Discredited City analysts find themselves under attack from all sides

The credibility and value of City research has long-been questioned. Now the Myners report is challenging the way it is paid for The Research Industry
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The Independent Online

A year ago, they were the gurus of the City, and often media stars in their own right: The super-brains paid millions to determine whether a share is a "buy" or a "sell". Today, the City's army of investment analysts is under fire from all fronts. Their advice is not worth paying for, critics say. Some are wondering if they will have a job in a few years time.

A year ago, they were the gurus of the City, and often media stars in their own right: The super-brains paid millions to determine whether a share is a "buy" or a "sell". Today, the City's army of investment analysts is under fire from all fronts. Their advice is not worth paying for, critics say. Some are wondering if they will have a job in a few years time.

It is hard to understate the power that the City's top investment analysts command. A "buy" recommendation from a well respected number-cruncher can add billions of pounds to a firm's valuation on the stock market. Equally, a "sell" recommendation can sink a company's share price.

Not surprisingly, the best analysts also command phenomenal power over their pay packets. The most sought-after analysts can earn more than £1m annually in salary and bonus payments. According to this year's Reuters UK Larger Company Survey, one-third of all analysts enjoy basic salaries of between £100,000 and £150,000, while one quarter take home a minimum of £200,000. It is not an easy life, mind. The survey also finds that two-thirds of analysts work between 60 and 80 hours a week. Most are at their desks by 6am; only a minority still have energy for the job after age 40.

Despite analysts being so handsomely paid, many of their recommendations last year have gone spectacularly wrong. The heavily tipped technology shares have tanked, many to well below the price at which the shares floated. As dot.com mania raged last year, many analysts constructed astronomical valuations for recently floated companies, arguing that the internet would enable the firms to quickly dominate the global market in their particular industry segment. Take Thomas Bock, an internet analyst at SG Cowen, the US research boutique. He tipped shares in QXL, the online auction house, when they were 267p back in April last year, citing a price target of £44. Today, the shares are just 6p.

David Abraham, an analyst at Goldman Sachs, the US investment bank, recommended shares in Bookham Technology, the fibre optics group, at £25 in October, citing a price target of £60. Today the shares are just 365p. Brian Skiba at Lehman Brothers slapped a "£35-£40" price target on GEO Interactive Media, the video streaming company, when the shares were 2,065p in February. Today Emblaze, as the group is known, trades at 370p. And so it goes on.

Whilst there is no suggestion these analysts have acted improperly, investors suspectothers have avoided writing critically about companies, lest their investment bank employers lose lucrative corporate finance work, such as advising companies on mergers and fund-raisings.

Corporate finance generates huge fees, and companies are unlikely to give their business to an investment bank whose analyst has recently slapped a "sell" on their shares.

There has long been concern about the integrity of analysts' research, and fund management groups have been boosting their in-house research departments over the last few years. Even so, most research continues to be sourced from the "sell-side" - brokers rather than fund managers. And fund managers are especially reliant on analysts from investment banks when it comes to research on initial public offerings, such as the many technology companies that floated last year. Often the investment bank sponsoring a flotation will be the only source of research on that company.

Last year's Primark Extel survey, an annual assessment of the research industry, found that fund managers regarded analysts' trustworthiness as more important than their innate analytical abilities and company or industry knowledge. "For every respondent who took the view that trustworthiness was not a major issue, five took the view that it was," it said.

As if being accused of lacking integrity wasn't bad enough, earlier this month up popped Paul Myners, chairman of leading fund manager Gartmore Investment Management. In his government-sponsored report into the pensions industry, Mr Myners posed an embarrassing question: What is research worth? Mr Myners proposed abolishing the "soft commission" system under which pension funds pay for the research used by the fund managers they outsource to. The proposals have turned up the heat on the investment research industry.

Even the City's house newspaper, the Financial Times, has turned hostile. In a leader entitled "Shoot all the analysts", it mocked analysts for turning up on television, wearing suits worth more than pension funds, when really they "should learn a little humility and get back to analysis".

The Myners report has, meanwhile, forced into the open some of the more questionable aspects of the research industry. Last week, a memo circulated within JP Morgan was leaked, revealing that the US investment bank's analysts had to obtain approval for their research from the investment bankers in the corporate finance department and the companies themselves. It has long been customary for analysts' research to be shown to companies before publication, to check for errors. Indeed, the practice has been attacked for letting companies massage market expectations without making formal announcements. But the leak has compounded scepticism of the integrity of the investment research industry.

Against this backdrop, nominations open this week for the investment analysis industry's version of the Oscars, the annual Primark Extel survey. Fund managers have begun voting for analysts in a multitude of categories, such as "Rising Star". There is plenty of bitching about the winners - "You don't get voted for being clever or right, but for being diligent and e-mailing your spreadsheet to clients at the weekends," says one analyst - which probably has a lot to do with the uplift to one's salary afforded by an Extel top 10 ranking. Investment banks are willing to pay vast sums for Extel-rated analysts, who tend to draw corporate finance work.

Still, even Mr Myners has praise for the winners. "There are analysts who have remarkable insights. Many companies' management say that to speak to the very best analysts is to have a conversation of very real value," he says.

So where does the industry go from here? Mr Myners for one says analysts have nothing to fear. He sees his proposals leading to the creation of a new research industry consisting of small, independent boutiques. "Today's mass-produced research will be replaced by targeted research produced to order. No good researcher should be quaking in their boots."

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