Transparency and bias in the face of disruption

Imagine getting an opinion on the Netflix business model from Blockbuster, or from a firm that worked closely with Blockbuster. Would there be an inherent bias, and would you trust it?

When industry incumbents are rocked by disruption, they fight back. Those who have a vested interest in the status quo will reveal their biases in an effort to fight the future and preserve the past, working to shape public opinion to their advantage.

The battleground we’re reviewing today is the U.K. real estate industry. The particular cast of characters is familiar: Countrywide, the incumbent; Purplebricks, the disruptor, and Jefferies, the investment bank in the middle.

Investment banks and transparency

This article centers on Jefferies, a well-respected investment banking firm that, among other things, provides deep industry knowledge across a number of sectors to investors.

The firm often pops up in media coverage of Purplebricks, the disruptive online estate agency, due to its coverage of the business. Its first detailed analysis of Purplebricks pulls no punches with this opening:

“Whether people buy or sell their homes through Purplebricks, we don't recommend that they buy shares in the company. The numbers in the business model look very attractive, however it is our view that they don’t add up.”

Purplebricks is commonly viewed as the top competitor to Countrywide. Its rise in market share and market cap coincides with the decline at Countrywide (for more, see Traditional vs Tech: How the U.K.’s biggest real estate incumbent is reacting to digital disruption).

When Jefferies is quoted about Purplebricks in the media, it is usually critical, ranging from a blistering attack on Purplebricks’ sales performance and finances to suggesting Purplebricks should be viewed as more of a gamble than a property services firm.

Jefferies also puts out deep analysis notes on particular businesses with recommendations to buy, hold, or sell that business’s stock. Here’s the one that kicked off its coverage of Countrywide in 2013.

Interestingly, Jefferies counts Countrywide, the largest estate agency group in the U.K., as a corporate client; it was named sole broker to Countrywide in June 2013, soon after the firm was refloated by its private equity owners. This fact is never mentioned in any media coverage of Jefferies’ thoughts on Purplebricks, and is contained in the fine print in its reports (page 113 of 117 in the Countrywide report linked above).

This type of conflict of interest is not unique to Jefferies and is well understood (and regulated) in the finance industry. Firms such as Jefferies are legally required to declare any potential conflicts of interest, especially when reports and recommendations are issued for corporate clients.

The potential and reality of bias is well documented across numerous research papers. In “Inside the 'Black Box' of Sell-Side Financial Analysts,” the authors sum up their findings:

“Whereas issuing earnings forecasts and stock recommendations that are well below the consensus increases analysts’ credibility with investing clients, it can also damage analysts’ relationships with managers of the firms they follow.”

And in “Conflict of Interest and the Credibility of Underwriter Analyst Recommendations,” the researchers conclude that:

“ … Stocks that underwriter analysts recommend perform more poorly than “buy” recommendations by unaffiliated brokers prior to, at the time of, and subsequent to the recommendation date. We conclude that the recommendations by underwriter analysts show significant evidence of bias. We show also that the market does not recognize the full extent of this bias.”

Stock recommendations

One way an investment bank or broker provides value to investors is by issuing stock recommendations. These typically come in three flavors: buy, hold, or sell.

The following chart summarizes Jefferies’ stock recommendations in the real estate field for three-and-a-half years between August 2013 and March 2017. The three corporate clients of Jefferies (Countrywide, LSL, and Zoopla) are listed on the left, and three direct competitors of those clients are listed on the right (Rightmove, Foxtons, and Purplebricks). This chart plots the total duration of the recommendations in days. The results are illuminating.

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Jefferies issued twenty separate “buy” recommendations for its corporate clients, spanning over 2,000 days, while issuing none for their direct competitors. It issued five separate “sell / underperform” recommendations that spanned 700 days for direct competitors of its corporate clients.

Meanwhile, the sustained positive stock recommendations for Countrywide and LSL corresponded with massive underperformance (a 71 percent and 52 percent drop in stock price), while the negative stock recommendations for Rightmove and Purplebricks corresponded with a big gain in stock price (60 percent and 88 percent respectively). Investors would have lost a lot of money if they had heeded Jefferies’ advice.

The data, pulled directly from Jefferies and covering 38 data points over that three-and-a-half year period, raises questions about whether Jefferies favors its corporate clients and may indeed be biased in its research.

Jefferies’ recommendations in a wider context

To further understand Jefferies’ position on Countrywide, I’ve added a time-based dimension. The following analysis focuses on a key period between March 2015 and June 2016. It was during this defining 15 months that Countrywide’s prospects slanted noticeably downward while Purplebricks continued to grow and floated on the London Stock Exchange.

The chart below highlights that period of time with the stock recommendations of Jefferies (in red) and seven other investment banks and brokers (in dark blue): Goldman Sachs, Credit Suisse, Panmure Gordon, Numis, Citigroup, Peel Hunt, and Barclays. (The data sourced for these other brokers is from Broker Forecasts and may be incomplete, but tells a clear story).

Countrywide Stock Performance (2013 - 2017)

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During this 15-month period, Jefferies made or reiterated a buy position on Countrywide on five separate occasions.

Citigroup was the only other broker to issue a buy recommendation during this period, but only maintained it for one month. For the other brokers, there were a total of three downgrades and one upgrade (from sell to hold).

While Jefferies maintained a positive outlook on Countrywide during a challenging period, the peer group of investment banks and brokers clearly saw things differently. While seven brokers maintained hold recommendations, Jefferies stands out as the only broker to maintain a positive buy rating during this time -- over 15 critical months.

Why we should care

Everyone has biases. Even Jefferies addresses this in its reports:

“Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have a conflict of interest that could affect the objectivity of this report.”

There’s a reason banking firms are heavily regulated and legally required to highlight potential conflicts of interest: transparency. Whether it’s an investor looking for stock advice, a consumer reading the news, or a homeowner considering options to sell their home, they deserve transparency.

Jefferies is often at the center of debates around Purplebricks, with its detailed analysis and public opinions, and is presented as a knowledgeable and objective source. What my analysis shines a light on is not Jefferies’ knowledge of the real estate space (its analysis is comprehensive), but rather its objectivity.

Objectivity is especially important for new, disruptive business models. When evaluating new businesses, the public deserves to be fully aware of where they get their information from. Even seemingly objective sources may be biased.

Jefferies declined to comment for this article.

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Stock charts courtesy the wonderful Financial Times and stock recommendations pulled from Broker Forecasts. My own personal bias is towards truth and transparency. Neither myself nor any associated entities have any business relationships with any firms mentioned in this article.

I am a senior consultant and principal at AIM Group, and a strategic advisor in the global real estate tech space.