Normally, brokers issue research reports to express their view on a stock to investment managers and also to investors. Analysts can be on the buy side (affiliated to investment firms) or they can be on the sell-side (affiliated to brokers). While buy side analysts tend to track more stocks with a lesser degree of depth, the sell side analysts are normally industry experts specializing in just one or two sectors.
What Are The Qualities Of A Good Research Report?
It is hard to point at any specific quality but the important point is that it has to be concise without being economical on facts. Here are 8 features that should define a research report.
- The report should have clarity of the core idea. It should be very clear why the analyst has zeroed in on that particular company and what they want to convey.
- Every research must be a combination of facts, data and opinions. All opinions must be backed by hard facts and also embellished by charts and info-graphics.
- Simplicity of delivery is the key to a good report. It must avoid pompous language, long winding phrases and must use simple yet elegant language.
- Presenting the argument clearly calls for understanding and a clear logical bent of mind. The arguments must flow seamlessly towards the conclusion.
- Any research report is supposed to tell a story and hence it should have a narrative structure. It cannot be dull and boring like a typical statistical supplement.
- Reports should ideally be customized according to the reader type. The thrust of the report should be based on whether you are catering to MFs, FIIs, HNIs or retail.
- A self-sufficient summary is a must. This may sound simple but the summary should capture the gist of the report, yet enticing the reader to look inside for details.
- The report should contain clear ratings and action points. Is it underweight, overweight, strong buy, buy, sell or a neutral report? The call to action must be clear.
How to interpret stock ratings by the analyst
Typically, every research report is backed by a view at the top of the front page mentioning whether it is a Buy / Sell / Overweight etc. What do these ratings actually mean?
It means that the analyst expects the price of the stock to fall in the future and strongly recommends investors to sell their holdings in the stock. In addition, the analyst also suggests that high risk investors can take leveraged short positions in the stock.
The analyst expects the price of the stock to fall in the future and recommends investors to sell their holdings of the asset. Here the calls are only for delivery selling but not strong enough to take leveraged short positions.
This is a neutral view. The analyst expects the price of the asset to remain unchanged in the future and recommends investors not to change their existing stance on the stock. A “Hold” means there is no new information to impact the price of the stock.
The analyst expects the price of the stock to rise in the future and recommends investors to increase their holdings of this stock. Here upside expectation is moderate.
The analyst expects the price of the stock to rise sharply in the future and recommends investors to increase their holdings of the asset. It also suggests that aggressive investors can even leverage and take larger long positions.
Overweight and Underweight
In addition, some analysts also tag the stock as Underweight or Overweight. This has reference to the model portfolio of the broking house and whether the allocation should be above or below the recommended benchmark?
Crux of Unfair Trading Practices
It is essential to understand the SEBI approach to unfair trading practices before getting into how analysts are regulated by SEBI. The principal legislations that is relevant in this context is the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulation, 2003 (amended in 2007, 2012 and 2013). These set of regulations prohibit fraudulent, unfair and manipulative trade practices in securities. These regulations have been made in exercise of the powers conferred by section 30 of the SEBI Act, 1992.
Here fraud is defined as inclusive of any act, expression, omission or concealment that is committed to induce another person or his agent to deal in securities. There may or may not be wrongful gain or avoidance of any loss but that is inconsequential in determining if fraud has been committed. Fraud is about wrong intent and hence outcome is immaterial.
Here are examples of such unfair and fraudulent practices
- Wilful misrepresentation of the truth or concealment of material facts to knowingly induce another person to act, to his own detriment
- Suggestion or indirect reference to a fact which is not true, with full knowledge and belief of being untrue
- An active and purposeful concealment of a fact or truth by a person having knowledge or belief of the particular fact
- A promise or assurance made without any intention of performing it just to lure the other party to act on it
- A representation, whether true or false, made in a reckless and careless manner either with or without regard to the possible consequences
SEBI (Research Analyst) Regulations, 2014 (Amended In December 2016)
This is the core act that regulates the functioning of the research analysts putting necessary framework and responsibilities on the analyst. Timely and accurate information about investment products is an important ingredient for making investment decisions. However, due to the volume and complexity of information it would be difficult for an investor to evaluate the information in the right perspective. It is in this context that Research Analysts play an important role. They bring deep insights into sectors and companies, ability to analyze raw data and make forecasts or recommendations about whether to buy, hold or sell securities. This is a relationship of trust and hence the research analyst has a fiduciary responsibility to deliver the best judgement in a transparent and honest manner.
Quite often, such investment advice by research analysts is prone to conflicts of interest that may prevent an independent and unbiased opinion. Since the relationship is a fiduciary one, the prime objective is to protect investors and enhance confidence in the integrity of the market mechanism. That is why it is imperative to identify and deal with conflicts of interest arising from the production and dissemination of research reports.
Principles for Addressing Research Analyst Conflict Of Interest
It is globally accepted that a sound and foolproof regulatory framework is mandatory to ensure impartial reportage. Hence the IOSCO report on addressing conflicts of interest in September 2003 has prescribed certain key principles on which the research analyst report should be based. These are the guiding principles that are applied by SEBI also in the Indian context, with necessary modifications and adjustments to reflect the Indian context.
