Small Cap Research Performance: Perception vs Reality


New York, NY – Over the years, numerous surveys have shown that buy-side investors do not value the ability of their research providers’ recommendations to generate performance, suggesting that they don’t expect much in this regard.  However, a recent survey conducted by Integrity Research as a part of our recently published US Small Cap ResearchFocus report reveals that buy-side investors are notoriously bad at being able to judge if their research providers can generate good returns with their recommendations.

US Small Cap Research – Actual Performance

Integrity Research Associates calculated the returns of the top small US cap research firms it analyzed in a two stage process.  First, the coverage lists of all research providers we evaluated were filtered to extract only the recommendations of the companies that are also included in the Russell 2000 index.  Then, we calculated a weighted average return of all of a providers’ Buy and Sell recommendations. 

If the stock price of the Sell recommendations declined, this would enhance the raw returns; if the stock price increased, it would reduce raw returns.  Our calculation did not take into account Hold recommendations.  This weighted average took into account not only the performance of the Buys and Sells, but also the number of Buy and Sell recommendations a research provider generated during the measurement period.

The table below shows the average weighted returns of small cap Buy and Sell recommendations for the top US small cap specialists and large investment banks over a three-year period from November 1, 2006 to November 1, 2009.  The data used for our performance calculations was provided by research performance measurement provider, Investars.  

As the table shows, there is a wide range in the one-year returns of the small cap Buy and Sell recommendations for the evaluated research firms. The range for one year returns (+102% to 18%) was significantly higher than the three year returns range (+32% to -17%).

Raw Returns of Small Cap Recommendations of Top 25 Small Cap Specialists

(November 2006 to November 2009)

                                   Company 1- Year Returns 3- Year Returns
1 Pacific Crest 55.3% 32.1%
2 Leerink Swann 34.7% 20.0%
3 Thomas Weisel 49.2% 10.3%
4 Piper Jaffray 35.3% 7.3%
5 Deutsche Bank 52.6% 3.0%
6 Collins Stewart 19.9% 0.0%
7 Longbow 37.4% 0.0%
8 Soleil 21.9% 0.0%
9 Barclays Capital 40.7% 0.0%
10 Goldman Sachs 30.3% -0.9%
11 Credit Suisse 37.3% -0.9%
12 Stifel Nicolaus 24.1% -2.3%
13 Wedbush Morgan Securities 31.1% -5.1%
14 KeyBanc Capital Markets 37.3% -5.4%
15 Needham & Company, LLC 35.9% -6.1%
16 UBS 40.0% -7.8%
17 Bernstein 102.1% -8.2%
18 Robert W. Baird & Co. 24.4% -8.9%
19 BB&T Corp 18.8% -11.2%
20 Brean Murray, Carret & Co. 39.2% -11.5%
21 William Blair & Company 37.8% -12.5%
  Russell 2000 13.1% -13.6%
22 RBC Capital Markets 32.1% -13.8%
23 Raymond James 29.6% -14.2%
24 JP Morgan 30.0% -16.9%

Source: Investars

As you can see from the chart above, the top three small cap research providers, based on the three year performance of their Buy and Sell recommendations were Pacific Crest Securities (+32.1%), Leerink Swann (+20.0%), and Thomas Weisel (+10.3%).  Over this same time frame, small cap stocks, as measured by the Russell 2000 index declined 13.6%.  

Only five (5) research providers had positive returns over the three year period which ended on November 1, 2009. During this same period, sixteen (16) providers’ small cap Buy / Sell recommendations generated excess returns when compared to the Russell 2000 Index. 

Average Performance of Top Research Firms vs. Russell 2000

Average Performance 1 Year Returns 3 Year Returns
Regional Investment Banks  31.11% -9.53%
Large Investment Banks 35.60% -7.05%
Top 25 Research Providers 36.75% -2.94%
 Russell 2000 13.1% -13.6%

Source: Investars

The above table shows that for both the one-year and three-year period ended November 1, 2009, the regional investment banks firms underperformed the bulge bracket investment banks by a modest amount. Both groups outperformed the Russell 2000 index over a one and three-year timeframe. 

