Actuaries on Wall Street: the party’s over...
CAS 2004 Spring Meeting
Actuaries in Non-Traditional Roles
May 18, 2004
Analyst: Todd Bault
212-756-1857
BaultTR@bernstein.com
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Agenda
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What I do (overview of institutional research)
What I think (how to look at companies and stocks)
What I recommend (to keep actuaries relevant)
Warning: don’t tell me anything!
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Seriously, all communication regarding a company needs to be through
Investor Relations (if you work for a mutual, gab away)
If I hear inside information, I am “tainted”
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I cannot speak to anyone (including bosses) until information is disclosed
They often send analysts away to remote places during tainted periods (not so bad—
Bermuda ranks pretty highly)
We can talk all day about the industry and general issues, or anything that I or
a company have publicly disclosed
Credits:
Thanks to Bernstein’s CEO Lisa Shalett for some of the data and perspectives presented here
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Todd R. Bault—quick bio
 Analyst background
• Senior Research Analyst for Sanford C. Bernstein since 1999
• Named #3 non-life insurance analyst in the 2003 Institutional
Investor poll
 Insurance background
• Fellow of the Casualty Actuarial Society (FCAS 1994), Member of
the American Academy of Actuaries and ASTIN
• St. Paul Companies 1988-1998
 Officer—Corporate Development: strategic planning, acquisition analysis
 Corporate Financial Actuary: rate of return analysis, acquisition valuation
 London Reinsurance: pricing, reserving, planning, strategy
• Odyssey Reinsurance: 1998-1999
 Senior Vice President & Chief Actuary
 Brought in by new CEO to help turn around company (then TIG Re)
 Developed new products, structured deals, helped set policy and strategy
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Sanford C. Bernstein

Was one of the last private partnerships (like Goldman)
• And is no more (like Goldman)—bought by Alliance Capital in 2000
• Known for disciplined investment philosophy and rigorous hiring process
• Recently made a case study of the Harvard Business School

Asset management
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•
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For pension funds, mutual funds, private clients
$482 billion assets under management for Alliance in total
Historic value focus (low P/E stocks), complements Alliance growth emphasis
Private clients a Bernstein specialty
Institutional research
• What I do
• Outsourced research for institutional clients (i.e. no retail, or individual investors)
• Bernstein hallmark is detailed, unbiased research
 No investment banking (conflict of interest)
 Analysts from covered industry, not “The Street”
 Consistently ranked #1 overall for research quality and industry knowledge
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Institutional investors
Support
services
Buyside
analysts
Portfolio
manager
Buyside
traders

Institutional investors manage money for others

Centers around the portfolio manager (PM), who makes the investment
decisions
• Mutual funds, pension funds, hedge funds, private clients
• Called the “buyside”, as they buy the stock for their customers (retail investors)
• Buyside analysts provide research and insight to the manager by sector, investment
style, or individual stock
• Traders execute the manager’s trading decisions
• Vast network of support services: IT, admin, legal & compliance, etc.
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Institutional research

Support
services
Buyside
analysts
Portfolio
manager

Buyside
traders
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
Sellside
analysts
& sales
force
Sellside research
Sellside
traders

