The three components of a broker dealer: corporate finance, research, sales & trading, are all dependant on each other in order for the firm to make revenue. If one of these three units broke down, the investment bank would become unprofitable, correct?
I am proposing a prediction that the equity research component is breaking down and at some long-term point (5-20 years), investment banks will be completely out of favor.
Industry veterans have commented to me that “back in the day” sell-side research analysts had a real advantage over the average investor because they had real access to management. Models could be sent back and fourth from the analyst to management and if the analyst was off in their forecast - management could let them know about it clearly and succinctly. In essence, the market was more efficient.
These days, the analyst and management are more separated (rightly or wrongly, probably rightly) and analyst predictions suffer from lack of management input as a result of tighter information regulations.
Another matter plaging sell-side research is the inherent conflict of interest between providing objective research, and pleasing corporate finance. If an analyst acutally provides true un-biased research, it is more like contributing to the public good and it is not a self-interested move. Contributing to the public good is not a profit-maximizing move for the investment bank. The credibility of the research is hindered - before it is even written.
I believe that a good chunk of research analysts may sublty design their models and assumptions to be accountable to the client company and not the instituional investor - even when their own common sense may tell them otherwise. Using company guidance is a safe bet, the company can’t get mad at you - but there is not thought that goes into it and therefore no value in the research reports.
Equity research analysts have tended to stay out of the scandal spotlight, probably because they don’t actually spend, invest, or otherwise handle transactions. The facebook launch brought it a little to attention, but I say the problem is much deeper than it appears.
Without credible research, a trading desk has difficulting attracting trades, and without trades, corporate finance has difficulty attracting deals. Investment banks were the hotspot to be, now I think it is on its way out. I don’t know what will replace it, but something else will.
- former equity research associate