After a couple of minor roles in the City, I wound up at Goldman Sachs in their ultra high net wealth private client division. As is usually the case as a junior you are keen to make a good impression and find promising investments to pitch. The problem was I was rather independent minded and preferred to come up with my own ideas…. which were rejected. I was told my idea would always be rejected if it wasn’t on ‘the recommended buy list’ and I hadn’t “checked the idea with the analyst upstairs” personally. Who were these gurus upstairs, and why did their opinion matter so much? Could they really hold the secret to infinite wealth? As I was soon to find out, in the most painful way possible, their opinion was worth diddly-squat.

Understanding analyst incentives

If you are a novice you might not be sure how the City pumps out its stock ideas. Here’s how the game works. The City is split into the “buy-side” (fund managers who run the assets) and the “sell-side” (brokers who place their trades). The sell-side is always trying to pick up commission by encouraging the buy-side to trade. So their research departments write flashy research reports and their sales teams get on the phone.

If you’ve ever been given a flower by a Hare-Krishna on the street ‘for nothing’ you’ll know how this works. Whenever we receive a gift, we feel obliged to give something back in return. It’s a well-worn Jedi mind trick. So fund managers often send their trades (and pay commission) to the brokers who have most influenced their thinking.

But investment bank research departments don’t just cater for their brokerage clients, they have historically had their arms twisted by the suits further upstairs - the corporate financiers. These are the slick guys who do corporate mergers & acquisitions and raise the equity and debt capital to fund them. They really don’t want any negative research published about their clients, and they’re a bit like the Men in Black…. so most research analysts don’t dare mess.

If you consider these skewed incentives it’s hardly surprising that most sell-side research is rather biased. It’s either written as a great pitch (to encourage trading) or given a positive spin (to not upset a corporate client). Now I know a lot of people will object to the above comments (as research departments are generally more independent these…

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