The Future of Research ( Capital Markets)
Reseach For The Sake of Research
A couple of months back, when me and my like-minded partners — all of us with careers well-baked in traditional institutional research, came together to set up Investory — we knew one thing: Capital Markets were headed for a big change.
The winds of change have been blowing for some years now. The “sell-side Industry” as it traditionally exists was (and is) facing severe headwinds with
· Falling rates of brokerage, i.e., the commission it earns from money managers, i.e., the “buy-side” for executing their trades), and
· Unabated competition, notwithstanding the closure of some broking companies affiliated to large banks.
During this time, “unbundling” and its aftermath has been a topic of intense debate, even though unbundling is still in the realm of discussion for most money managers in most jurisdictions.
Unbundling essentially meant the buy-side splitting commissions incurred into:
a) what can be paid for plain-vanilla execution of trades and
b) the cost that is incurred for third-party research (popularly known as soft dollars).
With this raging debate, the sell-side decided to shift gears to overdrive in an effort to grab a share of the shrinking pie of soft dollars. The buyside in the meanwhile had to do their bit to justify the spend on research. The need to have a transparent pricing structure (almost as detailed as a shopping / phone bill ) was imminent — after all “costs” were being transmitted from those who incurred them, for professional investing, to those who entrusted their savings to these professional hands. Technically (from the buy-side perspective), these costs needed to be determined before-hand; But more often than not these were detailed post a trade. This left a gaping void in truly understanding the value of such third-party research.
This “third party” in question is usually a financial conglomerate ( or rarely a standalone Institutional Broker) whose scope of work is a wide net cast amongst a) advising corporates on various matters (aquisitions, mergers, hive-offs etc) to listing them on exchanges , advising them on secondary offerings etc as an Investment Bank to b) writing research on companies (which could include companies advised by the investment bank,with a Chinese wall in between the two sides), scheduling their management meetings with Fund Managers and then executing trades as an Institutional Broker.
This brings us to the question of inherent interdependence of all parties involved and moots us to question the scope of transparency of any kind — be it the un(?) biasedness of research or rationale for a trade recommendation. This may all be a case of perception but it’s a perception that won’t fade easily. The point is (to quote Tversky) the writing has been on the wall all along…but the question is: was the ink invisible?
Large investment banks with their breadth of research have commanded a large chunk of the overall brokerage pie — leaving limited scope for standalone Institutional Brokers or Independent Analysts. The advent of CSA ( Commission Sharing Agreements which started in the UK and later spread over) was an important step in unbundling . With MIFID II (just over six months away), there is a massive change brewing on the horizon and it is only time, we believe, that it spreads beyond UK & the EU.
When the Fund Management industry creates RPA ( Research Payment Account) it will imply “sell- side “ research to priced for what it is truly worth — for instance what value would you give to a corporate meeting or research where the fund house owns shares of the company or similar companies in the portfolio or what is the price to be paid for a technical analysis maintenance research ,or aggregating just data ? Because ultimately this will be a cost out of the buy-side’s pockets which, now, wont be transferred to the end investor — this will amongst other things truly entail full unbundling.
On the flipside , even during the current state of “partial unbundling” — the sell-side tends to be a zealous research factory, producing large amounts of emails, messages, macro, thematic, quarterly and stock specific reports. The buyside remains under-equipped to handle, assimilate and pick-out the winning ideas from these tomes of information, a lot of which might end up in the electronic bin. But when things truly unbundle there will be a need for depth and quality of research over quantity — to justify payments. While this should dim down a lot of “noise” — it will eventually enable the voice of valuable and unbiased inputs to be heard and be paid for thereby truly creating a level playing field for all.
This brings us to case for Research for the sake of Research. Can a crucial domain that has traditionally been a cost center be a profitable proposition ? Can “star analysts” or focussed specialist stake out on their own ?
The answers is absolutely Yes!
While its certainly hard to predict the time line for a “ global” unbundling some say it might be anytime between a year to 4 years — what is undeniable is that we are at the cusp of a revolution. This is not going to be a smooth sail or even an easy one . Finally — real “insight” and data that is “exclusive” , differentiated, niche and more importantly relevant shall have a chance to command value transparently and importantly, the Buy-Side will have a chance to look beyond look beyond bundled commissions to pay for quality research . Thus leading to the segregation of the proverbial wheat from the chaff — and maybe a new breed of effective communicators, data interpretors and financial analysts completely divorced from the trade flow — shall rise. They could even be cheaper ( as they wont potentially have the same cost framework).
We do see a future where exclusive research platforms ( aggregators , online repositories) , independent — unbiased research houses ( smaller teams or sector specific houses ) or even solo star analysts -can survive.
Its a brave new world out there !