When the US leveraged loan crisis hit in August
2007, bullish analysts at the bulge-bracket firms argued a
sell-off in risk assets would be a healthy cyclical correction
to normalize pricing. By early 2008, the financial turmoil had
intensified and predictions of a synchronized global downturn
Economists and strategists then emphasized the
fundamental credit strength of emerging market issuers and
argued economies, such as Russia and the Gulf, with low debt to
GDP ratios and current account support could ride through the
external storm. Even the bears, who argued dire external market
technicals would derail fundamentals, reckoned good relative
value analysis and a flight-to-quality could help ensure the
safety of EM investments.
And then came the Lehman collapse. All emerging
market foreign exchange, credit and equity markets witnessed
catastrophic losses. Second-round effects kicked in instantly,
with collapsing exports, weak consumption and falling growth.
In short, sell-side analysts had failed to predict the biggest
crisis to hit emerging markets since the late 1990s.
I got the market absolutely wrong... I was
unable to translate my bearish views on the developed world to
the developing world, says Roland Nash, chief strategist
at Renaissance Capital, whose research team in the fourth
quarter of 2008 predicted Russia would grow 6% in 2009 compared
with the current IMF forecast of -6.5%.
Clearly I didnt forecast the financial
crisis or the impact on EM trade and markets in the immediate
aftermath of the Lehman collapse, but neither did the buy side
and nor did anyone else, says Kasper Bartholdy, chief
emerging markets strategist at Credit Suisse.
And after the storm came the flood and the massive
resurgence of emerging market risk appetite from March.
Liquidity has poured back into emerging markets with investors
now overweight EM credit and equity at the expense of developed
But again investors accuse sell-side strategists of
failing to predict the shift in market conditions. When
the market came down, the sell side always remained bullish for
far too long, and then when the market came up they remained
behind the curve, says Julian Jacobson, an emerging
markets fixed-income portfolio manager at Fabien Pictet &
While analysts argued emerging market assets were
due for an upswing after massive losses, many argued the rally
was not driven by strategic inflows seeking to normalize asset
prices to long-term fair value. Instead, it was down to market
technicals: oversold positions and cash on the sidelines.
Spread compression for lower-grade credits may not
be sustainable in the short term because of the prolonged
global market distress, they argued so forget about
fundamentals for now and concentrate on relative value and
liquidity risk. For example, JP Morgan was overweight US
high-grade credit and neutral EM credit in March when
the rally in risk assets took off. Although US high-grade
spreads have tightened strongly since, investors say many EM
sell-side analysts have been too negative on the asset class
from the spring.
While investors have been making a lot of
money, not many analysts at the global banks predicted
or wanted to predict the rally, says Edwin
Gutierrez, emerging debt portfolio manager at Aberdeen Asset
Management. The intellectual and psychological torment from
their previously over-optimistic forecasts triggered a
competition to see which bear could growl the loudest, he
It was and it continues to be a
very popular call by sell-side researchers to be as bearish as
Nevertheless, emerging market economists have, to
an extent, been shielded from the blame game, as the burden to
predict the shifts in global credit cycles has fallen to
developed market economists due to the western origins of the
crisis. More generally, mainstream economics has failed to
provide a framework to understand the nature of financial,
economic and psychological linkages in an increasingly
But Peter Twist, CEO of IND-X Securities, a broker
of research distribution agreements between investors and
research outfits, says the buy side has still been
disappointed by the quality of the sell-side reports
since the global crisis began. The reputational damage
has paved the way for the structural growth of independent
research providers, he says.
There is a lot of soul-searching among
analysts about how we collectively got the crisis so wrong as
well as the questionable accuracy of current market
predictions, says Lars Christensen, senior analyst at
For example, Bank of America/Merrill Lynch left it
until mid-August to change their recommendation on Ukraine
five-year CDS to go overweight from underweight.
Credit protection for Ukraine swelled to 8,500bp
over in March after fears the countrys leaders would
renege on conditions imposed by the IMF after its November
bailout. However, as the probability of sovereign default
eased, Ukrainian credit protection as well as cash bonds
staged the biggest rally in EMEA, tightening to 1,400bp
at the time of the banks revision.
One global macro investor slammed the belated
revision. To change their recommendation only after
investors have made massive returns on this trade is hugely
embarrassing for them and in many ways, highlights how
the sell side has been behind the curve before, during
and now after the crisis.
I clearly missed the move, says Benoit
Anne, emerging market debt and FX strategist at Merrill Lynch.
Back in March and April, my macro team was bearish on the
global economy, and I didnt think it made sense to go
long on a risky asset class.
But as the bears growled, sell-side bulls also
charged. From the spring, we have been very bullish on EM
credit and equity, and we came under fire for doing so from
many of our buy-side clients, says Bartholdy.
