Decision-making in the fund management industry: Empirical evidence from European fund managers, buy-side analysts and sell-side analysts

This thesis responds to calls from prominent academics for research on the so-called investment management ‘black box’ of decision-making practices in capital markets. Motivated by four overarching research objectives, the study examines the following key areas of investment management praxis: (1) the backgrounds, personal traits and investment management proclivities that tend to influence the decision-making practices of portfolio managers, buy-side analysts and sell-side analysts; (2) the utility of intrinsic and relative accounting valuation techniques for pricing equities; (3) the utility of single and multi-factor risk-adjusted finance models for pricing equities; and (4) the utility of sell-side research in buy-side equity decision-making. Adopting a mixed-methods research philosophy, the study conducted in-depth semi-structured interviews with 10 high-ranking European fund managers, and collected 339 completed structured questionnaires from portfolio managers, buy-side analysts and sell-side analysts around the world, to build on the ‘black box’ perspectives provided by Brown et al. (2015), Bradshaw (2011), Ramnath et al. (2008), Brown (1993), Schipper (1991) and Arnold & Moizer (1984). The main findings reveal that capital market participants are: (1) ambivalent to human capital. The interview findings indicate that portfolio managers view gender, experience, age, education and graduate skills to be important workplace attributes that tend to positively influence buy and sell-side investment management practices, but comparatively, for example, the questionnaire findings reveal huge gender disparity exists across buy and sell-side firms even though the evidence reveals females frequently outperform their male counterparts; (2) ambivalent to accounting theory. Investment managers use DCF and P/E techniques as the mainstay of their accounting-based valuation practices, but seldom take advantage of convenient short-cut approaches to intrinsic valuation, such as RIV or AEG; (3) ambivalent to modern finance theory. Investment managers use CAPM a lot, but seldom use CCAPM, ICAPM, APT or other stylised single or multi-factor finance models to price equity stocks; and (4) ambivalent to sell-side equity research. Portfolio managers and buy-side investment managers believe it is currently unfit for purpose, citing sell-side bias and dysfunctional sell-side incentive schemes as the primary attributing factors. Some of the more notable manifestations of their ambivalence towards the sell-side include: (a) ‘binning’ sell-side analysts’ reports with disquieting regularity; (b) distrustful of analysts’ earnings forecasts, stock recommendations and price targets, yet expressing confidence in their periodic earnings updates and revisions; (c) incredulous, per se, towards sell-side ‘industry knowledge’, yet accepting of ‘specialised’ sell-side industry knowledge, (d) wary of Institutional Investor All-Star sell-side status rankings, yet believing innate ability, work experience, education, age and sometimes gender equip some sell-side analysts with a comparative, even star-like, advantage in analysing certain stocks. The findings also identify a need to: (1) redefine theoretical explanations of ‘value premiums’ because apocryphal stories in the accounting and finance literature (Penman, 2011; and Fama and French, 1992/3) about ‘value’ stocks and ‘growth’ stocks can sometimes mislead1 investors; (2) re-assess the value-relevance of theoretical market efficiency (Fama (1970) because the evidence indicates that capital markets are becoming more efficient as new technologies begin to permeate the investment management industry – which in turn has implications for the ‘active’ and ‘passive’ investment management paradigms; (3) recognise the emerging educational importance of big data reduction and computer algorithm skills, lest under-graduate and post-graduate education 1 Arguably, ‘value’ stocks are simply ‘cheap’ or ‘bargain’ stocks. falls out of step with employers’ fast changing needs; and (4) recognise that gender diversity is extremely lacklustre across the investment management industry; and (5) re-assess the value-relevance of conference calls and private communications with company management because some investment managers distrust them, preferring to observe and judge management and/or their communications from a distance.