As Europe’s big investment banks and brokerages scale back their research efforts, particularly towards small and mid-sized companies, some hedge funds and other specialist players spy an opportunity.
If the major players aren’t ferreting out investment ideas among Europe’s thousands of non blue-chip companies, figuring the effort is too costly and time-consuming at a time of cutbacks and rationalization, other participants see a chance to capitalize on the resultant gap in the market.
The hope? That less analysis and information flow has left the best investment ideas undiscovered, even in an era of data overload via everything from specialist investor websites to social media.
"If it’s shrinking, that research is going to be replaced by independent research firms and hedge funds, which are doing their own deep dive and explicitly investing behind their ideas," said Soren Aandahl, head of research at activist investor Glaucus.
Data underlines the scale of research cutbacks among the big banks.
Four in every 10 European stocks tracked by analysts have seen a drop in coverage over the last two years, twice the number of firms recording a rise, Thomson Reuters figures show.
And calculations by Reuters based on year-end statements show Europe’s 30 largest banks by stock market value cut staff by 80,000 in 2013 alone – not all equity analysts of course but certainly that category was far from immune.
This has led to fewer eyes looking at some of the 9,000 listed companies in Europe, especially those with a smaller market capitalisation.
Some clients have noticed the difference.
"For many of the European mid-cap companies we cover, the breadth, depth and quality of the sell-side research (from banks and brokers) has declined," said Moni Sternbach, head of European mid-cap investing at $6.5 billion hedge fund firm Cheyne Capital.
LUCRATIVE IDEA
Yet finding the right investment idea among overlooked small companies can still prove lucrative, as evidenced by events around Spanish wireless networks provider Gowex, a thinly analyzed company whose shares fell 60 percent after a firm called Gotham City Research issued a detailed report questioning its accounts.
Gowex subsequently filed for bankruptcy.
Gotham City had said in its original report that it stood to benefit from a drop in Gowex shares, presumably by taking a "short" position by borrowing stock it then sold in the expectation of being able to buy it back cheaper.
U.S.-based Gotham may also have been taking advantage of Europe having been hit harder in equity research than other regions, given a steep fall in commissions paid to banks by fund managers and a subsequent focusing by banks on the large companies that are more likely to offer them other business.
That same pressure on resources has also seen the quality of research fall, some fund managers say, with some companies often only covered by a brief note when they release their results.
But there can be risks in being too original.
Even if an investor discovers a great bet, the rest of the market may be too slow to agree.
"Lower coverage means it may take longer for your expected price action to crystallize and hence increase your risks and carrying cost," said Aquico Wen, owner of fund firm Victoire, referring to the cost of having money tied up in a position.
NOTHING NEW
In the case of Alent, a performance materials company that was demerged in 2012 from Cookson, now renamed Vesuvius, activist fund manager GO Investment Partners advised the firm to split, expecting the market to applaud the move, only for the firm’s stock to drift sideways.
"There was no-one to take it up," said Steve Brown, chief executive of GO. "These analysts carry on following Croda or Elementis (other comparable companies) because they’ve done it for the last 40 years, but none would take anything new on."
After finding a hidden gem or dog, funds hope a catalyst such as an analyst earnings revision, an improvement in analyst coverage levels or a change in the business – such as a well-executed business plan or, in the case of Gowex an admission of fraud – will trigger a strong move in the share price.
One winner has been Cheyne Capital, whose stakes in Irish firms UDG Healthcare and DCC surged when the companies relisted in London, drawing more analyst coverage.
DCC Plc is now tracked by 10 analysts, up from just one at the start of last year, and its shares have risen about 40 percent after it moved fully to the London Stock Exchange in May 2013.
UDG has gained 50 percent after a similar move in October 2012 and a five-fold rise in analyst cover in two years.
Cheyne Capital’s Sternbach is one of those convinced that less bank-led equity research means room for those prepared to do the legwork.
"The reduction in sell-side research provides opportunities for active buy-side asset managers," Sternbach said. "Particularly the fundamental bottom-up stock pickers with a focus on meeting management teams and undertaking their own research."