And while Nash at RenCap failed to warn his clients
about the oncoming in asset prices in the EMEA region last
year, since December he has touted Russian Eurobonds and
blue-chip stocks, which have subsequently staged massive
Barclays Capital has been the most bullish this
year, arguing at the end of March that green shoots of global
economic recovery had arrived and recommending greater EM
While there is plenty of research into the
correlation between investor flows and sell-side analysts
forecasts for developed market stocks and bonds, research into
the emerging market sell side is thin on the ground.
EM research outfits are far from homogenous. Morgan
Stanley is one of the most bearish and, in particular, its
emerging Asia research under Stephen Roach, who has long warned
of the perils of global imbalances and argues Chinas
economic recovery has weak foundations. Meanwhile, the
shops Latin America research team predicted in March that
Brazil would contract 4.5% this year against the TKTK 2.0%
consensus estimate at the time and the IMFs current -1.9%
Investors credit Goldman Sachs for providing
interesting long-term, macroeconomic trend pieces while JP
Morgans emerging markets research, headed by Joyce Chang,
is favoured for its consistent quality.
So where does emerging market research need to
Blaise Antin, head of research for the $1.9 billion
TCW Emerging Market Fixed Income Fund in Los Angeles, says
eastern Europe coverage leaves a lot to be desired. The
sell side did not do a good job at warning about the
accumulating leverage in eastern Europe.
WHY THE WRONG CALLS?
Christensen at Danske, who warned of an economic
crash in eastern Europe as early as autumn 2006, offers one
theory. A lot of the central and eastern Europe analysts
at the global banks tend to be quite junior, due to the small
size of regional economies, and so they have less experience
and feel the pressure to follow the consensus.
Antin says these regional analysts lack the
knowledge or local contacts to capture the legal, political and
market dimensions to opaque debt restructuring in the
Sell-side research often provides a useful
aggregating service, helping to pool primary and secondary data
about a credit or an economy into one document. But, to add
real value, investors demand quality and opinion-orientated
pieces rather than streams of empirical forecasts. Antin is not
alone in calling for more scenario-based pieces as the
world is not black and white. This demand is partly
driven by a shift in investment strategies.
There is unprecedented uncertainty about the
medium-term direction of the world economy, meaning that global
macro management strategies, which rely on predicting systemic
shifts in market conditions, will become more popular,
This contrasts with traditional alternative
investment strategies such as mean-reversion analysis that
target underpriced securities based upon the long-term fair
value of assets a strategy that failed when the crisis
erupted at the end of 2008.
We are now getting our analysts to have
better cross-regional understanding of macroeconomic conditions
so they can make better informed country and sector
recommendations, says Nash at RenCap. My view is
that more than 50% of individual stock performance is driven by
economic and political conditions so, if you get that right,
then the right calls will follow and vice versa.
The sell side is, in theory, well positioned to
offer the broader picture. Analysts at the bulge-bracket firms
can offer unrivalled intelligence, thanks to their army of
international economists and G-7 strategists to provide a
top-down view of developments in the global economy.
Nevertheless, a good credit analyst is also
attentive to credit and economic fundamentals as well as market
technicals, says Matt Ryan, fund manager of more than $3
billion in EM fixed income assets at Boston-based MFS
Investment Management. The credit risk and the liquidity risk
together with macroeconomic factors in sovereign
securities have always been incorporated into emerging market
Emerging market credit has enjoyed a tremendous
bull run since the Asian and Russian crises, thanks to
expanding global output, declining external public debt and
de-dollarization. These factors changed the sensitivity of EM
sovereign spreads with respect to global factors and blinded
both the buy side and sell side to the underlying weakness of
Ryan says a lot of research published by research
shops in the grip of the radical repricing of risk from the
fourth quarter of last year was not realistic from a liquidity
point of view, given the storm of forced selling. As a result,
the sell side needs to beef up their research on market
structure, liquidity and transparency at the micro level, he
Claudia Calich, who manages $1 billion of emerging
markets debt at Invesco in New York, says analysts may now be
stepping up to the challenge. She notes an increase in research
output from desk analysts whose research is not
traditionally published and is primarily used for proprietary
trading to investors via Bloomberg to bypass compliance
But some investors are still not satisfied.
Sell-side research houses at bulge-bracket firms, with their
huge global debt and equity distribution capabilities,
international client base and large proprietary trading
networks, have unrivalled knowledge of the flow of funds.
Jacobson at Fabien Pictet says research houses
refuse to disclose information of real interest to investors
trading volumes of stocks and bonds by geography and
investor type as this would put their own traders at a
competitive disadvantage. In response, sell-side analysts argue
that trading flow information from banks is of limited use, as
they are lagging indicators of market trends, while independent
data providers already offer this information.
The crisis has made investors aware of the
fallibility of all forecasting and may have triggered fund
managers to go it alone, says John Cleary, managing director of
Focus Capital, an emerging market absolute return fund of
But he warns: Fund managers can become dangerously wedded
to a position due to an emotional and investor-time bias.
By contrast, the sell side are, in theory, motivated to be more
objective about their predictions and if they are right,
stand to gain fortune and fame.