Module IV

ROLE
 Buy-side Research Analyst
• Buy-side refers to the investors or firms who works within and advises the
investors or institutional buyers for security and investment selection. These
investors are typically mutual funds, insurance companies, unit trusts, hedge
funds and the pension funds.

• The financial analyst who works for such firms is known as Buy-Side Analyst.
This concept has to be viewed from the perspective of securities exchange
services, and “buy-side” are the buyers of the services. On the other hand, ‘sell-
side’ are the sellers of the services. They are also known as ‘Prime brokers’.

• A buy side analyst is an analyst who works with fund managers in mutual fund
companies, financial advisory firms, and other firms, such as hedge funds, trusts,
and proprietary traders. Recommendations made by buy-side analysts are
confidential and not for public consumption, unlike sell-side equity research. Buy-
side analysts assist the in-house fund managers with stock recommendations.
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 Role of Buy-side Research Analyst
• Buy-side analysts perform financial research on companies, deriving
formulas and strategies that will help the buy side firm earn the highest
possible risk-adjusted return on their capital. Analysts are usually
engaged in reading current news and trends, tracking down valuable
information, and building financial models.

• A buy-side analyst determines how favorable an investment seems and

how well it fits with the fund’s investment strategy. Their
recommendations are based on this research and analysis, and made
available exclusively to the firm that employs them. The success of a buy
side analyst is measured by the quality of their financial
modeling, analysis, and recommendations to the firm.

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 Institutions a Buy Side Analyst works for
• Buy-side firms are investing institutions that purchase securities and other assets
for themselves, as well as for their clients. They employ buy-side analysts
and portfolio managers who work side by side in order to add value to the
business. The following is a list of the types of firms that employ buy side
analysts:

• Mutual Funds

• Pension Funds

• Insurance Companies

• Sovereign Funds

• Endowment Funds

• Hedge Funds

• Private Equity / Venture Capital

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 Skills needed for Buy-side Analyst
• Being a buy-side analyst is about providing research and recommendations of
equity portfolios to fund managers within the firm in order to help them decide
which investments are valuable or risky. Buy-side analysts with higher skill-sets
and greater knowledge often earn higher pay than sell side analysts do. The
following skills are needed:

• Strong intellectual eye for investment opportunities

• Consistently monitors market developments

• Able to create productive, timely, and high-quality reports for investment

decisions

• Able to analyze risks and industry characteristics

• Able to constantly monitor portfolio performance

• Always up to date with global and economic trends

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 Fund Manager
• A fund manager is an investment professional who is appointed by a mutual fund
company or trustee to manage one or more schemes offered by the fund house. This
individual is responsible for managing a fund’s portfolio and taking responsibility for all its
trading activities. They implement the investment strategy of the fund they manage in
order to achieve their investment objective. Given that thousands of investors entrust
this individual with their money, the role of a fund manager gains much importance.

• Typically, a fund manager is a highly experienced professional who has cut their teeth in
research as an analyst. It is, after several years of experience in market
analysis, that an individual may get to manage a scheme on his/her own. Needless to say
that apart from experience, a high level of education can be found as a common trait
among most fund managers.

• Investors should note that a fund may be managed by a single manager, co-managers,
or a team of managers in which each manager is responsible for a section of the
portfolio. A team of managers is usually appointed when the investment strategy of a fund
is complex and/or it invests across a vast region.
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 Role of a Fund Manager
• A fund manager is responsible for implementing a fund's investing strategy and
managing its portfolio. A fund can be managed by one person, by two people as
co-managers, or even by a team of three or more people. For actively managed
mutual funds, the fund manager is basically in charge of stocks, bonds or other
assets the fund will buy with the money given by investors. Essentially, the fund
manager will function as a stock-picker.

• He is responsible to attain returns consistent with the level of risk for the
particular scheme.

• The fund manager monitors market, economic trends and track securities in
order to make informed investment decisions. By functioning as the stock picker,
the fund manager is responsible for making sure that the portfolio is ahead of its
benchmark and peers.

