Why the sell-side is NOT harder than the buy-side

Stephen Clapham recently wrote a good post on his blog “Behind the Balance Sheet” why he thinks working as an analyst on the sell-side is harder than working on the buy-side. I agree with much of what he says about the requirements to be a good sell-side analyst and why it is a good place to start your career. But as someone who has worked for twenty years on the buy-side and now works on the sell-side, I respectfully disagree with Steve when he says the sell-side is harder. In my experience, being a buy-side analyst is different and, in many ways, harder than being a sell-side analyst. Let me explain why.

Steve argues that being a sell-side analyst is harder than being a buy-side analyst because you have to serve many masters. You have to cover a sector you specialise in, publish research notes, and talk to clients (mostly fund managers and their analysts), work with companies to brief them on investor attitudes, etc. and keep your own sales team happy as they serve their clients.

That is a very diverse portfolio of tasks, and it is why I think that starting your career as a sell-side analyst is a good move because it allows you to find out what you are really passionate about and then progress into that area.

But in his post, Steve mentions only in passing what in my view makes being a buy-side analyst a hard job: the need to create performance.

In my experience, people on the sell-side tend to underestimate the pressure that comes from having a performance track record. I have seen many sell-side analysts move to the buy-side because they thought they had a good track record at picking stocks and then fail to outperform with their recommendations on the buy-side. This is not always the case, obviously. I have also seen many great sell-side analysts become successful on the buy-side, but it is rarer than one thinks. Why?

In my experience, two behavioural factors conspire to create this effect. First, throughout the last 20+ years of my career on the buy-side and the sell-side, I noticed how sell-side analysts are not keeping track of their recommendations properly. That is no surprise. Sell-side analysts are not incentivised by the performance of their recommendations but by the money they create in research meetings, trading revenues or how they support corporate clients in raising capital.

Of course, making good recommendations helps a lot in creating a following among the buy-side and building credibility in the market, but I notice time and again, how sell-side analysts think essentially in terms of ‘hit ratios’. Many sell-side analysts will tell you about the good calls they made where they have been correct in their buy or sell recommendations and they may remember a few of their poor recommendations (we all tend to have a selective case of amnesia when it comes to our recommendations, that is just normal). But the attitude of sell-side analysts to their recommendations is the same as the attitude of husbands to household chores: Taking out the garbage counts as much on the positive side as forgetting your wedding anniversary counts on the negative side. Well, it doesn’t.

On the buy side, your performance track record does not count hit ratios but the impact each hit and miss has on the portfolio. And one really big miss can wipe out the performance of many hits.

Assume you are a sell-side analyst and you have had several stocks on buy. Five of these stocks went on to rally by 10% or more while one of them went into bankruptcy within 12 months of your buy recommendation. Most sell-side analysts will think they have done a good job. After all, the vast majority of their buy recommendations have made their clients money. Meanwhile, if you do the same as a buy-side analyst, you will find out that you have just lost a ton of money because the 100% loss on the one stock will wipe out all the gains from the five stock recommendations that were accurate. And trust me, nobody on the buy-side will thank you for getting five recommendations right if the sixth one was a wipe-out.

This is something that sell-side analysts often don’t realise. If they have made a couple of really bad calls, the buy-side will be increasingly reluctant to talk to them. Because the buy-side will remember your bad calls for a long time. The situation gets worse if you as a sell-side analyst backed a company with a buy rating all the way down to zero. This will tarnish the reputation of a sell-side analyst in the eyes of the buy-side for a long time and they will increasingly avoid meeting you, reading your research or considering your recommendations when there is an IPO or a capital raise. Most buy-side analysts and fund managers will be too polite to tell you personally that hey have lost trust in you, so they will just ghost you, which makes it hard for sell-side analysts to understand why meetings suddenly dry up.

Thinking in hit ratios instead of actual performance is one of the behavioural reasons why being a sell-side analyst is easier than being a buy-side analyst. You have a much easier time compartmentalising your performance and focusing on the good while ignoring the bad. On the buy-side you do not have that luxury. Your bad recommendation counts as much if not more as your good recommendation.

And what makes things worse (and harder) on the buy-side is that your track record never forgets. As humans, we tend to have a fading memory and are subject to recency and primacy effects, i.e. we tend to remember the most recent events and the first events in our career more vividly than the stuff in between. This means that as a sell-side analyst, you tend to have a good time when your recommendations turn out well and a bad time when your recommendations turn out poorly. However, a spell of bad recommendations and poor performance fades into the background quite quickly.

If you work on the buy-side, you don’t have that luxury. Your underperformance in one year will stay with you forever and you will be fighting for years to make up that underperformance. In my career, the year 2013 was my personal annus horribilis. I was heavily invested in gold and underweight equities. Yet, in 2013, the MSCI World equity index was up 27%, while the price of gold dropped 28%. The underperformance of that year haunts me to this day because it is visible in my personal track record. The same goes for every fund manager. As long as you manage your fund, your periods of underperformance will stay with you forever and often you have to work for years to recover from one bad year.

And this is why the buy-side is not easier than the sell-side. It is different. The challenge on the sell-side is to keep many balls in the air at the same time, which can make the job stressful and tough. The challenge on the buy-side is that you have one metric and one metric alone on which you are measured. Make one mistake and you will regret it for a long time.

In my experience, it depends on your psychological make-up if you can handle one job better than the other. Some people cope really well handling many different tasks and selling their ideas but can’t handle the pressure of working in an environment that doesn’t forgive mistakes lightly. Others find it easy to deal with the knowledge that they have made mistakes in the past that still influence their job today but have a hard time multi-tasking and actively dealing with many different clients with competing interests.

PS: There is another dimension that I think is underappreciated by sell-side analysts. If you work on the sell-side, you are dealing with professional investors on the buy-side. These guys tend to be, well, professional. I have spent my years on the buy-side in private banking where your clients are private investors who asked your employer to manage their life savings. I think if you are a fund manager dealing with pension funds and endowments, this might not be the case as much as in private banking, but let me tell you, in private banking, emotions can run quite high.

Because private clients have a lower degree of financial knowledge and because the money you manage for them is their life savings, things can and do get heated when you lose money. The worst that ever happened to me were clients shouting at me non-stop for an hour or two for losing their money (never mind that the market was down overall, and you have outperformed the market). I know many a buy-side analyst in private banking who had chairs thrown at them, who have been pushed against a wall or have been the target of threats of physical violence and possibly ruinous personal lawsuits. If you are not prepared for that kind of pressure, you shouldn’t become an analyst in private banking.