Harry Geels: Help, the number of analysts is decreasing!
Harry Geels: Help, the number of analysts is decreasing!
This column was originally written in Dutch. This is an English translation.
By Harry Geels
The number of analysts has fallen by 30% in the past ten years. The active investment industry is under pressure from passive investing, regulation and AI. This has negative consequences for fundamental 'price discovery', which is already under pressure from other trends, such as the increasing influence of central banks, sustainable investing and industrial politics.
According to a recent article by Bloomberg, there has been a major clean-up among bank analyst departments over the past decade. The number of investment analysts has fallen by 30 per cent and the average salary, with a range of $110,000 to $170,000, has hardly risen since the 2008 credit crisis. In fact, that is a purchasing power decline, taking inflation into account. Citi and Deutsche Bank would have reduced relatively most analysts.
Adjacent, the amount spent on research buybacks has also fallen by 50%, and has done so since 2018, when MifID II was introduced. Asset and fund managers have not been allowed to receive free research from investment banks or brokers since then. They have to pay a market-based price for it. Some of the departed analysts have moved on to other jobs, while others have remained active, for instance through their own firms.
Figure 1: ‘Headcount’ analysts at 15 largest banks in the world
Source: Bloomberg/Vali Analytics
All this is not good news for fundamental price discovery, which has been under pressure from other trends over the last decade anyway.
Three factors can be cited for the decline in the number of analysts. The question is what that decline means for price discovery. Efficient price setting - as part of free markets - is crucial because it ensures the ‘best’ allocation of capital in the economy, as also argued by Professor Albert Menkveld in this interview.
Three causes for the falling number of analysts
The aforementioned Bloomberg article identifies three causes for the falling number of analysts. The main one is the rise of passive investing, which no longer involves fundamental analysts because an index is followed. The role of regulation has already been discussed. Research has to be paid for and as this is happening less, fewer analysts are needed. A consequence of the new legislation is also that smaller parties in particular have less money to buy research. Larger managers are at an advantage here.
Then there is the influence of AI, which initially meant mainly automation but nowadays also provides thinking power. This makes human thinking less necessary. There is currently debate in the financial industry whether this is a good development. Do we let computers make investment decisions entirely? It is not that far yet, because ultimately the models will still be built and monitored by humans. But it is a development we should watch with suspicion.
Reinforcing inefficiency factors
A debate is also currently taking place on whether fewer analysts now leads to less efficient price discovery. Proponents of passive investing, regulation and automation/AI will probably say that market efficiency is not negatively affected by it. However, my contention is that the ‘wisdom of the crowd’ - as a key driver of price discovery - becomes less powerful. The less people think about what financial instruments are worth and how best to trade them, the worse it is for efficient price discovery.
The matter is further complicated by the existence of other trends that are negative for price discovery. In their monetary policy, for instance, central banks have other motivations for buying or selling certain investments, such as steering interest rates. They do not look at the value of a financial instrument. In addition, sustainable investing can also be disruptive. Roughly speaking, perceived sustainable stocks rise, while ‘sin stocks’ fall in value. Finally, the government also has a distorting effect, for instance with subsidies.
Two concluding remarks
The issue of market efficiency is, as mentioned, important for the ‘right’ allocation of wealth across firms and sectors in the economy. As Menkveld also states in the aforementioned interview: ‘If we no longer have the free market mechanism, we miss the “wisdom of the crowd”, or we run the risk of bureaucrats doing the capital allocation. The market mechanism may not always work perfectly, but history has shown that it is better than central capital allocation.'
It is therefore worrying that the number of analysts is decreasing. It probably does not directly affect the efficient pricing of larger stocks. For those, there is still reasonable to good ‘analyst coverage’. For smaller stocks, however, we do see problems arising, with the result that they are increasingly privately traded (and the number of listings is falling). They are valued lower and lower (cheaper) until they are delisted by private equity.
As an aside, opportunities also arise again for investors who do still bother to analyse smaller stocks, as long as they are still there of course.
This article contains a personal opinion of Harry Geels