Institutional investors in the U.S. are fundamentally changing their investment process by bringing the analytic function in-house, says new research from Greenwich Associates.

“Whereas in the past institutions relied on sell-side analysts for their expertise in uncovering the intrinsic values of stocks and identifying favourable investment opportunities, buy-side analysts are now appropriating those tasks for themselves,” it suggests. “These buy-side research staffs are looking to their sell-side counterparts for important data and information, custom research, feedback on their own ideas and analysis, and, increasingly, access to meetings with company officials in which institutional analysts can test their own hypotheses against the views of corporate management teams.”

Says Greenwich Associates consultant Jay Bennett. “In many ways, the job of a sell-side analyst is evolving into one that combines traditional hard-core analysis with increasing doses of sales and customer service.”

Greenwich reports that of the US$10.8 billion in U.S. equity brokerage commissions paid by U.S. institutions between Q1 2005 and 2006, 42% — or roughly US$4.5 billion — was allocated as compensation for broker equity research, sales coverage and access to corporate management. “Of that amount, some 60% was directed as compensation for ‘analyst service,’ facilitation of direct access to corporate management and invitations to the research conferences and industry seminars,” says Greenwich Associates consultant John Colon.

These spending patterns represent a major departure from the thinking that dominated institutional investment as little as three or four years ago, the firm points out. As recently as 2003, payments for analyst service, management access and conferences made up less than 44% of research commissions, it notes. In the same year, allocations for individual company or industry studies, thematic investment ideas and specific stock recommendations accounted for 38% of research commissions. Between Q1 2005 and 2006, payments for those products and services fell to 23% — a reduction of some US$700 million over three years, it says.

When asked by Greenwich Associates to define the characteristics that make a great sell-side analyst and to describe the criteria used in selecting the firms they deem their top research providers, U.S. institutions rank the generic “intensity of service” behind only “industry knowledge” and “trust”.

“It is not surprising that buy-side analysts would value the time and industry connections of their sell-side counterparts to such an extent, since the typical buy-side analyst is charged with covering more than 50 companies,” it says.

Bennett explains, “What the typical buy-side analyst needs right now is help: help in covering a portfolio of companies that is often far too large to allow him or her to collect the information needed to conduct a thorough analysis, and is certainly too big for one person to track down and set meetings with senior management of all the relevant companies.”

The challenges facing buy-side analysts have been exacerbated in recent months by the growing popularity of international equity investing, it notes. “The time demands of trying to secure meetings with such a large number of companies almost require buy-side analysts to out-source the function, especially when some of the companies are outside the United States,” says Greenwich Associates consultant John Feng. “Indeed, over the period covered in the Greenwich study, institutional investors paid approximately $1 billion to brokers as payment for their facilitation of access to company management teams.”