Stock Analysts Seek Upgrade by Scaling Down - Many Top Researchers Are Leaving Large Banks

Wall Street Journal

Alexandra Scaggs

Sep 10, 2014

Stock analyst Scott Devitt left Morgan Stanley MS +0.81%  early this year. The main reason: He wanted more time for stock research.
At Morgan Stanley, the Internet analyst was spending much of his time meeting with companies, bankers and investors ahead of initial public offerings run by the New York bank, such as the Facebook Inc. FB -0.56%  IPO. He also was spending significant time marketing his research to money-manager clients and fielding calls from colleagues in Morgan Stanley's overseas offices.
So Mr. Devitt decided to join a former employer, Stifel Financial Corp. SF +0.33%  , a St. Louis, Mo., brokerage firm a fraction of the size of Morgan Stanley.
While Stifel underwrites stock offerings and analysts tend to clients, both happen on a smaller scale, he said. That affords more time for research. Mr. Devitt continues to work in New York.
"The ability to have more flexibility in what you're doing is appealing," he said. "At a company that's the size of Stifel…there are less constraints."
Mr. Devitt has plenty of company. Many top analysts have left large banks, expecting that their clients will follow them and boost trading and banking business at their new firms.
This shift to smaller firms is driving a yearslong decline in big banks' share of the research market, according to financial-services consulting firm Greenwich Associates. Since 2007, the nine largest global banks have on aggregate lost more than one-fourth of their market share to smaller peers.
This comes as fund managers are paying more attention to Wall Street research. For the first time in 12 years, money managers in the year ended February raised the share of stock-trading commissions allocated to research, according to Greenwich.
"A decade ago, the big firms were at the top," said Mark Freeman, chief investment officer of Westwood Holdings Group, which manages $20 billion. "Now it's been turned on its head."
Morgan Stanley declined to comment. Representatives from other banks declined to comment on the outlook for their research businesses.
A number of forces are driving big-brokerage analysts to smaller shops.
Amid a decline in stock trading—which leads to lower commissions—banks have found it tougher to pay up to keep star analysts, industry-watchers say.
In 2007, senior analysts at large banks made as much as 33% more than those at midsize banks and brokerages, according to executive-search firm Options Group. That difference fell to 20% last year.
"For the real rainmakers in the research business, it's very hard to be fully compensated for your value in anything other than a partnership," said telecommunications-stock analyst Craig Moffett. At a public company, "to some extent you're just a cog in the machine."
Mr. Moffett is an extreme case—he went solo. Earlier last year, he left Sanford C. Bernstein & Co., the brokerage division of AllianceBernstein LP. Media analyst Michael Nathanson, previously of Nomura Securities, soon joined him to form MoffettNathanson Research LLC.
Wall Street stock analysts also face regulatory pressure. Research has been under the microscope since 2003, when 10 firms were hit with $1.4 billion in fines for conflicts of interest, after they sometimes pressured analysts to put upbeat ratings on stocks to win banking business from companies. Regulations were introduced to keep banks' investment-banking and research businesses separate.
Recently, Mr. Devitt's team at Morgan Stanley was caught in a regulatory scandal. In late 2012, Morgan Stanley paid $5 million to settle allegations one of its senior bankers tried to "improperly influence" analysts before Facebook went public. Mr. Devitt declined to comment on the settlement.
"You feel much more heat if you're at one of the larger brokerages," said Marcus Kirk, accounting professor at the University of Florida. "Regulators are going to go after the cases that will have the largest impact."
Executives at large banks say research is an important business. They say it remains a lure for corporate executives who often want high-profile analysts covering their company's stock. Evercore Partners Inc. recently bought International Strategy & Investment Group LLC, known for its research, to help boost its business of underwriting stock offerings.
Research is also major driver of trading revenues. Money managers decide where to send trading commissions based on both research and trade execution, executives say.
At Westwood, Mr. Freeman said some of his firm's commissions stayed with industrial-stock analyst Jeffrey Sprague when Mr. Sprague left Citigroup Inc. C +0.29%  four years ago to launch a boutique firm, Vertical Research Partners LLC.
"I don't want to pay everybody at a big bank for mediocre work, but I'll pay one for really good work," said Mr. Freeman. Citigroup declined to comment.
Because of the complex way that money managers pay commissions, industry experts say they can't pinpoint the amount of money directed away from the largest firms. But according to a separate survey from Greenwich, big banks have lost roughly 18% of their share of commissions since 2007.
To be sure, Wall Street still has more than half the stock-research market, Greenwich says. And fund managers say they have go-to analysts at big banks, which offer valued services like meetings with company management, industry conferences and sophisticated trade execution.
But more departures could further hurt large banks' research reputations, they say. Money managers like Scott Migliori, who manages a $676 million large-cap growth-stock fund for Allianz Global Investors, say quality of research is most important, regardless of where an analyst works.
Mr. Migliori liked biotechnology-stock analyst Mark Schoenebaum's research at Deutsche Bank AG, he said, so he continued to use it when the analyst moved to ISI Group four years ago. Deutsche Bank declined to comment.
"We find him to be a valuable resource," said Mr. Migliori. "And frankly, we don't care who he works for."