WHY INVESTEC BLUNDERED
The debacle over the bank’s ‘apology’ for its analyst’s view on Tongaat Hulett exposes an unhealthy conflict of interest in modern finance firms
raig Butters, a veteran portfolio manager at Prudential Investment Managers, knows a thing or two about how tricky it is to take a contrarian and critical approach to a company. It was Butters who, in 2010, organised a meeting with Christo Wiese and advised him to “stay as far away from Steinhoff as he could”.
Wiese, famously, didn’t take that advice — an error that cost the Shoprite chair R59bn in the end.
But the market for critical analysts, who can sound the alarm on corporate malfeasance or bungling, has been dealt a blow by SA’S fifth-largest bank, Investec.
Last Friday, Investec fell over itself to apologise for any “embarrassment” caused to Tongaat Hulett’s CEO Peter Staude after an analyst in its brokerage business, Investec Securities, published a report arguing that based on the sugar company’s results, Staude should quit. That analyst, Anthony Geard, cited Tongaat’s “appalling” year-end results as the reason why “it is time for the CEO since 2002 to step aside”.
It wasn’t just that the numbers were awful (profit plunged 24%), it was that in December Tongaat was all gung-ho about how the company was “poised for a positive earnings and cash flow period”.
In forecasting terms, it was about as accurate as IBM’S boss who said in 1943 that there was a “world market for maybe five computers”. Geard, citing 10 years of falling returns, made the right call.
But Investec threw Geard under the bus — presumably to ward off any prospect of Staude firing Investec as Tongaat’s sponsor, or blacklisting Investec from any corporate finance work being dished out. So
Cmuch for the Chinese walls.
When asked about this, Butters told the FM that investment managers “want to receive independent, unbiased research from all of the expert sources we use for the benefit of our clients. If research is to have any value, analysts should be free to express their views on the companies they cover.”
This principled stance almost seems like mistyeyed naiveté in the era of cut-and-thrust backscratching that characterises modern financial services. The grim reality is that there’s inherent tension between a bank’s advisory arm, which is looking for business, and the research side, which is meant to independently assess the companies who hire those advisers.
Devin Shutte, head of investments at the Robert Group, a private wealth manager, says that if analysts aren’t allowed to remain objective, it devalues their advice. “You have to wonder how many similar negative reports aren’t seeing the light of day because of this structural conflict,” he says.
Butters agrees, pointing to Steinhoff: “It is hard not to conclude that there was undue influence on analysts’ recommendations by other divisions, in anticipation of obtaining advisory, lending and capitalraising business from the highly acquisitive Steinhoff.”
Academic studies bear this out, revealing a disturbingly asymmetrical relationship between analysts’ positive recommendations and published company information. Regulators have also noticed, Butters says, as they look for ways to reduce this positive bias that has produced suboptimal results for investors. Take Steinhoff: the week before it imploded last December, there were 11 “buy” recommendations on the stock, six “holds” and precisely zero “sell” calls.
Piet Viljoen, who now chairs Regarding Capital Management, used to work at Investec Asset Management. He says: “In those days, I had some strong views on certain companies, but Hendrik du Toit [head of Investec Asset Management] always backed me.”
In this case, Viljoen feels Investec could have supported Geard’s right to have that opinion, while saying his view wasn’t that of the bank’s own management.
“But it does highlight the pressure analysts are under. The research industry is facing serious headwinds, and conflicts of interest just add to them. There seems to be clear pressure not to endanger relationships in other parts of the business,” he says.
In particular, there’s a new rule in Europe (Mifid II), which will force fund managers to pay separately for investment research and trading activities. This will create a cash crunch that could drive many analysts out of their jobs. The loser in this scenario will be investors, as there will be less transparency into what companies are truly worth, and less price discovery.
Publicly, Investec should have done nothing. Privately, it should have backed Geard. Instead, by bulldozing its own staff to appease a client, Investec’s tin ear for this dynamic has only made it incrementally worse for SA’S analyst community.
If research is to have any value, analysts should be free to express their views on the companies they cover Craig Butters