Thursday, August 7, 2014

What makes a sell-side investment analyst different than someone who works on the buy-side?

A question frequently asked by students beginning their study of investments is: What makes a sell-side investment analyst different than someone who works on the buy-side?

Basically, the main difference between these two types of investment analysts (buy-side and sell-side) is the type of firm that employs them and the people to whom they make their investment recommendations. 

A sell-side analyst works for an investment firm that manages individual accounts and makes recommendations to the clients of the firm. Sell-side analysts are those who issue the often-heard recommendations of "buy", "outperform", "neutral" , “underperform” or "sell". These recommendations help clients make decisions to buy and/or sell certain stocks. This is beneficial for the brokerage because every time a client makes a decision to trade stock, the brokerage firm gets a commission on the transactions.

This is not to say that sell-side analysts recommend or change their opinion on a stock just to create transactions; however, it is important to realize that these analysts are paid by and ultimately answer to the brokerage or investment firm - and not the clients. Furthermore, the recommendations of a sell-side analyst are called "blanket recommendations" because they're not directed at any one client, but rather at the general mass of the firm's clients. These recommendations are inherently broad and, as a result, they may be inappropriate for certain investment strategies. When you are considering a sell-side recommendation, it's important to determine whether the recommendation suits your individual investment style.

A buy-side analyst usually works for a pension fund, hedge fund or mutual fund company. These individuals perform research and make recommendations to the money managers of the fund that employs them. Buy-side analysts will determine how promising an investment seems and how well it coincides with the fund's investment strategy; they'll base their recommendations on this evidence. These recommendations, made exclusively for the benefit of the fund that pays for them, are not available to anyone outside the fund. If a fund employs a good analyst, it does not want competing funds to have access to the same advice. A buy-side analyst's success or talent is gauged by the number of profitable recommendations he or she makes to the fund.

Do you ever wonder how buy side analysts and portfolio managers generate investment ideas? While a lot of investing ideas come from proprietary research, sell side equity research can play a large role in generating investment ideas for the buy side. This is where the two types of analysts intersect.

When you step back and compare buy side and sell side equity research, the similarities are numerous. Both involve researching and analyzing companies to generate investment recommendations. The only real difference is the end-user of the research. Sell side equity research creates value for the buy side by being the go-to source for detailed and accurate company and industry knowledge, trading ideas, and company management access.

Sell-side equity research makes money indirectly, primarily through commissions generated when the buy side trades through the sell side trading desks. Research at most investment banks is one (very important) part of a three-part team that also includes sales and trading. Basically, sell-side research creates value by generating trading ideas (or arranging tours, industry expert discussion panels, company management meetings, etc.) and sales relays those ideas on the phone to buy side clients and trading talks to their buy side trading counterparts to get the trades that earn the commissions that get the firm paid for the research.

Sell-side research can be different from firm to firm. Many firms have their own specialty or niche and it might mean the difference between loving your job and hating it. For example, some firms are all about getting down to the nitty-gritty details and finding that little nugget of information in the back of an SEC filing that makes a difference in valuation. Alternatively, the company might put on great investor events, bringing in the top experts to share their outlook, or they might provide meetings with hard-to-access management teams, or any other niche that the buy side will find valuable pay for through increased trading.

What are the differences between working on the sell-side for bulge bracket firm versus a boutique shop from an equity research perspective? Bulge bracket shops seem to be more focused on maximizing the number of companies under coverage; while smaller boutique shops tend to dig deeper on specific names, and are more academic, theoretical, and model-focused.

What is the typical day in the life of a sell side equity research analyst? As far as daily routine, when it’s not earnings season, an analyst usually gets into the office about 6 AM and scours the news for any stories that might affect the companies they follow while listening to the morning research call. After that, it’s time to jump into longer-term projects, topical reports or initiation reports.

Throughout the day, there are emails and phone calls and news events that will interrupt the analyst’s work, requiring quick analysis and write-up. You can be on the phone with a client who has a question about a valuation model, or with someone who wants to know the risk factors on a company that the firm covers, or be asked for their take on a recent news event. In addition, when any SEC filings are released or there are company news releases, it may mean a formal note needs to be published and sent out to all clients which means the analyst needs to draft that as well. If this happens after the market closes, it could mean a late night. On a normal day, though, an analyst will leave at about 6 PM.

However, during earnings season (2-3 weeks every 3 months), the hours get longer, usually from 6 AM to 9 PM with some time to catch up over the weekend. Each company reports and holds a conference call, and so the analysts must update their models and write two published notes on each company.

All-in-all, sell-side research is very demanding – and highly rewarding. The AIM program helps prepare students for careers on the buy- and sell-side of the investment industry. To learn more, follow this blog and the AIM web site.