- There should be a documented mechanisms so that analysts’ trading activities and personal investment exposures or any other financial interests do not prejudice their research and recommendations
- The mechanism must ensure that analysts’ research and recommendations are not influenced by the trading activities or business relationships of the firms that employ them or the business interests that they represent.
- Reporting accountability for research analysts and their compensation structures should be such as to eliminate or substantially limit actual and potential conflicts of interest
- Brokers on the sell side or buy side that employ research analysts must establish written internal procedures or controls to identify and eliminate, or at least transparently disclose actual and potential conflicts of interests
- The framework must also ensure that any undue influence of issuers, institutional investors, promoter groups, brokers, proprietary desks and other outside parties on the analysts should be eliminated or, at least, mitigated
- Disclosures of actual and potential conflicts of interest should be complete, timely, clear, concise, specific and prominent rather than being generic and vague. Also, analysts should be held to high standards of integrity and intellectual honesty.
- Investor education must also play an important role in managing analyst conflicts of interest and the analyst and the investors acting on the advice must be properly educated and enlightened about the risks, apart from the returns.
Mandatory Certification of Research Analysts
SEBI has made it clear that on and from the commencement of the present regulations, no person shall act as a research analyst or research entity or represent as a research analyst without a valid certificate of registration. Here is a quick run-down on analyst certification.
- Any person acting as research analyst or research entity before the commencement of the extant regulations may continue to do so for a period of six months from such commencement or, from the date of application for a certificate of registration within the period of six months, till the disposal of such application
- An investment adviser, rating agency, AMC or fund manager, who issues research report or circulates / distributes research report to public or its director or employee who makes public appearance, shall not be required to seek registration under regulation 3, subject to compliance of Chapter III of these regulations
- An application for grant of certificate of registration shall be made as specified in the First Schedule to these regulations and shall be accompanied by a non-refundable application fee to be paid in the manner specified in Second Schedule
- The Board may call for further information for the purpose of consideration of the application or call the concerned applicant or his / her representative for a personal meeting with an official.
- Any person located outside India engaged in issuance of research report in respect of securities listed or proposed to be listed on an Indian exchange shall enter into an agreement with a research analyst or entity registered under these regulations.
Analyst Qualification and Certification Requirement
Any individual registered as research analyst under the present regulations or individuals employed as research analyst and engaged in the preparation and publication of research report in electronic or print format shall have the following minimum qualifications at all times.
- A professional qualification or post-graduate degree or post graduate diploma in finance, accountancy, business management, commerce, economics, capital market, financial services or markets provided by (a) university which is recognized by University Grants Commission or by any other commission/council/board/body established under an Act of Parliament in India for the purpose; or (b) an institute/association affiliated with such University; or (c) an institute/ association/university established by the central government or state government; or (d) autonomous institute falling under administrative control of Government of India; or
- A professional qualification or post-graduate degree or post graduate diploma which is accredited by AICTE, NAAC or National Board of Accreditation or any other council / board / body set up under an Act of Parliament; or
- Graduate in any discipline with an experience of at least five years in activities relating to financial products or markets or securities or fund or asset or portfolio management.
In addition, individuals registered as research analyst under these regulations, individuals employed as research analyst and partners of a research analyst must have a valid NISM certification for research analysts as specified by the Board or other certification recognized by the Board from time to time.
If the research analyst or entity is already engaged in research analysis and seeking registration under these regulations, they shall ensure that the individuals employed by as research analyst obtains such NISM certification within two years from the date of these regulations.
Fresh NISM certification must be mandatorily obtained before expiry of the validity of the existing certification to ensure continuity in compliance with certification requirements.
Capital Adequacy for Research Analysts
Capital adequacy is more to ensure that the analysts have their skin in the teeth so that they are able to appreciate the entire process from the perspective of the client.
- A research analyst who is an individual or partnership firm shall have net tangible assets of not less than one lakh rupees
- A body corporate or limited liability partnership firm shall have a net worth of not less than twenty five lakh rupees to be certified
- All existing research analysts shall comply with the capital adequacy requirement within one year from the date of commencement of these regulations.
Note: Net worth means the aggregate value of paid up share capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses.
Grant of Certification to Research Analyst, Validity and Renewal
- The Board on being satisfied that the applicant complies with the requirements specified in regulation 6, shall send intimation to the applicant and on receipt of the payment of registration fees as specified in Second Schedule, grant certificate of registration in Form B under First Schedule, subject to such terms and conditions as the Board may deem fit and appropriate.
- The certificate of registration granted under regulation 9 shall be valid till it is suspended or cancelled by the Board
- The research analyst who has already been granted certificate of registration by the Board, prior to the commencement of the Securities and Exchange Board of India (Research Analysts) (Amendment) Regulations, 2016 shall be deemed to have been granted a certificate of registration, subject to payment of extant fees.