Industry Hype Machine

Gary Schwartz talks with industry pundit, Richard Kramer in London on how corrupt industry and Wall Street analysts are complicit in industry hype machines.

Richard is the main founder of Arete (formed in 2000), the pioneer of the independent equity research space (prior to the Wall Street scandals of 2001-2003), and is based in London. For over 20 years he has focused on the wider mobile internet space, including smartphones, digital consumer products, advertising technology and other internet services. He is a frequent and highly-rated speaker at industry conferences, known for his frank dissection of industry hype and willingness to offer critical as well as positive comments on leading tech companies. His team includes Muzhi and Rocco and he regularly supports interns to give them a leg up in the technology space. Prior to founding Arete, Richard was for four years #1 ranked technology analyst in Europe at Goldman Sachs, and prior to that, worked for Nortel and at a prestigious Columbia University economics think tank.

On a recent Bloomberg interview you (as your are known and loved for) challenge market pundits on playing corporate cheerleader to Linkedin, Twitter and Alibaba. You argue that research analysts are conflicted and not providing dispassionate market advise.
Are you saying that there is no Chinese Wall between the folk that promote and research securities?
The Chinese wall is a legal fiction. Analysts are not stupid- they realise bankers set their pay, not the equity investors. Morgan Stanley in the Snap IPO “corrected” an error wiping $5bn of profit off its DCF but “fixed” other numbers to reach the same $28 price target.
The question for analysts (and often managements) is: are they ignorant/negligent, or knowingly deceptive? In this case, the analyst was both - making a basic error, then trying to “correct” it by changing a few other numbers to “solve” for the desired target. Shameful.
There does seem to be an optimism bias for equities analysts. I see in an 2010 McKinsey study that there are only two instances in the last twenty-five years when analysts actually became too bearish.
If analysts are essentially overoptimistic with an natural tendency to make inaccurate forecasts when it is in their company’s best interests, then why does no one call out the elephant in the trading room?
Why does no one correct analyst’s optimism? Because cos. and bankers both want cheerleaders and apologists. Any analyst who says “congratulations on a great quarter” shows this. The other great Q is “how should we think about....” i.e. ask the co. what to tell investors!
How do you decouple the church from the state. How do you create a business culture where analysts are dispassionate about the data?
This is why we founded Arete - to provide independent research. To not have conflicts of interest that cloud thinking, or worse, lead analysts to say one thing when they might believe another. Why are there so few sell notes? They are too busy currying favour!
What can we do to break this down?
First, regulation - in Europe, investors now have to budget/pay directly for research. They won’t pay to get bad IPOs pitched to them. Second, performance - Investors need to find it. Conflicted research hurts it. Great link - Sellside isn’t paid to make money for investors.
Its also interesting how the companies support this - Apple’s earnings calls “pick” the same 7-8 analysts, in same order, to ask Qs of the “how great are you guys” variety. They don’t want deep scrutiny of their operations, or to face challenging Qs.
So on one side, we have regulation that is pushing for independent budget for independent research. On the other side, we have corporate status quo trying to avoid scrutiny and challenging questions.
This is a perennial issue. FINRA clearly states that research analysts are prohibited from participating in a bank’s efforts to solicit investment banking business.
Will regulation ultimately provide the physical and informational “firewall” that is required between Investment Banking and Research departments?
Regulation rarely works as intended when the regulated seek to game the system. The rewards are too great, and penalties borne by shareholders, not managers.
And the companies like a system that allows them to provide de minimis disclosure. AT&T, Google, Apple, AMZN, etc all systematically disclose as little as possible, and do their best to hide what happens, esp in their Treasury depts.
So if companies will not turn the tide and regulation cannot create a firewall between public companies and their research agenda, then investors have to directly budget/pay for research? I guess the goal is to starve the incumbent and conflicted analysts into submission?
welcome to our world! we think there is a clear performance difference btw investors who work with indep research, and those that listen to conflicted and misleading research. This change is being regulated in EU, just not yet in US!
Sound counsel. We may all avoid what Sir John Templeton called the “four most dangerous words in investing: ‘THIS TIME IT’S DIFFERENT.’” :)