clarification, research reports are not written for you

Yesterday morning at this time I was just some mope with a work history and more free time on his hands than usual. This morning, thanks to Josh Brown (who I can’t thank enough) and the freaking FT, I’m….well, I’m still just some mope with free time. But, had  I known people were actually going to read what I wrote at this early juncture, I would have been clearer on a couple of points.

The Institutional Sales scenario I outlined has similarities to conversations between Financial Advisors and individual investors, but not many. It was not my intention to suggest that outgoing calls from the sales desk were analogous to a used car saleman moving a wreck into poor Widow Smith’s garage. The licensed portfolio manager on the other end of those calls has heard thousands of pitches and is perfectly capable of verifying every aspect of the trade idea, and they are obligated to do so.  It is also highly, highy unlikely that a salesperson would attempt to deceive a PM – the risk of never having the PM pick up their calls in the future is too big a risk. Will inconvenient details be omitted? Definitely. But both sides of the conversation know the rules, and the PM knows that they alone are responsible for the effects the trade may have on their clients’ performance.

Some of the comments and emails I received on Over – Optimism post implied that I was accusing sell-side analysts of willfully misrepresenting their opinions. In my experience this does not happen, the multiple layers of (potential litigation-focused) fact-checking and Compliance are persuasive in this regard. I do believe that reports can be tilted towards the bullish for business reasons, but outright fabrication and cynically deceptive research is very, very rare. Capital markets does, for the record, have a structural bias that benefits the optimistic and it is that bias that I was trying to describe.

This brings us to another point, one that I’ve made to Financials Advisors hundreds of times; most of the frustrations individual investors have with research arises from the fact that, while they have access to research reports, they are not the target audience. Research is written for institutional portfolio managers. This is easily proven by the fact that success or failure within the retail brokerage arm of the firm has little or no impact on an analysts’ compensation. Portfolio Managers are well aware that, for instance, the twelve month target price is not a prediction but a guideline. A target price is merely the output from the analysts’ model in an “all things being and remaining equal” state that neither the analyst nor the PM for whom the report is written believe will actualy take place. So, DON’T PICK STOCKS BY TARGET PRICE.

Importantly, I am humbled and vaguley terrified by the response to date from “Over-Optimism” and I want to thank everyone who has taken the time to read.

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3 thoughts on “clarification, research reports are not written for you

  1. I remember this from the first hedge fund I as an analyst for out of school. You quickly discerned the difference between the sell-side guy who called when he had a good idea and the sell-side guy who called with simply his best idea of the week. You always wanted to be able to differentiate between the two.

    We liked the guys who occasionally gave us an off-the-beaten-track idea that we could research. The idea that we would ever trade a sell-side idea based on their pitch alone was an impossibility.

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