Title: The Usual Suspects: A Primer on Investment Banks
1The Usual SuspectsA Primer on Investment Banks
Recommendations and Emerging Markets
- Javier Santiso
- Chief Economist and Deputy Director
- OECD Development Centre
Sebastián Nieto Parra Chaire Finances
Internationales Sciences Po Paris
Conference Opening and Innovation on Financial
Emerging Markets Beijing - China ? March 28 2007
http//www.financesinternationales.sciences-po.fr/
2Objective of the paper
I
Overview of the literature
II
Description of the data
III
Investments banks business and research
publications
IV
Emerging markets capital flows and research
publications
V
Conclusions
VI
3Two core questions
- Do recommendations given by investment banks have
an impact on the allocation of portfolio flows in
the emerging markets? - That reveals the influence of analysts
recommendations on investors behaviour. - Above all, do recommendations are related with
the business of investment banks? - Information provided by banks to investors could
be biased depending on their own objective that
sometimes could differ from those of investors.
4Objective of the paper
I
Overview of the literature
II
Description of the data
III
Investments banks business and research
publications
IV
Emerging markets capital flows and research
publications
V
Conclusions
VI
5Investment banks recommendations
- The impact of investments banks recommendations
on capital markets has been concentrated in OECD
countries. - Womack (1996), Jackson (2005), Boni and Womack
(2002), Barber et al (2001), Asquith et al
(2005), - Variety of results
- analysts are confronted by a trade-off between
sending true signals and optimistic signals. - Larger number of buy recommendations than sell
recommendations. - Market reaction to upgrades is less pronounced
than the market reaction to downgrades by
analysts. - Impact of the measures introduced by the NYSE and
NASDAQ, but also the sanctions established by the
SEC in 2002.
6Investment banks recommendations
- Research literature on emerging markets is scarce
and concentrated in the equity market - Seasholes (2000), Bae et al (2005) Accuracy of
local vs foreign forecast analysis. - Bacmann and Bollinger (2001) Boom of the stocks
covered by analysts between 1993 and 2000. - Empirical studies of the relationship between the
recommendations and underwriters are scarce and
concentrated to OECD countries - - Womack and Michaely (1999). Results suggest
that there is a conflict of interest between
investment banking and research department.
7Capital Flows to Emerging Countries
- A large body has studied the determinants of
capital flows - Push factors or global factors literature
First half of the 90s Fernandez-Arias (1996) and
Calvo et al (1993) - Pull and Push factors Taylor and Sarno
(1997), World Bank (2001), Alfaro et al (2005), - Most of the results conclude that local factors
combined with external factors explain capital
flows (FDI, foreign banks lending, bond and
equity flows,). - In addition to pull and push factors, recent
empirical literature has studied the impact of
information and distance on capital flows - Ghosh and Wolf (1999), Savastano (2000),
Papaioannou (2004) and Portes and Rey (2005). - In particular Portes and Rey (2005) develop an
empirical model in which international
information flows are a significant aspect to
explain international equity flows.
8Our research
- By using untapped and rich dataset, the purpose
of this study - First, it is an attempt to analyse the
determinants of the recommendations given by
investment banks in the sovereign emerging bond
market. - Second, it allows to determine the impact of
information on capital flows. For that we take
into account investment banks recommendations as
an additional factor to explain capital flows.
9Objective of the paper
I
Overview of the literature
II
Description of the data
III
Investments banks business and research
publications
IV
Emerging markets capital flows and research
publications
V
Conclusions
VI
10Investment banks recommendations
- Construction of a unique database containing the
recommendations given by the major investment
banks to the Latin American bond markets. - Direct and strict link between financial
intermediaries and investors (not public
information). - First publication that studies the impact that
investment banks recommendations may have on
Latin American Capital Markets. - Period July 1997 - July 2006.
- Frequency Monthly Reports
11Investment banks recommendations
- We have taken the recommendations given by 10
investment banks. All of them important players
in the emerging bond markets.
12Investment banks recommendations
- Main aspects concerning the recommendations given
by investment banks - Composed only by sovereign emerging debt.
- We have classified three types of
recommendations Overweight (1), neutral (0) and
underweight (-1). - These recommendations are assimilated to the
cases of buying, maintaining and selling with
respect to a portfolio (the index EMBI
calculated by JP Morgan) - Given portfolio restrictions a buying
recommendation must be compensated by a selling
advice. -
-
13Investment banks recommendations
- Example Average of the recommendations given to
Brazil by the investment banks with respect to
the weight of Brazil in the EMBI Global index.
14Investment banks recommendations
- We have taken 11 Latin American countries that
represent nearly 95 of the GDP of the region.
The total number of recommendations is over
3,000.
15Objective of the paper
I
Overview of the literature
II
Description of the data
III
Investments banks business and research
publications
IV
Emerging markets capital flows and research
publications
V
Conclusions
VI
16Investment banks business
- Banks are faced with a trade-off concerning
recommendations - While sell side business could have the incentive
to build reputation by giving accurate
information in the long term . - . in the short term recommendations could be
biased in order to obtain short term profits. - Additionally, investment banking activities could
be motivated to recommend optimistically the
assets which they are participating as
underwriters in an IPO.
17Underwriters recommendations
- Recommendations given by banks that have been
underwriters for Latin American sovereign bond
issues. - - 90 of the underwriters recommend to investors
at the announcement date of the issue to buy or
to maintain in their portfolio the bonds issued
by the countries where they are acting as
underwriters.
