New York – Last Friday, Integrity Research wrote an article discussing the recent defection of a senior Morgan Stanley analyst, James Valentine. In that article we intimated that the quality of the firm’s research was suffering due to a sharp increase in the coverage ratio (the number of stocks covered per analyst). We are embarrassed to admit that the data used to come to this conclusion was erroneous.
In our prior blog we noted that Morgan Stanley covered 3,269 stocks (a number provided in the firm’s recent Settlement Disclosure Report). This number, however, is significantly higher than the 2,275 stocks Morgan Stanley actually produces research on. Based on the actual number of Morgan Stanley analysts that have primary research coverage, the coverage ratio should have been 8.5 companies covered per analyst with primary coverage rather than the 11 companies per analyst originally reported in Friday’s article.
We also compared Morgan Stanley’s coverage ratio with Merrill Lynch’s ratio of 5 companies per analyst (actually 4.8 companies per analyst). The underlying data for this calculation came from a New York Times article which revealed that Merrill covers 3,600 stocks with 750 “analysts”. Unfortunately, we mistakenly assumed that this data reflected the number of publishing analysts. Actually the Merrill Lynch ratio was based on the number of “total research professionals”. This includes research assistants, research editors, etc. As a result, we were mistakenly comparing apples to oranges. If we calculated Morgan Stanley’s coverage ratio based on the number of total research professionals (analysts with primary coverage and junior analysts), it would actually be 4.5 – slightly lower than the Merrill Lynch total of 4.8.
Lastly, we compared Morgan Stanley’s coverage ratio to the coverage ratio seen at many buy-side institutions. Again, this was incorrect. According to studies conducted by Greenwich Associates, the average number of companies covered by the average buy-side analyst in recent years has ranged from 51 to 54 stocks (considerably larger than Morgan Stanley’s coverage ratio of 8.5 stocks per analyst with primary coverage, and even larger than the coverage ratio of Morgan Stanley’s most prodigious analyst who covers 36 stocks).
So what do we make of the Morgan Stanley defection and the now accurate research coverage data? First, it is clear to us that Morgan Stanley (like many other investment banks) is undergoing significant stresses as a result of the subprime crisis. It is likely that these issues have impacted a wide range of employment decisions across the firm – including in the research department. I am sure this is particularly frustrating to Morgan Stanley’s research management (including Mr. Valentine) given the firm’s recent improvement from #8 to #6 in the Greenwich Associates’ research ranking.
In fact, we have not seen any data to support the notion that the quality of Morgan Stanley’s research has deteriorated, nor that the firm has reduced its commitment to its proprietary research product. Morgan Stanley’s recent introduction of its AlphaWise service, which conducts customized primary research for investment managers, suggests that the firm continues to search for unique and creative ways to provide value to their institutional clients.
However, after evaluating the coverage data, it is clear that the traditional sell-side research model doesn’t scale well – an issue that is a real problem for all investment banks in an environment where profits are squeezed by losses in other parts of the bank and where clients are starting to consider unbundling their sell-side execution and research payments.