Perceived Performance

In addition to measuring the actual performance of research providers’ small cap recommendations, Integrity Research also tried to determine how good buy-side investors thought their research providers recommendations were when it came to their performance.  Consequently, we asked the 141 participants in our 2009 US Small Cap Research survey to rate the performance of their top 5 research providers’ recommendations on a scale of 1-5, 1 being highly unsatisfied and 5 highly satisfied.   This enabled us to generate average ratings for each of the 35 US small cap research providers we measured for the perceived performance of their Buy / Sell recommendations.

Perception Gap

You would expect that buy-side investors would be reasonably good at determining how good their research providers’ recommendations are at generating alpha.  However, this is far from true as most clients were atrocious at being able to accurately tell us whose research produced good returns.

The chart below compares the ranks for ratings received from clients for “Perceived Performance” versus the rankings from Investar’s “Actual Performance” discussed previously. A quick glance reveals that for a large majority of the firms listed, there is a significant discrepancy between perceived and actual 3 year performance.

Perceived versus Actual Performance

Research Providers Rankings for Perceived Performance  Rankings for 3- Year Returns 
FBR Capital Markets 1 30
Longbow 1 8
RBC Capital Markets 3 23
Canaccord Genuity 4 n/a
Pacific Crest 5 1
Morgan Stanley 6 n/a
Morgan Keegan 6 26
William Blair 8 21
Oppenheimer 9 15
Goldman Sachs 10 11
Keefe Bruyette & Woods 11 32
Off the Record Research 12 n/a
Barclays 14 6
Citigroup 15 31
Deutsche Bank 16 5
JP Morgan 16 25
Bank of America- Merrill Lynch 16 n/a
Jeffries 19 28
Wedbush Securities 20 13
Stifel Nicholas 21 12
Leerink Swann 22 2
Keybanc Capital Markets 23 14
Raymond James 23 24
Sandler O’Neill 23 33
Piper Jaffray 26 4
Robert Baird 27 18
Needham 28 15
UBS 29 16
Credit Suisse 30 10
Sidoti 31 n/a
Thomas Weisel 32 3
Cowen 33 n/a
Roth Capital 33 n/a
Stephens 35 n/a

Source: Investars and Integrity Research Associates’ 4th Quarter 2009 US Small Cap Buy-Side Survey

For example, the three firms that produced the highest actual performance for their BUY / SELL recommendations over the past three years were Pacific Crest, Leerink Swan, and Thomas Weisel.  However, these three firms did relatively poorly in “Perceived Performance”, with ranks of 5th, 22nd, and 32nd, respectively. 

The top three ranked firms in “Perceived Performance” of their recommendations according to our survey were FBR Capital Markets, Longbow Research, and RBC Capital Markets.  Based on the “Actual Performance” of their small cap recommendations, these three firms ranked 30th, 8th, and 23rd, respectively.

Why Such a Wide Gap?

So, the question you must be asking is why are buy-side investors so bad at being able to determine which of their favorite research providers’ recommendations generates excess returns?  We think there are two reasons. 

First, we suspect that buy-side analysts and portfolio managers are influenced, to a great extent, by the confidence communicated by a research firms’ analysts or institutional salespeople.  Analysts or salespeople who regularly highlight the performance of their winning calls can generate a perception among clients that their recommendations are generally good.

However, we think the primary reason buy-side investors are bad at determining which of their research providers’ recommendations generates healthy returns, is because they don’t really value these recommendations.  It is clear to us that if the performance of research providers’ recommendations really mattered to the buy-side, then they would pay a great deal of attention to them, track them, and be able to accurately assess whose recommendations were good and whose were not.

In fact, this calls to mind a study that was done a few years ago by a firm that tracks research performance.  They measured the performance of all of the Buy / Sell recommendations produced by each of the research firms used by a certain large buy-side institution, and then correlated this data against the amount this firm paid these providers.  The result of this analysis was that the performance of a research provider’s recommendations was NEGATIVELY correlated with the amount of commissions that buy-side institution paid to its brokers and independent research providers.

For more information about Integrity’s 2010 US Small Cap ResearchFocus report, please contact Jim Kempski or Matt Bannister at


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