18Size of the market and recommendations
- Objective of the sell side business to sell
portfolios to a large variety of financial
intermediaries. The percentage invested in these
portfolios increases relative to the size of each
country. -
- High correlation between recommendations and
size of the market too big to underweight - Credit risk is not a relevant variable to
determine the recommendations
19Objective of the paper
I
Overview of the literature
II
Description of the data
III
Investments banks business and research
publications
IV
Emerging markets capital flows and research
publications
V
Conclusions
VI
20Determinants of capital flows
- In order to test the impact of recommendations on
capital flows (Bond flows and Equity flows
respectively), we have used the following two
panel data regressions models - (i)
- (ii)
- where and percentage
allocated by funds in country i with respect to
the total amount invested in emerging economies. - the average of the investment banks
recommendations given to country i . - Pull variables defined by capital
markets (exchange rate, spread of sovereign bonds
and rate of return of equity).
21Determinants of capital flows
- Pull variables that are strongly influenced
by real sector (economic activity, inflation rate
and interest rate). - country invariant variables which capture
global factors (US nominal rates and US
industrial production). - Period of the analyses 1997-2005 for equity
flows - 2002-2006 for bond flows
- Frequency Monthly
- Countries Argentina, Brazil, Chile, Colombia,
Mexico, Peru and Venezuela - OLS and FE estimation. Since OLS estimation are
known to deal inadequately with time series and
cross-section heterogeneity, we reported also
Fixed Effects estimates (FEM estimators).
22Determinants of capital flows
- In order to determine if a Random Effects Model
(REM) was an adequate econometric model for this
analysis we realised the Hausman Test. The null
hypothesis underlying the Hausman Test (FEM and
REM estimators do not differ substantially) was
rejected. - In order to avoid problems of endogeneity between
independent and dependent variables we have also
taken into account the first lag of each of the
explanatory variables in the regressions. In
fact, by taking the lagged explanatory variable
we could solve causality problems which are
common to capital flows analysis. - We present only the results of FE estimators with
lagged explanatory variables (see annex for the
others results)
23Determinants of bond flows
24Determinants of equity flows
25Objective of the paper
I
Overview of the literature
II
Description of the data
III
Investments banks business and research
publications
IV
Emerging markets capital flows and research
publications
V
Conclusions
VI
26Determinants of capital flows
- 3 conclusions concerning the determinants of
capital flows - The impact of investment banks recommendations
on capital flows is positive and significant. - The impact of the recommendations given to
external public debt goes beyond sovereign bond
flows. Indeed, although their influence is minor,
these recommendations also affect private equity
flows. - 3. This new microeconomic variable improves the
fit of capital flows regressions more than some
traditional macroeconomic variables such as
interest rates, economic growth and inflation
rate.
27Business and Investment banks recommendations
- We can not reject the hypothesis that the
information transmitted to investors could be
biased with the purpose to obtain short term
profits and to recommend optimistically the
assets which banks are underwriters in an IPO. - Further research
- The results are preliminary. We have in part
neglected the role of the recommendations in the
sell side long term business. - Indeed, further research must be done concerning
the performance of these recommendations in terms
of investment value and to contrast them with the
underwriting activity.
28Policy Lessons
- There is a need for more detailed information
disclosure by investment banks in order to
determine if past recommendations are related to
macroeconomic variables and financial variables
or whether they are associated with their
business in emerging economies. - Given that banks recommendations and portfolio
flows are related, an international co-operation
must be established in order to encourage
investment banks to cover more countries.
29ANNEXES
30Investment banks recommendations
- An example of the recommendation given by one of
the most important actor in the Latin American
Bond Market.
31Investment banks recommendations
- An example of the weight of some Latin American
countries in the EMBI index (depends on the
amount outstanding of sovereign debt).
32Underwriters recommendations
- 415 underwriters or Lead managers and 215
sovereign issues. Almost 75 of the underwriters
are located in Brazil, Argentina, Colombia and
Mexico.
33Underwriters recommendations Argentinean case
- The Argentinean case is very useful, interesting
and special case - 67 per cent of the recommendations were to
maintain the positions in Argentinean External
Debt (prior 2001) - Some of the comments given by banks months before
the crisis were unrealistic - Morgan Stanley We are maintaining our Market
Perform recommendation on Argentine
bonds.Relaxation of fiscal targets and an
innovative IMF-led financial package from
creditors both improve Argentinas credit
outlook. Argentina needs to raise an estimated
2.6 billion to fulfil its first quarter
financing requirements. New issues are expected
to total 5.6 billion in 2001. Growth and fiscal
performance are becoming the focus of investors
attention. January 26, 2001. - Salomon Smith Barney (Citigroup) The successful
implementation of the IMF support package with
the associated debt management transactions and
the change in the global outlook probably
increases the chances that economic activity will
pick up in the second half of the year. We
therefore recommend a neutral position in
external bonds and local currency instruments.
January 17, 2001
34Underwriters recommendations Argentinean case
Source Nieto Parra (2006) from Bloomberg
35Underwriters recommendations
- Underwriters recommendations vs.
Recommendations given by other investment banks - - 75 of the Lead mangers advice was higher
than or equal to that made by other investment
banks.
36Underwriters recommendations
- Underwriters recommendations vs.
Recommendations given by other investment banks
during the announcement date of the issue of a
bond. - - On average underwriters recommendations are
more favourable than no-underwriters
recommendations
37Underwriters recommendations
- What is the incentive that no-underwriters could
have to give an equal or higher recommendation
than underwriters? - For most of the Latin American countries 90 of
the issues were realised by 10 investment banks
38Underwriters recommendations
- By calculating the HHI we obtained the same
results - Theoretically, this market could be characterised
by an imperfect competitive market in which
underwriters are playing a repeated game. - By taking investment banks recommendations as a
marketing product, it is then advantageous to
investment banks to recommend a country even if
at that period they have not been underwriters.
39Determinants of bond flows
40Determinants of bond flows
41Determinants of bond flows
42Determinants of equity flows
43Determinants of equity flows
44Determinants of equity flows