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 Duties of a Fund Manager
a. Meeting the reporting requirements

• Mutual fund managers have to design funds keeping in mind the reporting standards
as per the regulatory guidelines. The building of a fund takes into account the
objectives of the investors, the strategies, risks, expenses and various policies. Fund
managers are responsible for ensuring that the investors are aware and abide by
these details and rules. It is also the responsibility of the fund manager to make sure
that all the documents are furnished on time and following the laws and regulations.

b. Complying with Regulatory Authorities

• The operations of the funds must happen in line with the rules set out by the
governing bodies such as the Securities and Exchange Board of India, and other
relevant authorities. These regulations cover all aspects, starting from signing clients
to handling the redemptions. Fund managers are answerable to legislators and
investors in case of non-compliance.
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 Duties of a Fund Manager
c. The Protection of Wealth
The fund managers have to protect the wealth of investors. It is given that
funds are subject to some risks to generate returns, but they must not be
subjected to reckless risk-assumption. The decision of the fund manager with
regards to the buying or selling of assets will be based on the extensive
research and due diligence. To protect the wealth of the investors, the manager
will, if need be, employ investigations into the company in question, use risk
management techniques to evaluate the investments, and so on. To address
risk, fund managers have to ensure that there is adequate diversification in
asset portfolios.

d. Monitor the growth and performance of the fund

The fund managers will take a call as to where to invest, and these decisions
are governed by regulations, expectations and objectives of the investors. The
fund managers are judged based on how well their funds perform and how
they deliver growth that is above the interest rates and inflation rate. This
justifies the risk they take for investing.
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 Duties of a Fund Manager
e. Oversight and Hiring

With the responsibility of managing funds being extensive, fund

managers have to get assistance from various professionals and even
firms in order to deliver. Specific duties like issuing annual reports,
getting capital, negotiating with brokers, and so on, are outsourced.
This way, the fund managers can transfer some of the regulation
related responsibilities to a third party. But ultimately it is still the fund
manager alone who is responsible for how the funds fare.

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 How To Evaluate A Fund Manager?
After knowing who a fund manager is and what they do, an important
exercise to undertake is learning how to evaluate them. The reason this is
crucial is that, at the end of the day, it is the fund manager who is
responsible for the investment strategy underlying the investment objective
of a fund. Poor planning and execution of that strategy will result in even a
sound investment objective failing an investor.

There are certain aspects in which investors can look at in order to

evaluate a fund manager. Though these aspects are not the be-all and
end-all of fund manager evaluation, they can give great insight into
whether a fund manager is right for you and if they are succeeding at his
mandate.

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 How To Evaluate A Fund Manager?
(A) Track Record:

This measure is common between a fund manager and the fund when it
comes to assessing performance. Though past performance is not a
barometer for the future and no investment should be made solely on the
basis of this, it remains an important component in selecting a consistent
performing fund and manager. Consistent performance over market cycles
indicates experience and expertise to navigate a fund portfolio through
tough times as well as generate superior returns when markets are
climbing.

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 How To Evaluate A Fund Manager?
(B) Investing Style:
Different fund managers would handle the same fund portfolio differently.
This difference is due to their different styles of investment.
In order to achieve the same objective, one fund manager may decide to
invest for the long-term while another may take several short-term
positions in stocks and bonds. While one manager may align the portfolio
in line with the underlying benchmark, another may completely ignore the
benchmark composition and create a portfolio according to their views on
the market. Further, one manager may remain fully invested in the market
nearly all the time while another may decide to liquidate part of the portfolio
and invest it in cash equivalents till such time he finds a suitable
opportunity to invest. These are just three examples of different investment
styles.
Investors can make out the difference in investment styles by looking at
the changes in the portfolio over the period that a fund manager has
managed the fund. They may also enlist the services of an advisor to
better understand investment styles of a fund manager. 13
 How To Evaluate A Fund Manager?
(C) Is The Manager Invested In His Own Managed Fund?
This may seem like a subtle point but is quite important. A fund manager
charges a fee for managing other peoples’ money, but do they invest their
own money in the fund that they manage? If they do, it indicates their
conviction in their own stock picks. After all, if their stock-picking
capabilities are so superior that they can beat market returns and multiply
investors’ money, would they not want to gain from that themselves?

(D) Outperforming The Benchmark Index:

Each fund has a benchmark index that it intends to outperform. If a fund
manager consistently outperforms the benchmark index, then they may be
worth investing with. It is important to consider a manager’s performance
during market declines, though. Because when markets are rising, many
managers may better their benchmarks and it is difficult to differentiate the
outperformance being due to luck or skill. Investors should choose a
skilled manager over one who just got lucky.
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 How do fund managers decide where to invest?
Apart from the comprehensive knowledge on the subject and far-reaching
insights, fund managers gather invaluable insights from their research
team. Some other considerations include:
a. They check for the shifts in the stock market to analyse the volume of
the shifts
b. An analysis of the competition in the industry plays an equally vital
role to gauge the macroeconomic outlook
c. A thorough review of the annual results of the companies that the
fund manager intends to invest in
d. Finally, all the information mentioned above is weighed along with the
experience of the top managers and directors before making investing
decisions
Investing in mutual funds is subject to market risk. Not having the insights
to pick the right fund or fund manager can be a costly affair.

