Gustavo Ballvé on May 6th, 2013
Corporate Governance, Food for thought, Home, Mental models, Portfolio Management, Risk management

It is one thing to point out the obvious conflicts of interest that may arise from how sell-side analysts’ performances are measured and rewarded. There’s no argument there – if you are a long-term, value-oriented investor, there are inherent, fundamental differences as to how each group sources and investigates investment ideas, and how each group measures and rewards success. If you don’t already think so, maybe this study on “sell-side analysts’s Black Box” will help enlighten you. It is a survey of 365 U.S. sell-side analysts who, protected by anonymity, ended up confirming several interesting and scary insights about industry practices. As the Wall Street Journal summarizes it: “Any investor – especially any individual investor – still clinging to the delusion that Wall Street analysts provide an independent, objective and skeptical perspective on companies needs to read this study.”

After pointing that out, it is another thing entirely to generalize and say that all sell-side research is inherently flawed. Sell-side analysts sometimes have been covering the industry much longer than any of us and with better access to executives, deal flows, private companies, political influencers, buy-side managers in public and private equity and whatnots. The distribution of the “talent curve” and drive in that industry isn’t different from that of the buy-side: the best analysts are pretty darn good and work pretty darn hard. And sometimes their relatively heavier focus on the short term can help uncover problems and warning signs.

Even so it’s clear that sell-side research has a set of particular issues that makes its investment conclusions more difficult to take at face value. My point is to take nothing at face value, whatever the source: any research that is not proprietary, i.e. any knowledge that is not “earned”, has to be taken with caution until you test it, unbundle and re-bundle it, mess with it and make whatever comes out of this process your own knowledge or building block towards that end.

That is why I can rest in peace after having cast my vote in the Institutional Investors’ 2013 All-Brazil Analyst survey. While some will see this as “feeding the beast”, I see my vote as an opportunity to point out who I think are the best in the sell-side industry according to my criteria. Until we long-term buy-siders don’t organize our own survey, I’ll use the weapons currently at my disposal.

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