For years, company bosses and investors would bemoan the City analysts.
These “scribblers” were paid small fortunes by the brokers who employed them to opine (with no great insight, the complaint went) on the financial prospects of stock market companies.
The brokerages would offer their research as an additional service to the fund managers for whom they were buying and selling stock. Hopefully, the brokers reasoned, their analysts’ recommendations and ideas would encourage clients to do more trading.
The complaint from the CEOs and fund managers was that there were too many analysts and most of their work was superficial or downright wrong; if only we could get shot of them altogether, they’d moan.
Be careful what you wish for. The new Mifid II financial rules mean brokers can no longer “bundle” the cost of research with the commission they charge fund managers for executing trades. In the interests of transparency, research has to be sold separately, at a price that reflects the salaries and overheads of the analysts.
Fund managers have been shocked by the cost and largely refused to pay, trimming the number of firms from which they take research to a handful.
This has dropped an H-bomb on the brokers’ business models. Unable to justify paying salaries, they have canned more than 160 of them.
Some fund managers say good riddance. Others are less happy. They say many of those fired were good at their jobs, and that their absence means less diversity of thought about companies’ valuations and strategies.
There’s no doubt the value of the “consensus analyst forecast” — the average of brokers’ views on where companies’ earnings should be — is denuded. Where a few years back, the average would be taken from a dozen or more, now it may be five or six.
This matters. On results day, companies’ shares rise or fall depending on whether they beat or miss the consensus. If the consensus is out, so is the share price.
The scribbler shortage is even worse for smaller firms. As fund manager Downing warns today, smaller companies are now covered by an average of just 0.6 analysts. About 200 have none at all. With little independent research on these businesses, few small investors are prepared to buy their shares. Given that private individuals make up 30% of small-cap share trading, that’s a big problem; SMEs are stifled of investment and fail to achieve their growth potential.
Some specialist research houses are carrying out analysis paid for by the company being analysed. That’s a start, but the quality can be questionable and investors fear the piper is calling the tune.
Mifid II was done with good intentions but has had unintended consequences. The City has yet to figure out how to deal with them.
Meanwhile, many are thinking: perhaps all those scribblers weren’t so bad after all.