Arete Manifesto II
Arete was founded on the principles of independence, exclusivity and insight, taking its name from an ancient Greek word meaning excellence and virtue. When we began in April 2000 – a brief period now seen as a bubble – no one thought to stand aside from the lucrative, all-encompassing hype and instead pledge to tell the truth. Our initial manifesto called for a creative renaissance in equity research, returning to its roots of helping investors make better informed decisions, and unearthing truths hidden or obscured behind the headlines. These principles are finally now widely appreciated, even as the content and reputation of analysts has worsened. Many hold out hope that a difficult market will separate wheat from chaff among analysts, as it has with companies.
False Dichotomies Are Unravelling
Just as we could scarcely imagine 95%+ falls in stocks, nor did we envision analysts' disrepute. Today, the fall from grace of high-flyers is now old news. With the investment banking bias laid bare (even if proprietary trading conflicts have not), we sense an unprecedented, and disheartening cynicism about research. We hope investors will not simply settle for "using research for what it is" even though the glut of banking-led reports finally disappeared along with IPOs. The lifting of corporate pressures has not yet unleashed more cogent writing: analysts may no longer be dragged off to pitch for deals or bullied into buy ratings, but the market is still starved of visionary work and critical views on management, despite share price collapses and record losses. Banks addressed serious questions of integrity by extending backpage, small font disclaimers to assume conflicts are always present. Many of the dichotomies posed to defend the status quo are proving false: European research is no less conflicted than its US equivalent. Banking-led reports are no different from stock calls aimed to please proprietary trading desks. Analysts are no more qualified today after successive cullings of research departments.
Bucking the Trend
When will our profession address its battered prestige? Why do buy ratings still dominate a plummeting market? Why are analysts so reticent to criticise management? Some of this is human nature: happy endings read better than tales of corporate tragedy; buy notes still curry favour with companies. Analysts are still reluctant to criticise management and lack the insights or expertise to offer better solutions. What would they do? Many fear losing access to companies. And it is especially unpopular to be negative on stocks vigorously recommended as good value at far higher prices.
Simple economics prevent many from taking up the gauntlet we threw down. Stockbroking at pennies a share remains a hard way to make money: declining commissions and volumes scarcely offset rising backoffice costs, requirements to commit capital, and narrowing spreads. Research is a cost centre and does little to generate lucrative one-off issuance or underwriting fees. Many banks have no interest to change the primary task of research: to sell banking services: after all, that's where the money is. Analysts, longaccustomed to rating stocks as buys and pitching for deals, may not know any differently. Even with the best intentions, changing how a department of hundreds of analysts works takes more than a few wellpublicised, high-minded memos. Today's "research" sadly comprises recycled rumours, gyrating earnings expectations, and little flair or creative approach to industry trends, issued under disclaimers as long as the research itself. Some practitioners will recast themselves as "independent" in seeking post-redundancy employment, but the learning curve on proper research remains steep in the best of times.
Passion First
Our first manifesto criticised the penchant for hiring MBAs with little passion for, or background in industries they were assigned to cover. In our view, there is only one test for any analyst: would the companies they cover hire them, not as a fawning sycophant, but as someone to help judge the business's assets, constraints, and strategic options. Sadly, we expect most would fail. Depth of knowledge is arguably more important than stock picking, ultimately the fund manager's job. Research requires criticalthinking skills rarely taught in rote-learning MBA courses, writing skills uncommon even in the best journalism, and a disciplined approach to financials.
There is nothing wrong with cheerleading analysts pounding the table on behalf of corporate banking clients: it should simply be called advertising, and tends not to be highly remunerative. Alongside this, we have proven there is an appetite and market for in-depth research, unfettered by hidden or obvious conflicts. Poorer quality product is withering away (or decomposing in the recycling bin) as commissions fall further and banks rationalise. This opens the door for others to follow our example: with IPOs, M&A and banking pitches all gone, analysts can focus on imparting insights to investors, without the need to uncritically parrot company guidance.
We Keep Our Promises
Arete was founded on three simple principles: independence, insight, and exclusivity. We are more than ever committed to them. We have never, nor will we take any money from companies we cover. We will continue in-depth coverage of close to 100 stocks in Europe's technology sector and widen our scope to formally follow the US and Asian companies we have been meeting for years. We will also seek to add coverage of other sectors, beginning with telecoms. With modest aspirations and cost base, we will maintain what has become the largest technology research team in Europe. We are confident it is also the best. Though the economics of our industry are under pressure, we will not change our policy of limiting our client list. Insights and resources are de-valued when spread too widely or thinly. Our clients remain foremost in our thoughts, not one of thousands of institutions "served".
Restoring Trust
There is one issue Arete will speak on publicly: the need for wholly independent research. Trust is essential to a healthy financial market. Endemic conflicts of interest have eroded this trust, and most of the changes proposed to restore it are cosmetic. Conflicts must not be relegated to text in tiny fonts on the back pages. A more honest approach to research – calling it promotional material – is a first step to restoring a market with integrity and economics that reward positive performance. Regulators on both sides of the Atlantic can encourage honest research by supporting its remuneration. One simple step would suffice: mandating transparency in commission structures.Just as we must ensure companies cannot hide behind carefully crafted statements or refuse access to analysts which have the temerity to criticise them, so we should not allow leading banks to mislead the public and tax investment managers to generate banking or proprietary trading income. These changes would surely be unpopular, but are vital to restoring the trust sadly so absent in today's financial markets and essential to any capitalist economy.
