UNCOVERING GEMS
The MAS and SGX initiatives to boost equity research seem welcome, but response has been lukewarm. And, the market has changed.
Ho Khin Wai is an equity investment analyst at Dr Wealth, a financial education site. He started researching and writing about value investing not long after he graduated from the National University of Singapore with a degree in finance.
Becoming an analyst, he says, was a “natural” choice because he had no desire to embark on a career in investment and/ or private banking. While he is happy to work at Dr Wealth and has no immediate plans to leave the company, his long-term goal is to eventually become a buy-side analyst. This, he says, is in line with his investing approach of long-term holding and bottom-up stock picking.
The buy side typically refers to financial institutions — such as insurance firms, mutual funds and pension funds — that engage in purchasing stocks, securities and other financial products. On the other hand, sell side refers to entities — such as brokerages and trading houses — that are involved in the creating, promoting and selling of these assets.
Yet, unlike many others, who first become sell-side analysts before hopping over to the buy side, Ho does not want to do sell-side research because it does not resonate with him. “Sell side really focuses on [producing] earnings forecasts and constructing valuation models,” he tells The Edge Singapore. “For me, I didn’t want to go down that road because I feel it will distort my research style.”
Ho’s reluctance to be involved in sellside research may be a personal choice, but it points to a deeper malaise plaguing the industry.
According to Chan Kum Kong, head of research and products at Singapore Exchange, the tightening of financial market regulations has led to a declining number of sell-side analysts in the local market. In particular, the introduction of the Markets in Financial Instruments Directive (MiFID) II in Europe last year led to an increase in record-keeping and transparency of costs. This, in turn, reduced the demand for sell-side research reports, causing sell-side research houses to downsize their analyst teams.
As Chan explains, sell-side research was never priced separately before. Instead, the cost of research was bundled together with the cost of executing trades by trading platforms and brokerages, he says. “So, the sell-side folks would be pumping [out] research reports to clients whether there was a need or not. The clients would just consume them since they were free,” he tells
The Edge Singapore in an interview.
The implementation of MiFID II, however, meant that the cost of sell-side research is now unbundled from the cost of trading execution. And, as part of the buy side’s evolving best practices, the cost of sell-side research is now borne by the firm instead of clients, to prevent a conflict of interest. “So, fund managers are rethinking whether they really need to buy the research reports since they have to bear the cost from their own pocket,” he says.
That aside, the devastating impact from the global financial crisis (GFC) in 2008 also contributed to the dwindling number of sell-side analysts, says Corrine Png, regional head of equities research at AIA Investment Management.
During the GFC, many hedge funds had suffered heavy losses and were subsequently forced to exit the market. This led to significantly lower trading volume, as hedge funds typically trade more than other market participants. As a result, brokerages earned lower fees from trade execution, which led to their cutting their research budget and/ or reducing research headcount to minimise costs. Similarly, the banks slashed their research budget and/or research headcount to strengthen their weakened balance sheet.
Inevitably, as the number of sell-side analysts fell, the quality of sell-side research reports also deteriorated. This is because the remaining analysts had to cover more research ground or drop coverage of certain sectors. This was made worse by the fact that senior analysts are increasingly involved in client-facing activities, such as roadshows, to generate more revenue for the brokerage. “So, how much time do they have to sit down and do financial modelling and number crunching and come up
with research?” says Png. “They are like marketing machines basically.”
At the same time, sell-side research is seeing a “juniorisation” of its analysts, says Png. As senior analysts are usually let go to cut costs, the remaining analysts are those with less experience. This has led to equity reports that are less critical and have less differentiation.
According to Png, 65% of sell-side analyst recommendations within the Asia excluding Japan equity universe last year were “buy”, while 26% were “hold”. Only 9% were “sell”. The bullish majority, however, failed to account for the significant dip in equity markets last year. So “we find that for stock calls, we probably have to rely on ourselves a lot more”, she observes. “If you look at the consensus earnings forecasts, [the street] tends to hug consensus. There is gravitation towards the average forecast level or average price target. That makes it hard for us [as a consumer of sellside research]. How do we generate alpha?”
New blood
The shrinking number of sell-side equity analysts and drop in research quality have not gone unnoticed by the authorities. About a year ago, representatives from the Monetary Authority of Singapore (MAS) and Singapore Exchange sat down with market participants to discuss ways to rejuvenate the local stock market, says SGX’s Chan. Among the issues raised was the importance of sell-side equity research and the analysts who produce them: Chan calls the job a “vocation”.
“There is a finite number of sell-side equity analysts currently in the ecosystem. This is likely a longer-term trend. If you do not have fresh blood coming into the vocation, you will only see a decline,” he says.
In February, MAS launched the $75 million Grant for Equity Market Singapore, which will be disbursed over the next three years. The aim of GEMS is to reinvigorate the local market by encouraging IPOs as well as broadening the research coverage of listed companies.
There is a listing grant that will help companies seeking a listing on SGX to defray part of their IPO costs. Two other components are aimed at reviving the equity research industry and broadening research coverage of public-listed companies.
A major part of GEMS is the Research Talent Development Grant (RTDG). Under the scheme, 70% of the salaries for fresh graduate hires and 50% of the salaries for re-employed experienced equity analysts will be subsidised over two years. The grant amount will only be disbursed if certain targets are met after 12 months from the hiring of the analyst, such as the number and quality of research reports. This is to ensure the success of the grant and to prevent any abuse of it, says Chan.
He points out that the aim of RTDG is twofold: to groom a pipeline of Singaporean equity analysts and to enhance the research coverage on mid- and small-cap companies. In particular, the new analysts are required to produce a certain number of research reports on small- and mid-cap stocks within a certain timeframe. Upon publication of the research report, a copy of it has to be submitted to SGX for tracking purposes.
