F.A.I.R. - Inside the trenches

Michael Oertli, Head of Asian Research at UBS Warburg reveals what it is like to work at the top of Asian equity research these days.

What are the chances of Asia seeing a major Enron or Worldcom-style disaster and analysts missing out on it?

Oertli: It can't be excluded, but Asia may be in better shape than what we see overseas. We already went through one big crisis five years ago that taught us to look more closely at asset valuations since corporates had mostly little or no earnings. And there was also a wrong perception that Asian companies have lower accounting standards than elsewhere, hence people were habitually looking at the balance sheet more closely. Lastly, Asia's corporates are often family owned and therefore equity protection comes before short-term earnings performance.

In this new environment of scrutiny facing your industry, how are companies dealing with analysts? Are they being more understanding or are they as prickly as ever?

The relation between analysts and companies has always been complex, and quite a few companies are acting defensive right now. This phenomenon is, by the way, not much different in Europe and the US. In my view, the pressure to write positive research is often much higher from covered companies than it may be from the investment bankers. With the latter, analysts can step in and mark their independence if necessary. But with companies, it can be very tough.

They have a hard time understanding that we must ensure our integrity and independence and that it is not our task to boost their market capitalisation. In the worst cases, we are taken out of their distribution lists, get locked out of the information flow, and are prohibited to see them or bring clients for visits. In cases where the pressuring goes too far, we drop coverage of a company completely.

Has UBS Warburg missed mandates in Asia because of what you have written in research reports?

Yes, of course.

So should there be more regulation of the industry not just to police analysts but also to protect you?

We need policing and protection. There are some bad guys in our industry. In the late nineties, the industry saw a high degree of greed, when some top shot analysts had unethical demands such as trading in stocks they took care of, participating in IPOs they helped launch or even becoming board members of companies they covered. And while they are probably cruising on their yachts by now, we have to deal with the aftermath.

We need mechanisms to prevent such excesses, but not rules that keep us from being creative. And we should if necessary also be protected from companies we cover. Regulations can be helpful, but it's also a matter of education. The investing client must always come first. Not all parties involved do accept this simple truth yet.

When the markets come back and this has been flushed through, is there a danger that all the new rules that have come in will be forgotten? It will only take one house to start offering IPO rights to analysts for the whole thing to go back to how it was.

Collective memory is often surprisingly short, but a lot of these changes won't be reversed anymore. The new regulatory and in-house rules have already become much tougher than a year ago. Remuneration should be decided on factors like accuracy of recommendations and earnings estimates, client service and client votes, teamwork and other factors.

I can see that such a remuneration structure makes sense logically, but practically does that not just turn all the analysts in traders, getting paid for their market calls?

No, the time horizon is completely different. Analyst calls should be made for 12 to 18 months; traders are dealing on a much shorter time basis. The process of making or changing a recommendation has become a lot more rigorous. We have an in-house investment recommendation committee where the analyst has to present her or his report prior to publication, in front of selective senior people, to ensure that the research has a reasonable basis, is well balanced and objective.

Given that all these changes to the research coverage are going to cost more, will commission rates have to start going up to compensate for the increased costs?

Institutional investors are interested in having sell side analysts and they do pay us as long as the quality is good and they can benefit from our service. There is still a trend for investors to cut their broker lists. The big clients used to have over 60 brokers, now half of that is the norm. If you are not among the best, you will suffer or die. The firms that survive will primarily be the ones with value added research and strong execution capabilities.

Given the need to be rated, there's a lot of pressure on analysts to do more marketing than analysis. Does this reduce quality of analysis?

I don't think so. I can see more harm coming from the mere quantity of stocks an analyst is covering. In Asia, we follow 450 stocks with 75 analysts, so each analyst covers an average of six companies. I cannot comprehend how you can know your companies inside out if you have 25 of them.

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