Seventy percent of analysts covering Chinese financial stocks rate them a buy, the highest among the world's top 10 markets for such shares. Yet its financials are the worst performing this year in the group, Thomson Reuters StarMine data shows.This particular piece is about coverage of Chinese banks, but many of the same points can be made about sell-side analysis elsewhere.
That disconnect has been on display in recent weeks, with Chinese financial stocks getting hammered on fears about a credit crunch and the country's slowing economy. While the majority of analysts remain positive, mutual funds have dumped shares and short sellers have moved in.
"The sell-side, as is typical, has their blinders on," said Thomas Monaco, a managing director at independent research firm Forensic Asia. He compared China's financial industry to the Titanic. "It has hit the iceberg," said Monaco.
Critics such as fund managers have long said research analysts were too soft on companies.
Analysts worldwide face pressure from investment banking colleagues to go easy on a stock in case that company wants to use the bank for an initial public offering, a merger or a debt deal. Analysts are also reluctant to cut access to a company they cover, something a sell rating can do.
Experts said the recommendation gap for China was wide for other reasons.
One is that big Chinese firms tend to be connected to the ruling Communist Party, and few analysts want to put their institution into an awkward position with the government.
Another reason, cited by industry insiders, is that China's banks and insurers might raise money in the next year to recapitalize, and no bank wants to miss out on what could be huge offerings and big fees.
"Sell-side research is inherently conflicted by nature," said Edward Stockreisser, chairman of the Asian Association of Independent Research Providers.
[T]he pressure to avoid being overly negative remains heavy.
Two industry experts said "hold" ratings in China often become "sell" recommendations in private conversations with clients.
"What's written and what's said are different things a lot of times," said one of the experts, a former fund manager who declined to be identified because he did not want to upset his contacts on the sell side.
There is mounting pressure on broking firms themselves as trading volumes fall and competition mounts.
They also do not want to miss out on potential investment fees should Chinese banks recapitalize under pressure from mounting bad loans or other hits to the business.
"Do you think you will do any business if you are strongly saying sell on ICBC, just to pick a name?" said Rajiv Jain, who manages $41 billion at Vontobel Asset Management and is shunning China banks. He was referring to Industrial and Commercial Bank of China (601398.SS), the world's biggest bank by market value.
Asia's investment industry is also largely dominated by long only funds that do not short shares like a hedge fund.
That makes a sell rating less profitable for a broking firm. Being neutral is also not favored as it doesn't result in trading to help a broking firm earn a commission.