. Morgan in February 2008 as the head of its five-person European insurance team after a brief stint with a hedge fund start-up that didn’t get off the ground. (Russell previously had been an analyst with Fox-Pitt, Kelton.)
“It was a very difficult environment, with a lot of uncertainty and nervousness in the market,” says Russell.