Support
services
Institutional research is
outsourced buyside
research
Generally viewed as
more in-depth than is
possible on the buyside
Called the “sellside”
because—well, good
question!
All functions are
replicated, with many
relationships between
PMs, analysts, and
traders
Sellside sales force
extremely important in
providing visibility and
relationships for
analysts
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Economics of a broker/dealer
We make money from trades made by institutional investors
• 4 cents a share and falling—compare to 8-30 cents for retail trades
• We can be paid lots of ways
 Directly for specific trades based on recommendations
 Indirectly for overall advice provided (e.g. I pitch insurance, you buy IBM)
 These are soft dollars, currently the subject of some controversy
• What broker/dealers provide for that 4 cents:
 Research and advice—the principal product of a sellside analyst
 Execution—some institutional trades are labor intensive and specialized
 Banking—taking companies public and giving clients access to IPOs
 Capital—commit capital behind clients to provide liquidity
• Bernstein does not do the last two
 Banking is a conflict of interest to research
 Example: most 1998-2000 tech research was secondary to the deals,
and is considered highly suspect by many clients
 Capital commitment enhances banking and other relationships
 We are still paid the full 4 cents—earned with high-quality research
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Deregulation has driven commissions down
$ 0.30
$ 0.25
$ 0.15
$ 0.10
$ 0.05
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
$ 0.00
1980
CPS
$ 0.20
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Sellside analysts
We perform three key functions (the Mahedy list):
• Recommend stocks
 Estimate earnings, set target prices, and make stock recommendations
 Great stock-picking desirable, but not necessary (often leads to being PM)
• Provide detailed research on industries and companies
 Build company models, conduct industry studies, talk to industry players
 Many ways to do this successfully:
 Quantitative/technical approaches that talk about stock behavior
 Qualitative/fundamental approaches about company/industry behavior
 Dig up good company dirt (hedge funds are masters of this)
 Best approach combines all of these to some degree
• Act as “thought partners” for clients
 Perhaps the most valuable service we provide
 In the end, PMs pick stocks, not analysts, so just picking our brains to gain
comfort with their own intuition is extremely important
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What’s important to investors?
 Making money—period
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Investors buy stocks, not companies (sorry, Mr. Buffett)
They buy stocks if they think the price will go up
They sell stocks if they think the price will go down
Stocks that don’t move are bad
 Understanding companies is a means to making money
• If there were another way, they’d use it, and many do (e.g.
technical analysis, quantitative analysis)
• So investors will never care as much about an industry or company
as an analyst
• As a sellside analyst, you are an expert they consult to help them
make money in stocks from your industry
 Not easy—investors are a VERY smart bunch!
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What matters to investors in non-life insurance?
 Pricing, pricing, pricing
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•
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The #1 concern: one could talk about nothing but this and be fine
This despite the fact that pricing can’t easily be measured by investors
Investors buy ahead of price increases, and far ahead of earnings
Supply-focused, as demand is viewed as fairly constant (erroneous?)
 Quality of balance sheet and financials
• Loss reserves a big concern, very hard for outsiders to analyze
 But relationship of reserves and earnings not well understood by some
• Capital adequacy matters for ratings, ability to bear risk
 But the flip side is the dreaded “excess capital” problem
 Qualitative factors (i.e. what actuaries allegedly ignore)
• Insurance is so difficult to analyze that these take on added value
• Quality of management, market share, business profile are examples
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How do investors value insurance companies?
 Discounted cash flow
• Our preferred method: takes into account all economic factors
• A properly managed DCF model serves as a valuation anchor
• But many investors don’t like the complexity or parameter sensitivity
 Price/book
• Best surrogate for DCF, and used with many other financial stocks
• Stocks often trade in a range of P/B, with a premium for future earnings
• Not as useful for comparing companies (capital structure matters)
 Price/earnings
• #1 valuation tool for stocks generally, so it matters
• Mostly understood that P/E less useful for insurance given volatility
• P/E could be more useful if normalized, but then why not use DCF?
 P/E is in fact a very quick and dirty DCF model
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What the insurance industry thinks of stock analysts
