Many firms claim to offer some kind of independent research these days, but if you scratch the surface of any research business model, you will find pressures that affect the coverage lists, the recommendations and all the underlying assumptions.
There are very few firms that can honestly claim to offer fully independent research into Asian companies, where the research is paid for directly by the clients. One of these is Riedel Research, owned by Salomon Smith Barney's ex-head of Thai research, David Riedel.
The firm offers regular and bespoke equity research to a limited number of clients (eleven at present rising to thirty by the end of the year). The firm covers about 200 stocks in China, Malaysia, Indonesia, Thailand and India as well as some Latin American names. Having started in May 2003, it now boasts 11 analysts. The firm is US SEC registered as an investment adviser and in 2004 its buy recommendations out-peformed MSCI Asia ex Japan index by 18%. We talk to the firm's CEO David Riedel about why he believes research is still so conflicted in Asia.
After all the changes that have happened, how conflicted is the world of investment research still?
Very. The conflicts between investment bank and brokerage and research are all pervasive. Not only do investment banking conflicts of interest make people more bullish, but it sways their opinions on one company or sector over another. The coverage lists and bias driven by the brokerage conflict of interest is also very powerful.
It drives people to cover certain stocks with liquidity or other attributes at the expense of other names that are investable. Foreign fund managers are ill served by research that is buffeted by both those conflicts of interest.
I think the conflicts are perhaps even more pervasive in Asia. I think there is a need for independent company specific research in Asia. There isn't any at the moment. There is some independent economic, or big picture, Marc Faber-type research, but no one has really solved the question of how to run a business of research that is paid for that supports a network of analysts that cover individual companies.
One of the criticisms of independent research firms is that they can never get the same level of access to companies that investment bank or brokerage researchers do. How do you get around this?
What you need to do in many of these local markets is find senior analysts that have been on the ground for a long time and have been frustrated by the growing compliance pressures of working at one of the investment banks. Many will tell you that in the last few years, their jobs have become virtually untenable because they cannot get their information to clients in a timely fashion or with the same emphasis that they would have had in the past. There are frustrated people who are out there looking for new ways to be stock and company analysts.
We have the clients; they have the local contacts. While we may not have the same calling card into the CEO as a Goldman Sachs or a Morgan Stanley, we are going to have more and deeper contacts throughout the whole of that local company. Maybe not in the executive suite, but we could have contacts in the distribution centres, or in sales training or whatever. Having good analysts on the ground rather than parachuting people in from Hong Kong or Singapore gives you deeper relationships and a better mosaic of information than listening to just what the CEO or CFO has to say.
How do you choose which stocks to cover?
Firstly we tend to focus on the top 40 stocks by market cap, de-emphasizing the top five, which are already very covered. So numbers six to 45 are our sweet spot. Then the analysts come to me with their history of what they've covered in past jobs. If an analyst has a history of Indonesian pharmaceutical and retail coverage then I won't turn them into an airlines analyst. Thirdly we get requests from clients to take a look at certain companies and add it to our coverage list.
How many stocks does each analysts cover?
About 12-15, which is about the maximum any one analyst can cover, remembering that a senior analyst without the pressures of morning meetings, investment banking or marketing trips does tend to have more time to focus on the names, cover more stocks and spend more time getting into the business model of individual companies.
How else does your coverage differ?
I would argue that many firms have gone to a more regional structure with larger teams in Hong Kong and Singapore rather than being on the ground in KL, Bangkok, Jakarta or Beijing. As a result they miss out on many of the interesting stories that are happening on the ground. So in addition to our independence and customization of our service, no one offers the in depth on the ground coverage that we offer.
But you still have things like recommendations, which is not much different from what everyone else has?
Absolutely. We have buy, sell and hold recommendations; we have 10-12 page initiation reports; we have update reports of three to four pages that are quite actionable. Abut 27% of our recommendations are sells, 50% are holds and 25% are buys. This is not part of a mathematical model to get that [distribution of recommendations] but we do look at absolute returns so if something does not have a 15%-20% upside or downside we will put a hold on it.
Is Asia under researched?
No not under researched, but poorly researched. Certain companies are dramatically over researched and some companies get no research at all. Fhere is some coverage of mid caps and none for small caps.
There is a bias from the bigger regional firms to cover certain sectors that can be covered on a regional basis such as airlines, banks and utilities. You miss out on some very interesting plays on the domestic consumer side that don't fall neatly into any category, such as an Indonesian baby food company or a Singapore printing company. No one can argue that this region is under-broked; there is a lot of brokerage activity.
Are investors in Asia now willing to pay for research?
Absolutely. And people are recognizing that they already are paying for research. Investors look around the region at opportunities to trade with execution-only brokers and then compare those trading costs with full-service, bundled brokerage houses and see that they are paying for a lot of stuff that they are not using. My view is that smaller fund managers can pay for execution with an execution-only brokerage like Instinet and then use the difference to pay for my research.
But your research doesn't cover the whole region, so they will still have to use the full service firms.
We are not a replacement, but a smaller or medium sized client will not get much service from a bank and they won't get the kind of custom work that we are willing to do.
Are clients in the US and Europe more attuned to paying for research than clients in Asia?
Over the last 18 months there has been some confusion [in the US and UK] about what was going to happen to soft dollars or unbundling, but that is starting to be clarified. People are realizing that they are already paying for research but will have to pay for it in a slightly different way in the future. In Asia, investors are starting to realize that, but are perhaps a bit slower to realize the value of it.