Sunday, July 09, 2006

Brokers, analysts, advisors, investment bankers, private bankers etc cannot be trusted

Why do brokers provide research service to their clients? Brokers, or analysts (from sell-side brokers), or investment bankers or private bankers for the matter, thrives on activity. Activity is their friend, and is what drives their profits. For every trade that you make, they will take a cut, regardless of whether you are buying or selling.

Now bearing this in mind, does it make sense for research analysts, working for brokerage firms to make a BUY recommendation and do nothing for the next 5 to 10 years? So, in a sense, research analysts from sell-side can only make short-term calls, to generate churning. They may not realize it, they may genuinely want to analyze companies and give their client good advice, but the system is in place for them to generate churning.

In the markets, to make short-term calls is like throwing a coin and then trying to guess whether it is heads or tails. Research estimates that investment professionals are right 40-50% of the time. The best guys are right 60% of the time. Trusting an analyst to make a correct short-term call is as good as trusting a monkey to throw a dart on chart to determine a stock's target price.

Having said that, brokers are good for information and flows, so use them for that. As far as they want to project an image that they are on our side, we must remember that their interests and ours are not aligned. We must be careful not to let them suck away precious returns in the form of transaction costs.

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