The drive towards unbundling research budgets from execution services under MiFID II will alter the fund industry landscape, placing greater pressure on smaller asset managers as the research tap – funded by commissions spent by their billion dollar brethren – slowly dries up.
Changes are already afoot as banks use ‘ghosting’ to scale back the volume of research that smaller managers receive. This is because sell-side institutions will be required to disentangle research from trade commissions and as such place greater focus on the value of research being produced. There will be no free lunch. Fund managers, large and small, will need to set their research budgets and allocate appropriately, spending dollars only on those research providers that can demonstrate they are offering good ‘bang for their buck’.
In a panel session hosted by Bloomberg in London on 27thJanuary, entitled “Spotlight on Independent Research”, moderated by Sam Fazeli, Director of Bloomberg Intelligence, the role of the independent research provider under MiFID II was discussed.
Under MiFID II, sellside research analysts will face growing competition for independent research providers as fund managers spread their commissions far and wide to obtain the best value research without fear of being negatively impacted by their favourite broker(s). One of the questions posed to the audience at Bloomberg’s event was: “Do you expect the number of research providers to increase, stay the same, or decrease?
Sixty-nine per cent said that they expect to see an increase in the number of research providers, with 15 per cent expecting to see a decrease. One member of the audience asked about the importance of scale within the industry. Do we need that number to increase they asked. When does the market become inefficient because they are too many players?
Peter Allen is Chairman, European Association of Independent Research Providers. He suggested that going forward, there is likely to be a smaller buy-side and a smaller sell-side industry, meaning that by default this could eventually lead to a smaller pool of independent research providers. Question is, how do you define an independent research provider?
A platform that hires eight or 10 people, or a single independent researcher who might have X number of clients are both, by definition, independent research providers. And as Allen noted, there is a proliferation of individuals in the industry. Asset managers will look to use these one-man bands, just as much as large branded independent research providers, because they help to create value.
Sandy Bragg is CEO of Integrity Research Associates. He pointed out that the industry does not necessarily need 60 or 70 different analysts all looking at Google, for example, and expects to see some consolidation over time. Then again, he added that he had been waiting for this to happen for the last decade. He nevertheless suggested that under MiFID II, there could be an uncomfortable period simply because there is too much oversupply. How that plays out, however, remains to be seen.
In a recent article penned on 29th January 2016 by Timothy P. O’Halloran, co-president of Westminster Research Associates LLC, he wrote: “Any policy regarding the use of commissions should not have the unintended consequence of limiting the production of, or the use of, research. And, any policy should be broad enough and flexible enough to accommodate a dynamic and growing research landscape.”
One member of the audience at Bloomberg’s event raised the point that unless the number of providers decreases, being confident of finding the most appropriate provider for the right price is going to remain a challenge. As they rightly added, in most other areas of regulation, one has to obtain two or three other prices to prove that one is spending the right money, in the right place, at the best price.
In response to this, Nick Anderson, Head of Equity Research, Henderson Global Investors said that there is more price discovery and transparency today than there was three years ago and that more independent research providers are setting benchmarks. Anderson said that research was an input into their decision-making process and that ultimately, they have to work out how best to allocate their time and resources to determining the best inputs.
He went on to say that external research has an enormous part to play because of the economies of scale. Asset managers like Henderson Global Advisors can delve into experts in all areas of the markets; it is near impossible for fund managers to replicate that level of expertise in-house.
One potentially interesting consequence of cost is that those managers who can integrate their approach to selecting the best research providers, with a proven ability to improve a fund’s performance at the best price, into their overall marketing strategy could differentiate themselves from the crowd in future.
Another question polled at the Bloomberg event asked whether there was a risk that the choice of asset managers would increase, stay the same, or decrease.
Some 54 per cent of the audience voted that there would be a decrease, underlining a fear in the industry that smaller managers simply won’t be able to absorb the extra costs of paying for research in a climate where regulatory costs are already becoming punitive.
Another possible unintended consequence of MiFID II regulation is that research coverage of smaller companies (SMEs) might change. Again, when put to an audience vote, 54 per cent felt that research coverage of SMEs would decrease.
The panel pointed out that some research providers who historically provided specialized research on SMEs have drifted, in recent times, to cover larger companies in order to generate the necessary commissions.
Bragg had a slightly more positive outlook on this issue compared to the audience. He said that mid-tier banks are coming under increased pressure and that one of the ways they could adjust their focus is to cover more small-cap companies as well as larger, regional companies. As long as there is demand from the buy-side, research providers will continue with supply.
The research landscape is undoubtedly changing under MiFID II. Opinions are divided on how cost will impact smaller managers, but one thing that needs to happen is for common sense to prevail among regulators. Research, at the end of the day, is one of several inputs that contribute to performance. Managers will still need to be judged on outcomes, not on how effectively they spend their research dollars.