The Great Divide: Talking to Lee Cooperman
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Leon G. Cooperman, CFA, is uniquely situated to discuss the gulf between Wall Street’s buy and sell sides. Cooperman has presided as founder and chairman over the hedge fund Omega Advisors, Inc., since he left Goldman Sachs & Company in late 1991. He was a general partner at Goldman for 15 of his 25 years there, and he spent more than two decades as the partner-in-charge of the research department. For nine straight years he won honors as the top portfolio strategist in the Institutional Investor All-America Research Team survey. In 1989, he founded Goldman Sachs Asset Management, serving as its chairman, its chief executive officer, and the chief investment officer of its equity products. He is the former president of the New York Society of Security Analysts, Inc.
Based on your experiences on both the buy side and sell side of the investment services industry, what are the biggest cultural differences between the two camps?
I don’t think there are cultural differences, per se, between buy-side and sell-side research analysts. They are incentivized differently. The sell-side analyst is evaluated based on his or her service to investing clients, trading, and other internal constituents. The buy-side analyst is almost completely evaluated based on his or her contribution to the firm’s profit and loss.
Another important difference is that sell-side research analysts don’t think like portfolio managers. Sell-side analysts don’t think of their coverage as a portfolio with risk and return characteristics. They think of their coverage as simply a list of names, each one evaluated separately rather than in relation to the whole. And they tend to spend much less time on valuation and downside risk than buy-side folks do.
There is a high entrepreneurial, risk-taking spirit on the buy side. Those who do well often want to strike out on their own. Still, a number of sell-side research analysts have been successful in creating hedge funds. In my case, I suspect that the launch of my hedge fund was easier because of my successful career at Goldman Sachs.
Has the buy–sell divide always prevailed?
My experience as a research director, and now as a money manager, certainly reinforces that this divide has existed for a long time. In the last several years, with the significant growth in hedge funds through 2008, it may even have increased as the number of buy-side analysts focused on profit and loss has grown.
Do you think that the Global Research Analyst Settlement of 2003–2004, which separated equity research from investment banking influences, has had a positive or negative long-term impact on the sell side?
Recognizing that there were a few bad apples, I think the Global Research Analyst Settlement has had a negative impact on sell-side research. By its very nature, it limits the ability of the sell-side research analyst to learn the fundamentals of a given company, and it limits the information the analyst can deliver to prospective investors.
What advice would you give to up-and-comers considering transitioning from the sell side to the buy side?
I would advise a young sell-side person who wants to transition to the buy side to work under a seasoned portfolio manager as a research analyst in order to see how a portfolio manager evaluates research and incorporates research into a portfolio. This experience would also demonstrate approaches to risk control.
What do you see as the biggest impact of the current financial crisis on the sell side?
The financial crisis was manufactured on the investment banking side with an assist from government. There were lots of warning signs, from articles in the Wall Street Journal about Fannie Mae and Freddie Mac, to Warren Buffet’s 2003 letter to investors declaring derivatives “financial weapons of mass destruction.” There was broad financial imprudence.
The biggest impact of the crisis on the sell side is that balance-sheet leverage and risk taking will be much diminished. This will reduce return on equity, earnings growth, and the size of sell-side financial institutions. Certainly, sell-side research departments will undergo shrinkage, including less recruiting of young people from colleges and graduate schools.
New product development and product innovation will be constrained, particularly with respect to derivatives. While derivatives are now a dirty word, such products can improve liquidity and market efficiency if they are constructed and used properly. I also expect to see fewer new products from sell-side research departments.
Sell-side research departments built up global coverage over the past decade based to some extent on the notion that geography brought portfolio diversification. But 2008 showed this was not the case. One impact of the current crisis may be less focus on global research and fewer resources devoted to this area.
Finally, the meltdown has badly dented the credibility of research analysts, many of whom didn’t fully understand the implications of the crisis on the economy and corporate profitability.
What impact has the financial crisis had on the buy side of the industry?
Risk aversion among investors is high and this will continue to bring redemptions. Assets under management will decline, the number of money managers will decline, employment by the buy side will decline, leverage will decline; all of this will be transforming for the buy side. Unfortunately, a less profitable buy side will not attract as many of the brightest individuals. With fewer money managers, market efficiency may be reduced and price volatility may stay elevated.
Do you foresee the crisis ending soon or having an extended run?
I think the crisis will have a long-term impact because it will take several years for the consumer and bank sectors to delever. The national savings rate among consumers, currently 5%, needs to increase to at least 7%. Likewise, the banking sector needs to reduce assets relative to equity. This delevering process will yield slow economic growth over the next several years, with broad socioeconomic implications.
How would you solve the current problems?
I would introduce a three-part program to address the toxic assets issue of banks. First, provide low-cost financing to private investors as an incentive to purchase toxic assets. Second, ring-fence private investor losses. Third, make even more substantial modifications to mark-to-market accounting than the Financial Accounting Standards Board accomplished on April 2. Mark-to-market rules have created artificiality. In addition, I would reinstate the uptick rule.
From a more philosophical standpoint, I’d encourage President Obama to move away from his policies of big government and class warfare economics. You don’t create jobs by punishing the job creators. His proposed budget includes hundreds of billions of dollars of business tax increases.
What have you personally learned from the continuing financial crisis?
That I should have been more bearish. I had a benign view. It turned out to be a lot more debilitating than I imagined.
It’s a tough game. You must keep the humility, keep your feet on the ground, and keep going.
If you had your career to do over again, what might you have done differently?
I had a glorious 25-year career at Goldman Sachs. I started Goldman Sachs Asset Management in 1989. At the time, Goldman did not want a hedge fund so I left to start one.
My son Wayne took a different path. He went to the buy side and runs a hedge fund. I would have gone to the buy side first to learn and be exposed to a broader range of companies. Although I had a great career with Goldman Sachs, I think I would have been better off getting an education on the buy side first.
--Lori Pizzani is an independent journalist in Brewster, New York.