So you want to be an equity researcher? Think again. Along with being an MD in M&A and a salesperson in FX, equity research is over-rated as a career, So says Brad Hintz, who should know.
“Equity research is a highly visible product demanded by active managers that clients are reluctant to pay for,” says Hintz, the veteran US banking analyst who retired from Wall Street last year and now teaches at New York University.
The fundamental problem is that equity research just isn’t profitable. “The institutional equity trading business has long faced margin challenges,” says Hintz. “It generates, on average a 13.5% pretax margin. Exclude the equity derivatives books, and the margin for the pure execution business is only 9.5%.”
While equity researchers can generate their own bread, they can’t therefore generate their own butter and jam. For this they need the help of equity capital markets (ECM) bankers and others whose businesses are far more profitable. “If a bank has a large enough equity underwriting franchise, the equity business, despite these weak execution margins, can generate reasonable returns due to the profitability and wide margins of IPOs and secondaries,” says Hintz. The research units at Goldman, Morgan Stanley. J.P. Morgan and Bank of America are fine for this reason, he adds. “The profit from ECM can support the returns of their trading businesses. Their segment returns are solid.”
The problem comes when unassuming equity researchers join banks without large ECM market shares. In this case, they’ll find themselves at the bottom of a long food chain, warns Hintz. “When a commission dollar comes in. Sales point out that they entertained the client and thus deserve credit for the commission. Trading point out that their unit did a large block trade to service the client and thus deserve the revenue. And prime brokerage point to the margin loans they originated for the client.”
Matters are being made worse by pressure on banks’ ECM businesses. Rising capital charges are pressuring prime brokerage businesses, says Hintz. At the same time, the US is threatening counter-party exposure limits, which have the potential to constrain the market shares of the largest players.
Although institutional clients want equity research and ECM clients want the research coverage of their IPOs and banks want the branding that comes from research, the upshot is that researchers end up unloved and over-worked, says Hintz. “Bankers are prohibited from pitching research to win mandates,” he says. “Research management is left with a begging bowl, pointing out all the insightful pieces its people have written.”