Investing is hard work. Little wonder that many principals (e.g., individuals, pension funds, and university endowments) seek guidance from highly-trained agents (e.g., research analysts and strategists) to help them determine how to allocate capital.
However, while relying on expert opinion may provide some psychological comfort to owners of capital, the fact that most of us either choose to ignore or are unaware is that agents’ interests are not necessarily aligned with our own.
This does not mean that agents’ advice is necessarily wrong, only that the motivation for giving that advice may not be tightly coupled with principals’ best interests.
A recent article in the New York Times shines a light on this very issue by investigating the stock calls of an analyst a research shop that prides itself on independence — Longbow. The analyst, Mark Rupe, initiated coverage on three firms, all which are mattress retailers: Mattress Firm (MFRM), Select Comfort (SCSS), and Tempur Sealy (TPX). Rupe initiated Tempur Sealy as a Buy and Mattress Firm and Select Comfort as Holds.
Nothing is unusual about that, so what’s the catch?
The catch is that Rupe picked up coverage on those firms for Longbow immediately after resigning as the head of Tempur Sealy’s Investor Relations department. According to both The Wall Street Journal and the Times, he maintains a holding of stock and options in Tempur Sealy.
Needless to say, Rupe’s advice may be less than perfectly objective when it comes to opinions about the value of Tempur Sealy’s equity.
While this case may be an outlier in the post-“Spitzer Settlement” world, for those of us in the investment business, conflicts of interest between analysts and industry are a matter of fact thanks to a revolving door between the two groups.
For example, when I was covering semiconductors for Morningstar, I found that many of my colleagues from Wall Street firms had worked in the IR or Strategy departments of firms in the industry. Similarly, I was surprised more than once when the voice I had heard asking a company’s managers questions on an earnings call was the same one that greeted me when I called the company’s IR department a few weeks later. “Oh, yes. I made the jump from Morgan to XYZ at the end of last month,” was the unabashed explanation.
Rupe’s case is no different. He began working for Tempur Sealy in 2012, after several years of covering the company for none other than Longbow. Four years later, the door revolved again, and he was back to writing reports for his employer about his former employer.
For those of you with an understanding of of the destructive influence of the lobbyist system on government policy in the US, this sort of revolving door may seem strangely familiar. In my opinion, the revolving door between Wall Street and the board room is no more helpful to investors than the revolving door between K Street and Capitol Hill is to the American polity.
Certainly, industry insiders have certain advantages in the “game” that represents Wall Street’s investment-industrial complex. They know the products and markets very well (so can ask questions on conference calls that serve to demonstrate to institutional investor research clients how savvy they are) and may be on a first-name basis with C-Suite managers of the firms they cover (which helps them schedule in-person meetings on behalf of important institutional investor clients).
And while it may seem as though access to these insiders’ opinions would confer an advantage to investors, more often than not, I find that these insiders 1) have a hard time seeing the forest for the trees and 2) often have unacknowledged motivations for holding a certain view.
The implication for principals is clear. As stewards of investment capital (whether our own, our family’s or our organization’s) our primary job is to consistently make wise decisions about where to invest. To do so requires an understanding of the investment environment and of our own personal biases, a clear and effective framework for assessing value and risk, and the knowledge to skillfully use all the tools available to us to express our investment opinions.
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