New York – News yesterday that a senior Morgan Stanley Analyst had resigned seems to suggest the strife within the sell-side equity research departments is set to continue. James Valentine, an associate director since December, is leaving at the end of the week. the main complaint from insiders is that they concerned about the quality of research that is being provided, given that they are being asked to cover more stocks than is appropriate.
Indeed, Integrity has estimated that the total stocks covered by Morgan Stanley (as of May 30, 2008) is 3,269. The number of analysts covering those stocks is 282, meaning that the number of stocks per analyst is just north of 11 stocks per analyst. While this does not seem exorbitant, it is more akin to coverage levels at the buy-side shops. According to a recent blog, Merrill’s average stocks per analyst is about 5. One analyst at Morgan current has 36 stocks to cover and there are several other analysts with this level of stock responsibility.
So it seems that outlook for sell-side research is starting to become apparent. Sell-side research models, unsupported by investment banking operations, are over priced for the firms they serve, especially with regard to the current economic burden many of the bulge firms are facing in the sub-prime debacle. The question is where is the industry going to get its informational alpha fixes if the sell side is becoming over-stretched?
In the past year, Morgan Stanley and Merrill Lynch launched primary research products that provide their buy side clients with access to a range of alternative research capabilities. These new offerings have emerged at a time when both banks have been aggressively cutting back on their traditional fundamental research offerings. The decision to launch these services in such a fragile market environment sends a strong signal that primary research is of growing importance to buy side professionals.
According to Integrity’s estimates, the buy side currently spends over a half a billion dollars a year on third-party primary research services. We forecast that the primary research space will grow at a rate of 14% over the next five years, which suggests that overall primary research spending will approach $1 billion in 2012. Morgan and Merrill’s new primary research initiatives are clearly an attempt to capture some of that growth, while simultaneously creating a turnkey offering that will bring more clients under their tent.
Morgan Stanley’s Alphawise service, which was launched earlier this year, leverages several primary research tools several primary research tools and approaches—including independent experts, investigative channel interviews and end-user data—to provide a broad array of primary research services to clients. Merrill Lynch’s Open Minds service, also launched this year, provides consumer market studies to the buy side. Both services are designed on the assumption that the buy side places a high value on customized, proprietary primary research. This is an assumption that is widely corroborated by Integrity’s in-depth studies of the financial research industry, as well as anecdotal evidence from clients and industry contacts.