In 2008, a Sell-Side insurance analyst named Alice Schroeder published the authorized biography of Warren Buffett, entitled The Snowball: Warren Buffett and the Business of Life. Like most investing books, I haven’t read it yet, but it has good reviews on Amazon and looks interesting.

I happened to come across an interview that Schroeder did in 2010, and what most struck me was her answer to the interviewer’s question regarding her experience as a Sell-Side analyst.

The quote below is a long one, and I will not comment specifically other than to point out the structural factors that she describes in her narrative:

  1. Standardized models and the emphasis to shift the “brand” from the analyst to the bank.
  2. The effect of the threat of law suits on the research product.
  3. The importance of “elevator research pieces” (love that phrase!) and emphasis on marketing rather than research.
  4. The inexorable pull toward “consensus” opinions.

So what is it like to be an analyst…When I started at [Oppenheimer Funds] it was very free form. Analysts used their judgment. Over time, as I moved through the different firms, especially Morgan Stanley, more and more requirements arose. There were things you had to write every time you published on a company. The financial models became standardized. Like any other business, the more you standardize something, the more you stamp out creativity.

This was more than just compliance. Through this process, big firms like Morgan Stanley were also trying to brand themselves. The firm wanted to be the brand, and discouraged its analysts from doing distinctive enough work to result in them becoming a brand themselves.

You may wonder why analysts at banks hedge themselves so much – on the one hand this, on the other hand that. Partly it can be lack of courage. But someone is always trying to lawsuit-proof your opinion. Decisive statements are lawyered into “may, can, could, might, potentially, appears” instead of “is, does, should, will,” much less “look out below.”

The time pressures that work against quality research are also well-known. You write up a lot of inconsequential things, especially what I call “elevator notes” (this quarter “X was up and Y was down”). Instead of writing original or probing views, you are really incentivized to spend as much time as possible marketing.

Also, if you adhere to consensus, it does protect your career. There’s an old saying that no one ever got fired for buying from IBM. Nobody ever got fired for making a wrong estimate that was within sell-side consensus.

Whereas, if you break from consensus, you really can’t afford to be wrong very often. That phenomenon really drives the sell side. It can be overt, such as when we were judged on how “commercial” our work was. This is a veiled threat, because, of course, our work has to be marketable in order for us to have a job. The firms essentially want two things that are incompatible. They really do want you to do nonconsensus work that’s attention-getting enough to be of interest to clients, but it also has to be right to be commercial, or you are punished. The fear of punishment nearly always beats the desire for reward, so this creates constant pressure to pull in your elbows.

I thought this quote really drew out the essence of many of the structural issues that influence the research coming from investment banks so well – a topic that we discuss in the IOI 101 class on Behavioral Biases and Structural Factors.

The entire interview is long, but worth a read so take a look when you have a few minutes.