Chan says the research focus on smalland mid-cap stocks is due to the fact that there is a lack of coverage in that space. “If you look at any of the exchanges out there, a lot of the information is concentrated on the index stocks. We will be tracking the output progressively. We don’t want the analyst to backload all the reports at the end of the period.”
Brokerages that apply for RTDG will have to adopt a mentorship model by pairing up their newly recruited analysts with senior analysts. “The whole idea is that skillsets will be imparted. That’s where you learn,” Chan says. “We could have chosen the path of merely using the money to pay for research from third parties. But that doesn’t solve the problem. For how long can you buy reports? If you buy reports, there is no transference of skillsets.”
The way Chan sees it, the mentorship model is a win-win situation. “The senior guy needs someone to crunch the numbers. He is happy to have someone help him with his work. On the flip side, there is a level of quality control for the mentee’s research report. They can co-author the report,” he says.
While it is crucial to recruit new analysts and generate more research reports, access and distribution are equally important, says Chan. He notes that SGX intends to invite analysts to speak at its investing seminars and events. “The whole idea is to have a live engagement, questions and answers and showcase the research reports. We want this information to be broadcast not just here but offshore.”
‘Good level of interest’
MAS says the response to the initiatives has been positive. “We are seeing a good level of interest in GEMS, particularly in [RTDG]. As we strengthen the pipeline of research talent and facilitate more innovative research offerings, we are confident that these initiatives will spur greater investor interest across a wider spectrum of companies listed on SGX and boost market liquidity,” a spokesperson says.
Lim Siew Khee, head of research at CGSCIMB Research, says the research firm has put in an application for RTDG. She agrees that the scheme is a “useful” one to attract new blood to the industry. CGS-CIMB has hired one new analyst under the scheme and is hoping to recruit one or two more. So far, the new analyst has yet to publish a research report, Lim says.
At DBS Group Holdings, Asean head of research Janice Chua says the bank too applied for RTDG. While she declines to reveal how many new analysts it has recruited, she notes that RTDG will widen the pool of analysts and resources so that small- and mid-cap companies that have remained under analysts’ radar may get coverage. “With competition for resources, the grant helps in developing new talent,” she notes. At the same time, market liquidity should improve, which will benefit the companies, she adds.
Meanwhile, SAC Capital’s head of research Joseph Yap, is more circumspect, although he acknowledges that the grants could be helpful. The firm sponsors Catalist listings, and its research arm has applied for RTDG. “Our hiring will be gradual, depending on the suitability of the candidate and the human resource requirements,” Yap says.
Other research outfits that The Edge Sin
gapore contacted have declined to comment on the scheme. Maybank Kim Eng Research says it did not apply for the grant. KGI Securities, OCBC Investment Research, RHB Research Institute and Phillip Securities Research did not respond to queries by The
Edge Singapore for this article.
Rules have changed
To be sure, the initiatives will take time to produce results. Still, it has been more than six months since the scheme was launched, and one would have thought that research houses and brokerages would have leapt at the opportunity to replenish their ranks. At the same time, it remains to be seen whether the scheme addresses the fundamental issues that the equity research industry faces. In particular, the companies themselves are finding a public listing less useful for their purposes. The number of delistings in Singapore so far this year has outpaced the number of IPOs.
Even as the equity market is on the decline, the stock exchange has been focusing on a “multi-asset” growth strategy for itself. As a matter of fact, the volume of derivatives traded has been on an uptick over the last two years. In February, MAS launched the $75 million Grant for Equity Market Singapore, which will be disbursed over the next three years. The aim of GEMS is to reinvigorate the local market by encouraging IPOs as well as broadening the research coverage of listed companies.
In any case, as AIA Investment Management’s Png points out, a good analyst is one who would have had at least 10 years’ experience in the industry. He or she would have witnessed the ups and downs of the economic cycle and have a better understanding of risks and valuations, she says. Yet, the more seasoned analysts and research heads spend most of their time taken up with their employers’ marketing efforts, rather than deep-dive research, as some have told
In the meantime, many buy-side firms have resorted to building their own research capabilities. Png says her role at AIA Investment Management was created specifically in response to the deterioration in the quality of sell-side research. She manages a team of 33 equity analysts who conduct research on companies in nine markets, namely Singapore, Malaysia, Indonesia, Thailand, Hong Kong, China, South Korea, the Philippines and Taiwan. Png says she decided to take up the role last November — after being headhunted — as it was similar to what she was doing previously at her own independent research outfit.
“We, on the buy side, need to be a lot more critical [than those on the] sell side,” she says. “Our analysts do rigorous fundamental analysis and visit about 7,000 companies a year. Then, they write their reports on where to find alpha-generating ideas to improve portfolio returns.”
This, however, does not mean that buyside firms no longer depend on research output from the sell side. Png says there are still some research gems produced by sellside analysts. And, because the sell-side firms, especially global banks, usually have a bigger analyst team, they are able to cover more research areas, such as the economy, currency and sectoral analysis. This is useful for the buy side, as they usually do not have the resources to cover a breadth of research, she explains.
Furthermore, the sell side has more clout and access to corporates. Png says people on the sell side are able to organise conferences and events, and invite senior management to attend. This provides convenience for the buy side to meet the “entire spectrum of companies” at a single location, she explains.
Ultimately, the market has shifted and investors are increasingly looking for longer-term, sustainable returns. So, how the grants uncover gems, and how that helps increase participation in the local stock market, remains to be seen.