Edison, in conjunction with Bloomberg Intelligence and Frost Consulting, has issued an update to the January 2014 white paper, The Future of Equity Research, following publication of the MIFID II delegated act and other regulatory and equity research industry developments over the past two years.
The paper finds that regulatory change has had a significant impact in the shaping of the equity research ecosystem and predicts a contraction in sell-side coverage and support and a more concentrated buy-side.
Asset managers have already started to fund external research from their own P&L or through research payment accounts with clear audit trails; this is expected to continue under the new regime. Managers will also be required to establish the monetary value of a research product or service where previously payments would have been made through the buy-side broker voting system.
If payments for investment research are more distanced from dealing commissions, competition for research may increase as asset managers look beyond traditional sources, which may trigger market fragmentation. There is also the possibility they could move research in-house or increase the size of their internal research groups.
With the same number of companies vying for a smaller buy-side with less sell-side, IROs and corporate management teams may wish to consider the following:
- Review budgets allocated to investment research activities as what was once perceived to be free is moving into a priced model and activity will need to be either supported by more in-house resources or using third-party service providers.
- Make it easier for both the sell-side and the buy-side to follow a company, which includes a review of websites, presentation materials, producing regular KPIs and introducing a downloadable model.
- IROs to allocate more of their time to the strategic targeting of investors as a concentrated buy-side presents a greater challenge in developing a diversified shareholder register outside of the traditional institutional fund manager route, particularly in private wealth assets.
Plans to separate research from execution spending could also cause banks to streamline their research offerings. Larger banks, which can cross-subsidise research and offer a wider range of ancillary services, may thrive in a more competitive market, along with established smaller providers. Those in the middle, however, may be more at risk, though they could see an opportunity in providing research on small or mid-sized companies that may receive less attention from larger competitors.
The price and underlying value of investment research will be subject to closer scrutiny and asset managers may become more selective about what they buy, choosing tailored coverage instead of paying a lump sum for a wider bundle of research.
Competition in the investment research market should rise as a result. Portfolio managers would likely be more selective about the research they purchase and could shop around from multiple providers as they gain a greater understanding of the implicit cost of investment banking research on a per product/service basis. If so, independent research providers would more easily be able to compete and gain access to the multi-billion-pound equity research market, which until now has been the near-exclusive domain of investment banks and brokers.
Will Goodhart, CEO of the CFA Society of the UK, said: “Clearer identification of the value of research and improved disclosure about the cost of research to clients are attractive outcomes, but we also need to take care to identify all the impacts of any change.”
With the asset-management industry continuing to consolidate and operate on a global basis where the top 120 asset managers now look after 53% of global assets under management, we expect these changes to resonate globally as asset managers are likely to adopt common systems to reduce complexity for their businesses.
The paper finds that regulatory change has had a significant impact in shaping the equity research ecosystem and sees six key developments in the short term:
- Content universe available to asset managers will increase, which will open up the competitive research landscape significantly.
- Model for research produced by investment banks will shift to priced from unpriced.
- Revenues generated from securities trading will continue to be separated from payments for investment research services.
- Shrinkage of overall payments made for research services to investment banks to continue, with the total amount paid by firms expected to decrease if research is priced.
- Reallocation of spend among research providers will continue with a commoditisation of pricing for average producers of research.
- Consolidation on both the buy-side and sell-side to continue as the buy-side moves to produce more of its research inputs in-house, effectively paying out of their own P&L.
Edison expects asset managers to become selective about what services and products they procure from investment banks and to evolve into a market place where each asset manager determines the implicit prices they are willing to pay for research based on the perceived quality of the research and levels of service provided.
Neil Shah, Director of Research at Edison Investment Research, said:“The global budget for sell-side research has halved over the past decade to under $5bn, while the number of quoted companies requiring in-depth equity research has remained constant, if not increased over the same period. With asset managers already funding external research from their own profit and loss or through research payment accounts, the pricing and quality of investment research will be subject to closer scrutiny than ever before, driving up competition among equity research providers and triggering fragmentation in the marketplace. While some of the larger investment banks may flourish in a more competitive marketplace and niche players will be able to command a premium for equity research, the mid-sized providers are likely to be more at risk of going out of business or being taken over as a result.
Against this backdrop, companies will need to adopt their approach to investor communications and allocate more resources to investor activities. Strategic targeting of investors should become a priority as a concentrated buy-side will present a greater challenge and companies should diversify their shareholder bases beyond institutional fund managers. Contracting supply of research while demand for research remains constant will be filled by the likes of Edison through the provision of quality, in-depth equity research and access to a global investor base, including those managing private wealth assets, on a scale that is still affordable.”
The paper was carried out in conjunction with Frost Consulting and Bloomberg Intelligence.