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 Integration of Fund Management Team
Only a very qualified team can effectively implement a fund’s strategy and
produce both financial returns and impact for investors. A typical fund
management team includes three core roles: senior deal team
leader, associate, and analyst. These roles can be expanded or
collapsed as needed; for example, a fund may have multiple analysts or
associates depending on its size and need. While advisors and experts are
usually not considered part of the core fund management team, except for
larger funds, they are regularly involved for specific deals, depending on
their areas of expertise. The responsibilities of the fund manager include
maintaining a roster of experts to consult when needed.
Finding the right fund management professional usually requires Trial and
Error combined with specific aid from investors in a similar position.
Diversity of Skills – The fund management team should have a diversity
of skills. PE investments particularly rely on relationships, which team
members must manage, and require nuanced expertise. The fund
manager must regularly interact with key fund stakeholders, namely
entrepreneurs, the board, and the board’s committees.
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 Responsibility of a Fund Manager

The fund manager is responsible for a fund’s performance and he looks

at optimizing returns, while managing risks for the portfolio. He has to
focus on quantitative parameter such as price-to-earnings ratios, sales,
earnings, dividends and other parameters. He tracks financial results of
the companies in the portfolio and its various metrics. He also decides
which stocks will form part of the scheme and builds a portfolio of assets
to accomplish the aims of the mutual fund.

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 Altman Z-Score

• The Altman Z score, a well-known financial statistic, is used to assess a

company's financial health and predict its likelihood of failing within the

next few years.

• The score, developed by Edward Altman in 1968, uses a single

numerical score derived from the combination of five financial factors to

classify businesses as being either safe, somewhat safe, or in distress.

• Investors use Z-Score to make decision regarding buying or selling

company’s stock based on assessed financial strength.

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 Altman Z-Score

• An Altman Z-score less than 1.1 suggests a company might be headed

for bankruptcy, while a score greater than 2.6 suggests a company is in

solid financial positioning.

• The Altman Z-score, a variation of the traditional z-score in statistics, is

based on five financial ratios that uses profitability, leverage, liquidity,

solvency, and activity to predict whether a company has a high

probability of becoming insolvent.

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 Altman Z-Score

• The Altman’s Z-score formula is written as follows:

​ζ = 6.56A + 3.26B + 6.72C + 1.05D

Where,

• Zeta (​ζ) = Altman Z Score

• A = Net Working Capital / Total Assets

• B = Retained Earnings / Total Assets

• C = EBIT / Total Assets

• D = BV of Equity / Total Assets

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 Altman Z-Score
• Working Capital / Total Assets

The working capital/total assets ratio is a measure of the net liquid assets of the
firm relative to its total capitalization. A firm with consistent operating losses will
often have shrinking current assets in relation to total assets

• Retained Earnings / Total Assets

The ratio measures the cumulative long-term profitability of the company and
implicitly considers the age of the firm. Studies have shown that corporate failures
are much more common in a firm’s earlier years, as many firms that go bankrupt
are relatively young ones that have not yet had the time to build up their cumulative
earnings. Also, it measures leverage of a firm. Companies with a high retained
earnings ratio relative to total assets have financed their assets to a greater extent
through retained earnings rather than debt financing, which may reduce the
likelihood of bankruptcy. 21
 Altman Z-Score

• EBIT / Total Assets

Firms depend on operating efficiently through the earning power of their assets

in order to have long-term viability. Return on total assets appears to be

particularly appropriate for predicting bankruptcies, since it has the highest

weighting in each of the Z-Score models

• BV of Equity / Total Assets

It indicates how much the company’s assets can decline in value before the

liabilities exceed the assets and it becomes insolvent.

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 Altman’s Z-Score and 2008 GFC

In 2007, Altman’s Z-score indicated that the companies’ risks were increasing

significantly. The median Altman Z-score of companies in 2007 was 1.81,

which is very close to the threshold that would indicate a high probability of

bankruptcy. Altman's calculations led him to believe a crisis would occur that

would stem from corporate defaults, but the meltdown, which brought about the

2008 financial crisis, began with mortgage-backed securities (MBS);

however, corporations soon defaulted in 2009 at the second-highest rate in

history.

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