Day by Day (The Analyst’s Song)
Day by day,
Week by week,
Quarter by quarter,
Three things we seek:
To keep the top line growin’,
To keep the cash flow flowin’,
Prevent the loss reserves from glowin’
So the analysts will cheer.
Month by month,
Year by year,
They think our business is linear,
Well, we can’t out shrewd ‘em
And we can’t subdue ‘em,
So we’ll smother ‘em with b***s*** and delude ‘em every
Day by day, by day by day, by day by day, by day by day, by day by day, by day!
Words by Mark Hinkley
Sung to the tune “Day by Day” by Stephen Schwartz
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Pressure on Wall Street and analysts has been huge
Spitzer, Global Settlement and
“Dis-honoring” of the
Analyst Profession
2002 / Q1 2003
Bear Market
Hangover
Trading Technology
Onslaught
Institutional
Equities
FSA Elimination
of “Soft Dollars”;
Baker/Oxley MF 2420
NYSE-Specialist
Investigations;
Strategic Turmoil at
NASDAQ
Rising Regulatory Scrutiny
Analyst Disclosures,
Certifications etc.
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Was the scrutiny of analysts deserved?
We consult the wisdom of the ages:
 NO!
 YES!
 A bit! A bit!
Let’s flesh out each of these points a little further…
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Scrutiny of analysts: the case for NO
 The real problem—roles morphed during the “bubble”:
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Corporate CEOs
Portfolio Managers
Research Analysts
Investors
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Rock stars
Magicians
Celebrities
Customers
 Traditional roles gradually returning:
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Corporate CEOs
Portfolio Managers
Research Analysts
Investors
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Managers, resource allocators
Professional investors
Analysts
Shareholders
 The mathematics of research deceptively simple
• Conflicts of interest ≠ Bad (bankers have their uses)
• Independence ≠ Good (Good = Good, surprisingly)
• Wrong ≠ Corrupt (human beings reward/punish a lot of randomness)
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Scrutiny of analysts: the case for YES
 Analysts were at their worst during the “bubble”:
• Analysts helped investors, issuers, proprietary traders, investment bankers, and
the media…
• “Tell stories” about their stock picks…
• Utilizing every communication mode possible (i.e. “marketing”)…
• Employing a plethora of valuation paradigms & ratings systems…
• Based on all kinds of company analysis, including “management guidance”…
• Trying to “win at the polls”
 For this questionable behavior, which still exists, analysts:
• Are paid a fortune…
• Wield extraordinary power, and…
• Cultivate enormous hubris
 Those with the power need and deserve the scrutiny!
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Scrutiny of analysts: the case for “a bit”
 Good research and analysts matter:
• Only 20% of stocks outperform, 50% of said performance in 1 month!
• Good analysis tells investors where to be, what to avoid
• Bernstein hopefully proves that deep knowledge and ethics can pay
 Reasonable regulations enhance trust in the system:
• The “bubble” happened, and people got hurt
• Capitalism can be driven to excesses without supervision
• Face it—lots of money can attract bad & dumb elements
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So you want to be a millionaire…ah, stock analyst?
 Can actuaries do this job?
• I’ll let you know for sure in a couple of years
• Yes, of course—this is a great application of actuarial skills, even
outside of covering the insurance industry
 Should actuaries look at non-insurance options?
• Absolutely—our modeling skills and general risk training are applicable
in any industry, suitably adapted
• Actuaries should also pursue broader roles in insurance companies
 Should actuaries supplement their training (CFA, MBA)?
• Only if you want the credentials—they are not necessary
• But either would probably be well-received by “The Street”
 So, can I be a millionaire as an analyst?
• I’ll let you know for sure in a couple of years
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How to keep actuaries relevant
 Good work only matters if it’s used:
• Actuarial work (and good equity analysis) is complex—it must be
oversimplified for non-experts to use
• If you do this, you will be appreciated beyond belief:
 E.g. My salesforce amplifies my message 50 times, but only if I
create a message they can sell
 They don’t need nuanced reality—they need to get clients to want
to talk to me (I then give them nuanced reality)
• If you don’t do it, someone else will do it—they will be appreciated and
you will be ignored (at best) or resented (at worst)
 I’m afraid it IS all about the money:
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Your job is to help your company make money, not to fit cool models
Your goal: show how fitting cool models makes the company money
If fitting cool models doesn’t do this, figure out what does
By the way, I like fitting cool models, too, and it can pay!
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