Quinlan & Associates, an independent strategy consulting firm specialising in the financial services industry, has released a thought leadership paper, ‘A Brave Call,’ looking at the changes in the investment research industry triggered by MiFID II. The report forecasts some global investment bank research departments could face potential losses of up to $240 million by 2020, but also looks at how cost reduction provides an opportunity for significant market disruption and innovation as investors look for new ways to access research.
The report discusses the inherent conflicts between the research and investment banking departments of full-service investment banks, supported by empirical evidence around stock recommendations. ‘The structural complexity and costs of sell-side research departments remain stubbornly high’, said Yvette Kwan, co-author of the report, ‘whilst regulation to-date has failed to fully resolve the inherent conflicts’. For example, there is a heavy bias towards the provision of positive ratings by integrated brokerage houses. When examining analyst recommendations across all major investment banks, an average of 43% of stocks covered by tier-1 banks and 48% of stocks covered by tier-2 banks were given a ‘buy’ recommendation, with a mere 12% and 7% tagged with a ‘sell’ recommendation respectively.
At the same time, Independent Research Providers (IRPs) have been steadily gaining traction, reflecting their capacity to produce high-quality, in-depth independent and local market analyses at a considerably lower cost than major sell-side brokerages. ‘We have seen a host of new IRPs emerge, with analysts from bulge bracket firms capitalising on low barriers to entry to set up their own firms, as well as consolidation amongst existing IRPs’, said Benjamin Quinlan, CEO of Quinlan & Associates and lead author of the report. From a buy-side perspective, the report explores the IRPs’ proposition, including specialised content and flexible payment options, which is especially compelling for smaller managers.
In the report, Quinlan & Associates discusses alternative research models available to brokers in the wake of this rising competition. Options include operating research out of a separately-owned entity, and outsourcing research to IRPs either directly or via online research marketplaces (ORMs), such as Société Générale’s partnership with Smartkarma.
Reviewing the Smartkarma platform, Quinlan and Associates highlight its benefits for both the independent research providers as well as the investment community:
- For investors, Smartkarma provides new and alternative content, as well as the curation of content both through its upfront selection of insight providers and smart algorithms to filter content, and dynamic engagement between users and insight providers.
- For insight providers, Smartkarma is not just a content distribution platform – through the use of content and work management tools, it is also a publishing platform. And whilst the platform is heavily reliant on technology, the humanistic aspects incorporated into the platform are particularly thought-provoking. These include the collegiate support network for IPs where desired behaviour is directly reinforced through remuneration, and income smoothing which provides income stability.
‘The most important priority for brokers now is to start making decisions around the structural make-up of their investment research offering’, said Mr Quinlan, ‘as the status quo of the fully-integrated model is no longer an option.’
Jon Foster, co-founder of Smartkarma adds, ‘By creating a new model for investors to collaborate, add and extract value from our community of independent insight providers, we are changing the research landscape for global investors, removing the inherent conflict seen today, and providing timely access to insight in a cost-effective way. Smartkarma’s bull-to-bear ratio of ~60:40 is a telling indicator of the independence of our insight providers, supported by our innovative compensation model and intuitive platform, which drives collaborative behaviours and improved insight outcomes, matched to investors’ needs.’