By Morey Stettner
Be skeptical of a firm’s investment research – especially when financial pros claim theirs is the best
In hiring a financial adviser, you want a professional who is smarter and more well-informed about investing than you are. In the vetting process, you’ll hear a variation on the same sales pitch: “We are experts in investment management, thanks in part to our proprietary research.”
Advisers who work for large financial firms may highlight their track record of harnessing the company’s robust research to generate consistent outperformance. The firm’s chief investment officer might oversee a committee of chartered financial analysts (CFAs) who crank out reports on the latest investment opportunities.
Advisers at smaller firms might do their own research or ally with independent research firms to provide market insights and portfolio management. They’ll argue that they have an edge over the giant brokerages because they are more nimble and innovative in spotting the latest trends, and will use technologies such as algorithmic trading to your advantage.
Regardless of the firm’s size, advisers often promote their investment prowess by citing their performance history. They might boast of how they beat a popular index like the S&P 500 SPX over a certain time frame.
All these claims lead you to one critical question: How can you assess the quality of an adviser’s investment research?
“It’s a big challenge,” says Scott D. Stewart, clinical professor of finance and accounting at Cornell SC Johnson College of Business. “Even if you do really good due diligence, the odds of hiring an investment manager who’s good is really hard.”
For starters, scrutinize how the adviser conducts equity research. Ask these questions to get a sense of its depth and reliability:
— What are your research tools and resources? What resources have you found most useful?
— What data or information do you collect? How do you analyze it?
— How do you measure the effectiveness of your research?
— How has your approach to research changed over time? What lessons have you learned?
— To what extent do you harness technology to do your research?
Pay special attention to how they answer the first question. The most reliable research starts with primary sources, Stewart says, such as Form 10-Ks, earning reports and transcripts of a company’s management presentation to investors.
“Research should draw on primary sources, not generalized industry reports that aren’t tactical but just background documents,” Stewart says. “Research should look at the company’s business model: How does it make money – its earnings, margins, growth numbers, management performance?”
To prove that their research differentiates them from competitors, advisers might cite statistics to show market-beating performance. Treat such claims with caution. “Check the benchmarks and time periods they are using,” Stewart sys. “They might choose a one-year time frame when they’ve done well but not three- or five-years when they haven’t.”
Ideally, advisers will level with you about the limits of even the best equity research. They’ll admit that advanced knowledge and number-crunching – and even meeting with a company’s executives and touring its facilities – does not produce a crystal ball that reveals the future.
“Good investment managers tend to have periods of good and bad performance,” Stewart says. “You want to hear them say, ‘In different kinds of market cycles, here’s how we tend to do well and when we might not do as well.'”
Also, beware of bias when scrutinizing research reports. Determine whether or not you’re digesting purely independent information. “Find out if there’s any conflict of interest,” notes Peter Ricchiuti, a finance professor at Tulane University’s Freeman School of Business. “Does the firm [providing the research] cover the stock? Is it one of the firm’s clients? Is the firm afraid to say anything negative about the stock?”
Here’s the most important measure of all when evaluating an adviser’s research: Can you understand it?
There are endless ways to overcomplicate investing by analyzing it through a particular lens. From newfangled screening tools to AI-driven market reports, advisers have ever-evolving tools at their fingertips.
So don’t tread blindly and let an adviser’s enthusiasm overtake your better judgment. As long as you can see a clear benefit to a firm’s research methodology and accept the risks built into it, you’re positioned to make an informed decision about your money.
More: The No. 1 New Year’s resolution isn’t losing weight or exercising – it’s this financial goal, surveys say
Plus: Get familiar with the market’s history. It’ll help you see what’s coming for stocks.
-Morey Stettner
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12-19-24 0438ET
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