A few weeks ago I wrote here that analysts who didn’t own the stocks they recommended were not to be trusted. Today I see that Felix Salmon over at Portfolio has up his own take on the subject, more or less arguing the opposite. I have invited him to have a little debate here.
June 25/2008 — 10:10am
Felix. You argue that analysts shouldn’t own the stocks they cover. I have argued the opposite, so we disagree. Let’s have it out.
The essence of your argument is three-fold:
- Institutional investors ignore analysts’ buy/sell recommendations. It is their analysis that counts.
- Owning or being short the stocks would introduce behavioral biases.
- Analysts can’t pick stocks anyway, so having them own the stocks they cover wouldn’t improve things.
Saying that institutional investors ignore analysts’ buy/sell recommendations is both a broad statement and an untrue one. While some institutions ignore analyst recommendations, many others don’t. Matter of fact, I am familiar with both quantitative and non-quantitative investors for whom analyst recommendations are key factors in their investing. For example, among the best performing factors in some current quant funds’ models is relative changes in consensus recommendations, while the underlying analysis to which you attach so much importance is irrelevant.
It is, in short, untrue and simplistic to say that institutional investors ignore buy/sell recs. There is ample evidence to the contrary, both at quant and non-quant funds.
Second, there is no question that owning stocks would create behavioral biases. But those biases exist anyway via the pegging of one’s reputation to one’s picks. Pretending that you can disassociate yourself from your picks as analyst, whether you own the stock or not, is just not the reality of the business. I speak from painful experience here.
Finally, saying that analysts can’t pick stocks, so we shouldn’t let them own stocks, strikes me as a heady mixture of cynicism and paternalism. We should let them go on publicly pretending they can pick stocks via price targets, earnings recommendations, and buy/sell ratings, but we should all, nudge-nudge wink-wink, ignore those things because we know it’s all a fraud.
The trouble is, first, they do hold themselves out as stockpickers. And since i-banking no longer pays the bills, it is through stock-picking they are paid, it is difficult for me to fathom why you insist they are not stock-pickers. They may be, as a group, poor stock-pickers, but that is a different problem — and one that allowing them to be paid better via owning their picks might help fix.
Over to you, Felix.