How do investors form credit opinions and make buy/sell decisions on bonds? Research shows that they are increasingly cutting out the middle man - the investment bank - and trying to go direct to the issuer. By Clive Horwood
In-house research and meetings with management are the most important factors when fund managers form credit opinions. The bad news for investment banks is that the influence of their credit research is declining. One reason for this decline is scepticism about the motives behind sell-side research. One fund manager who used to be a credit analyst at a major investment bank says: "You learn very quickly that there is a hidden agenda. Investment banks are there to sell bonds. No matter how unbiased sell-side analysts try to be, there is constant pressure from the origination side of the business because that is where the money is made."
That is a view shared by many fixed-income investors. There is a growing feeling that investment banks have to sell bonds so they will not tell investors the bad parts of the story. It is not that sell-side research does not add value, but more that its findings should be approached somewhat gingerly.
In-house research
In a changed market environment, fund managers are taking an increasing amount of responsibility for their investments, raising the profile and importance of in-house research. "Post-September 11, no-one wants to rely on external research," says Marino Valensise, head of fixed income at Baring Asset Management.
"In this market, it is hard to know if your opinion is right or wrong. If you make a mistake, you at least want to know it was based on your view rather than someone else's. Of course, we still speak to investment bank analysts but the final decision has to be made in-house," he adds.
Buy-side credit analysts are working much more closely with their in-house equity counterparts. At one major investor, channels of communication have been opened between the two sides so that corporate investment is much more consistent. A bond investor may still be underweight a credit and an equity investor overweight the equivalent stock, but the fund manager will have to justify the reasons for a contrary position.
Sell-side research is not the only area of influence that languishes. As one investor says, annual reports are designed for the population at large and hold little value for a professional investor. Investors want to form their own opinions. Issuers can make a difference. After price, the most important factors in a buy/sell decision are knowledge and understanding of the issuer. One-to-one meetings with corporate management are increasingly regarded as the only place where investors can obtain the sort of information they want. "We need to stare them in the eyes across the table," says a fund manager at a major UK institution.
In the past, it seemed important for high- yield investors to know the chief executive of an issuer but less so for investment grade buyers to know the head of a blue-chip corporate. In recent years, as credit quality deteriorated, such contact began to matter. Now, post-September 11, it matters more and more.
Less access to managers
The trouble is that often the necessary level of access to management is not forthcoming. One fund manager tells how she has to piggy-back off the meetings of her equity analyst colleagues to see chief executives and chief finance officers.
Cost cutting at investment banks is feeding its way into investor relations. One investor complains that many investment banks are trying to cut down on the number of roadshows and one-to-one meetings they arrange for clients and, instead, are relying on much less costly Bloomberg roadshows or webcasts. Investors are resistant to this trend; they still value personal contact with issuers above all else.
Some issuers are beginning to take more notice of their fixed-income investors, realising that bondholders are active investors who need looking after. Investor updates (issuers' non-deal specific briefings to investors) are taking place, at least, even if they are not taking place as frequently as they used to. Sometimes this proactive approach backfires. "Bond investors have never had the luxury of non-deal briefings before," says one investor. "We support and encourage those issuers that make the effort but the trouble is that a lot of 'innocent' updates are seen as pre-deal roadshows and impact bond spreads." The learning process, it seems, needs to be two way.
Clive Horwood is a director of Financial Issues, a specialist research and communications agency for the fixed-income markets. Research for this article was carried out by Kanishk Sharma. E-mail:chorwood@financialissues.co.uk