The following is a guest commentary from John Gallagher, Managing Director at Ludwig Wessel & Associates, an executive search firm specializing in the financial services industry, and is based on a recent survey of US equity research analysts conducted by his firm.
Despite a challenging environment for the global equity research industry, including new MiFID II regulations in Europe, the majority of US equity research analysts believe the current bundled form of commission payments for research will remain unchanged. However, most analysts also felt an alternative payment method for research would be preferable, according to a recent survey by search firm Ludwig Wessel & Associates. The survey also reveals US analysts believe the greatest challenge facing the research industry is an overly saturated market and shrinking commission dollars, and more than one in four analysts believe their firm needs to up their game in order to remain competitive or are actively seeking a platform with a more robust equity research strategy.
The equity research practice at Ludwig Wessel & Associates conducted an anonymous online survey of US sell side equity research professionals in October 2015. A total of 206 sell side equity research professionals took part in the survey. 69% of participants were publishing analysts, and the remaining 31% were associates (non-publishing).
59% of participants either believed the equity research industry’s importance will remain unchanged or demand for quality research will increase. However, a surprising 41% were uncertain how valued the equity research industry will be five years from now.
How do you view the future importance of the U.S. Equity Research industry?
The majority of participants either felt comfortable or confident in their firm’s equity research strategy to remain competitive. However, more than one in four (27%) believe their firm needs to up their game or are actively seeking a platform with a more robust equity research strategy.
Given the challenges facing sell side equity research, how confident are you in your firm’s strategy to remain competitive?
75% of respondents believed that corporate access would be either more important or unchanged over the next five years. 12% of respondents felt that regulatory pressure will restrict non-deal roadshows and corporate access.
How will the importance for corporate access change over the next five years?
By far, the greatest concern shared by participants was an overly saturated market and shrinking commission dollars. Unbundling, however, was not seen as a significant issue by US analysts despite potential negative effects such as further reduction in research spend. This likely reflects the lack of immediate threat posed by unbundling in the U.S.
What do you consider the greatest challenge affecting the U.S. equity research industry?
Ironically, any move to unbundling may actually be a key component to resolving the issue of an overly saturated market. If buy side firms are forced to become more selective in the research they pay for, it could lead to a reduction in sell side analysts and the exit of some research providers. To be successful in an unbundled environment, equity research providers will need to be highly specialized and provide a best in class service, or offer a suite of products/services which create economies of scale (e.g. bulge bracket banks).
Research Payment Methods
Although 69% of respondents believed that commission allocations would remain the primary form of research payment over the next five years, the majority felt an alternative payment method for research would be preferable to bundled trading commissions, with one third favoring a subscription based model.
What do you believe is a fair and reasonable method of paying for research?
Two thirds of participants indicate they would be open to exploring new opportunities over the next 12 months. However, one third are unlikely to consider moving, committed to their platform or would only be open if something fundamentally changed at their current firm.
Over the next 12 months, how likely are you to explore other equity research opportunities?
Notably, the majority seek a move away from sell side research altogether. This serves as a strong reminder of the importance in addressing the needs of top talent. Tackling issues such as insufficient resources, compensation, and career development will help improve retention and ensure successful succession planning.
Aside from compensation, what would be the driving factor if you were to consider a new opportunity?
The majority of survey participants believe continued improvements in technology will impact how future research is consumed. Tracking research consumption, via client portals and in-house software, has received increased investment in recent years. However, one would argue this has limited impact on revenue growth as institutional clients place more value on meaningful analyst insight and management access than the research material itself (note to online aggregator platforms).
The overriding take away from the survey is that sell side U.S. equity research professionals remain positive in their outlook for the industry. Ongoing challenges such as market competition, changing technology, and alternative payment models will continue to influence the industry, resulting in institutional clients becoming increasingly selective of which research providers they choose to partner with.
We agree current payment models could be improved. Top research analysts are coveted for their opinion and insight, acting as external advisors and consultants. Institutional clients derive greatest value from the quality of an analyst’s mind share and ability to advise how events and new data may impact them.
Helping clients improve decision making through a consultative relationship could lead to a retained advisory model in the future, similar to executive search firms. An annual retainer to secure analyst access could be tiered and may also include additional services such as research material, corporate access, and conferences. However, this may not be effective for bulge bracket banks; for independent providers and mid-size investment banks, there are some game theory challenges at play. We view first mover risk as the primary reason firms are hesitant to disrupt existing payment models.
To maintain or grow market share in this environment, equity research providers will need to better understand how they stack up to their competition. Maintaining a competitive edge will require firms to be more alert to changes in competitor strategy and research personnel, and to understand how changes in these areas may affect their business. Fierce competition for quality talent remains constant, and platforms who can provide clients with valuable mindshare from top analysts and a superior overall service will prosper.
Ludwig Wessel & Associates is a boutique search firm focused on the financial services and legal sectors. Ludwig Wessel has an established North American footprint with offices in Calgary, Houston, New York, Toronto and Vancouver. As a trusted advisor to our clients, we provide tailored search solutions, market intelligence, and strategic human capital advice. www.ludwigwessel.com