An evening last week brought me back to some survival signposts one learns early in a Wall Street career. The occasion was a mixer hosted by a mid-tier investment banking firm within a larger healthcare conference in San Francisco. Most attendees were public or accomplished private biotech CEO’s or CFO’s or from the rarified surrounding ecosystem (high-level bankers, lawyers, investors, journalists, etc.). Strangers shared unsolicited positive experiences about working with our hosts, although two attendees separately commented that the firm seldom landed top-tier clients. Left unsaid, but understood, was that the lesser-tier companies working with this banker contained additional risks.
These comments recalled my early Bear Stearns days and an IPO presentation I had attended for Ek Chor Motorcycles. We were lead manager on what became China’s fourth company to list on the NYSE. I learned that Ek Chor was China’s #1 motorcycle manufacturer excluding the military, that China had eight motorcycles per 1,000 people compared to 270 and 330 respectively for Thailand and Taiwan, and that Ek Chor was owned by CP Pokphand, a Thai conglomerate whose foreign registration number in China was 001, suggesting long-term ties I found reassuring. I rode the stock from $12 to $20.
One day a former San Francisco colleague visited from Bear Stearns New York where he now covered emerging markets on the institutional side. If Ek Chor was exceptional, he mused, then why had Bear Stearns and not Goldman Sachs landed the IPO? Based solely on this observation, we liquidated and watched the stock later fall to $2. Ek Chor had indeed been #1 in China, but only when considering licensed legitimate participants. With nearly all Chinese motorcycle manufacturing occurring on the black market, as it turned out, Ek Chor was in reality tiny and easily crushed by larger players. Presumably this wouldn’t have happened to a Goldman listing.
Anyone surviving beyond Wall Street toddlerhood learns these tells. We may even gauge the quality of food served at a presentation from quality chefs and fine silverware (danger) to steam tables (suspect) to sandwiches or nothing at all (possibly a solid investment). The best Wall Street pro’s see ourselves as working foremost for clients, our job being to promote the best aspects of our firms while shielding you from the worst. At Citi Smith Barney, a client once asked me to handle his company’s large 401(k) plan, and I requested 48 hours to review the landscape to determine whether my firm was competitive (it was). When a firm matches poorly to our clients, we tend to move to a firm with a better mix of strengths and weaknesses. Or in rare instances (like mine), create something from scratch.
We learn early to distrust any large firm’s preset investment portfolio. I once purchased a dull investment-grade bond portfolio as a newbie, only to watch three of the six positions default or nearly default in short order. A veteran bond colleague laughed when I mentioned it, asking why on earth I had trusted our employer. Large firms created prearranged portfolios to unload excess inventory passed over by sophisticated players, and I was just now getting the joke.
Wall Street equity analyst ‘focus’ lists meanwhile occupy a such pinnacle of distrust within our industry that I learned about it in interviews before landing my first financial job. The implicit flaw in ‘focus’ lists is a natural dynamic wherein Investment Banking may want Research to promote issuers notwithstanding securities laws forbidding such practices. While I was never privy to breaches of the wall between Investment Banking and Research, in my personal tracking experience, the focus lists for Bear Stearns, Hambrecht & Quist (‘H&Q’), and Citi Smith Barney performed poorly without exception.
Things got interesting, however, when I left Bear Stearns for H&Q accompanying a team of smart senior professionals. A few months later in November, one of these veterans read a published piece wherein any H&Q analyst could pick one or two stocks as having catalysts making them likely 12-month winners. This was informal and solely for bragging rights, not the H&Q focus list, but my boss crunched numbers to find that the previous year’s informal list had appreciated 158%.
Noticing that the Dow, S&P 500, and NASDAQ had risen approximately 30%, 40%, and 50% respectively during this period, he astutely asked Research for the previous year-end informal published list so that he could compare returns in a poorer market environment. During a stretch when the three major indices had each declined, the previous informal focus list had gained 25%. We were encouraged, recommending equal weightings in a basket of the current twelve stocks. We freely joked to clients about having no idea what these companies did, but all could be had for an end-of-the-year bargain basement special price of $39.99!
Our basket rocketed. So much so, in fact, that H&Q’s 500 employees all learned of it. Everyone wanted in. I found myself explaining it to an H&Q managing director in Boston who had cold called me for details. Breaking calendar precedent, H&Q issued another informal analyst favorites list in July to satisfy internal demand for unfettered and promising investment ideas. I worked in a trading room encompassing an entire floor of a skyscraper and watched as pretty much everyone stopped for an hour to take notes while July’s new 33-stock list and bullet-point rationales for each were read slowly and then repeated over the firm’s intercom.
Shortly thereafter, I stopped in to visit H&Q’s five-person Corporate Services team assigned to develop relationships with CEO’s and CFO’s of companies where H&Q had not established private client ties. H&Q hoped to shoehorn investment bankers into timely opportunities. If an organ transplant biotech company announced $30 million raised for a new research facility in Boston, as an example, the Corporate Services people might place an ingratiating call to a competing company’s CFO within minutes or less with the intel, if our private client people did not already have a relationship.
This Corporate Services team had discussed the informal analyst pick lists of favorite stocks, thinking the CEO’s and CFO’s of the roughly 1,000 targeted companies might be especially interested to learn about it. My visit happened to coincide with a call from H&Q’s head of Research expressing his reaction on speakerphone to the team. He strongly vetoed the idea of divulging the existence of these lists, using vocabulary not suitable for this writing.
Interestingly, when I later ran 50,000 Monte Carlo simulations on the track records of nearly 4,000 analysts at several hundred firms and identified approximately 2% as having a 75% chance or better of being ‘above average,’ none from H&Q made this cut. That surprised me, as I had spent time with each of at least 30 H&Q analysts and would have put money on any of them. There is value, however, in access to industry experts when you can glean their thinking prior to digestion through the Wall Street information food chain.
As a postscript, a fixed income colleague some years later at Citi Smith Barney brought me into a relationship to provide equity coverage for his hedge fund client who had an institutional background, and this client wanted only one thing from me: access to lunches when various of our analysts came to town. It didn’t so much matter who, only that he got a seat at the table.