Number-crunching nerds who should do better

City & Business
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INVESTMENT analysts are rather an unsung bunch in the City. Unlike merchant bankers, they cannot make their reputations on the back of the mega-deal. Unlike salesmen, they cannot make their fortunes from the commission on a single transaction. Analysts - the number crunchers who advise institutional investors on which countries, industries and companies to invest in - are neither Masters of the Universe, the bond salesmen immortalised in Tom Wolfe's Bonfire of the Vanities, nor Big Swinging Dicks, the traders depicted in Michael Lewis's Liar's Poker.

Instead they have rather a nerdy reputation. Beneath the pinstripe suit is an anorak with a fluffy hood. Nigel Lawson famously derided them as "teenage scribblers".

It's not terribly fair. Analysts probably exert more influence than anyone else over how our pensions, life policies, unit trusts and other investments are managed. Even the most churlish fund manager would have to admit that input from analysts plays a key role in their decision-making. This collection of perhaps 2,000 people in Britain has a huge influence on which companies and industries and entrepreneurs attract new capital, and which do not.

To financial journalists, analysts are tremendously useful. They are paid to have an instant opinion on anything from the latest lurch in the Tokyo stock market to the piddliest merger in the widgets industry. Moreover, like politicians, they learn to deliver their views in trenchant, pithy quotes.

Yet analysts as a species hit the headlines only twice a year. One is the annual dinner at the Grosvenor House Hotel, when the entire profession gets pie-eyed, providing a rich diet of stories for City diarists. The other is the annual Extel survey of analysts. Last week saw the 22nd. This is the Oscars of investment research. Institutional investors vote for their favourite analysts. Extel comes up with a string of league tables, ranking analysts in every conceivable sector. These are pored over in minute detail - by the analysts themselves at least, (though decreasingly by institutions themselves, which tend to conduct they own mini surveys in-house). A move up the pecking order means more prestige among one's peers. And highly ranked analysts are more likely to be headhunted by rival employers - for a suitable salary increase of course. The average analyst earns perhaps pounds 75,000, plus a 50 per cent bonus in a good year. The stars command pounds 300,000 or more. Add in administrative back-up and the research department of a large integrated securities house can cost pounds 30m a year.

Is it worth it? Frequently no. Speak to any fund manager and they have a pretty jaded view of analysts. More than half the reams of research they receive is unsatisfactory, according to Extel. There is far too much of it, and the bulk of it concentrates on short-term movements in earnings. The complaint you hear again and again is that analysts are too passive, simply waiting for the next set of corporate figures to comment on. Institutions want fresh insights, they want forecasts of new trends and how these might affect specific companies. It's not all the analysts' fault. Institutions who simply wait for the phone to ring add to the poverty of analysis. As one put it to me: "If we don't put good questions to analysts, we can hardly expect good answers."

Extel found this year a record 56 per cent of respondents believe that more than half of all research is unnecessary. And unlike Lord Leverhulme, who knew half his advertising was a waste of money but not which half, fund managers know precisely which research goes straight in the bin.

One of the few fund managers to put their heads above the parapet on the subject is Leslie Robb, head of the fund management arm of Scottish Widows. "The broking industry needs to be severely rationalised," he told me last week. "And that means closures and mergers, not takeovers."

When Mr Robb took over at Scottish Widows at the end of last year he held a beauty parade for brokers. His seven core brokers were pared down to four, and the long tail of niche brokers reduced to just five. Similar rationalising of brokers is taking place among other fund mangers, who are also doing more research in-house.

Why aren't analysts better? Three reasons. First, the cynical one. Their raison d'etre is not primarily to give good advice, but to generate commission. The important thing is to persuade clients to buy or sell stock. The problem is that clients do not directly pay for research. More enlightened institutions try to reward good research by putting business the way of brokers whose work they admire and by explicitly explaining why. But the linkage is generally poor.

Second, the structural one. Most analysts work for integrated securities houses and serve other parts of the business apart from the stockbroking side. There are horrendous potential conflicts of interest. Clients have to ask whether the analyst recommending Bloggs plc is doing so because he really believes in Bloggs's long-term prospects - or because his market- making colleagues have some unwanted Bloggs stock, or because his colleagues in corporate finance are manoeuvering to win Bloggs as a client.

The third reason is that British analysts tend to be young, inexperienced and under-trained - at least compared to their counterparts on Wall Street. Clients repeatedly complain that analysts are poor on the nitty-gritty of fundamental analysis, be it examining cash flow or the balance sheet, or spotting so-called creative (ie flattering) accounting wheezes. Almost one in four UK analysts have less than two years experience. And there are very few "old-timers" - those who have seen more than a couple of complete stock market cylces, say. A paltry 18 per cent of analysts have actually passed the exams of the Institute of Investment Management and Research. That compares to 24 per cent a year ago and 30 per cent in 1986. It's healthy that investment analysts come from a good range of outside disciplines such a s accounting and the law. But precious few have done a hand's turn in the actual industries they cover.

Where next for investment analysts? Extel consultant Geoffrey Osmint believes the industry will be rationalised into half a dozen core securities houses offering a full range of research plus a handful of niche brokers with specialist expertise. Logic dictates that should happen. I'm not so sure it will, though, while overseas banks continue to snap up London houses. Dresdner Bank's purchase of Kleinwort Benson does not reduce capacity one jot. Moreover the new owners have deep pockets and are prepared to sit things out for the long term.

That's wonderful news for analysts. The mediocrities can continue to live a quiet life putting out unread circulars. The high-fliers will continue on the merry-go-round from employer to employer, each Extel survey adding to their perceived value. But it won't improve the quality of investment decisions.

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