The following is a guest article by Will Richards of the Research Alliance, a leading business development agency for independent research (www.theresearchalliance.com). The article is the first in a series examining challenges and opportunities facing independent research providers.
As the owner of a business that makes its living selling independent research, there are many times that I wake up in the middle of the night in a cold sweat. It only takes one or two cancellations from buy-side clients to get my mind racing: “The research market is shrinking. MiFID II means the end of independent research. Clients don’t have a budget for independent research any more. We are going to be left behind and our business is going to close.”
But then I think of a conversation I had recently with a client and friend who is a buy-side fund manager running over $1B in AUM. “As a research firm, if you bring me what I need and want, I will always find a way to pay you. MiFID doesn’t matter, budgets don’t matter, research competition doesn’t matter – bring me what I need, and I will find a way to get you paid.”
The conviction in the way he said this provides comfort. But it also leaves a big question: What does the buy-side need and want?
What is the market for financial research?
According to a Reuters article, the global market for financial research is USD 9.3 billion/year. While figures for independent research are harder to measure, IRPs have 10% of this market at most – and probably much less than that. Most independent research firms have revenues in the low 10s of millions – or less – so the opportunity for growth in a 10B dollar market is massive.
These numbers are cause for optimism amongst IRPs: even if the global research market were to shrink by 50%, there is still a huge opportunity for independents to grow dramatically and take market share from the sell-side. But they must position their business properly if they wish to capture this market share. And unfortunately, most IRPs are languishing, with year-over-year revenues rarely increasing and often declining.
Who is our competition?
Unquestionably, the main competition for IRPs is the sell-side. Buy-side analysts only have a certain amount of bandwidth to consume research, and the sell-side does a fantastic job churning out huge volumes of reports on a monthly, weekly and even daily basis, creating analysis and data to drown out competition.
On top of this, large sell-side banks invest big bucks in their sales and marketing teams, and they will do whatever it takes to stay close to the buy-side clients. A bank may have more sales people than analysts, and they understand how to leverage their analysis with top institutional sales people to get their product to the top of their clients’ desks. Institutional salespeople are paid high six-figure salaries to understand the research, and to deliver the best ideas to their key buy-side clients.
On the marketing front, sell-side investment banks are brand names that are known not only in the investment community, but also by the general market. The influence of these brands are powerful: when a “Goldman Sachs” changes a rating on a stock, it can move the market – even if the analyst is not known, or the report is not even read. Banks understand the importance branding, and they invest millions to ensure that the influence of their brand remains high.
The problem with the independent research community is that we use very little of the strategies and techniques that the sell-side has proven so successful for capturing, growing and maintaining market share. On the whole, the quality of the research of independents is superior. We don’t have all the distractions tormenting sell-side analysts, allowing us to focus on better, more effective financial analysis and financial forecasting. But we have not done the same on the business development front.
What is wrong with independent research?
Managing directors and senior analysts at independent research boutiques are often brilliant individuals. The quality of the analysis and research that they produce can be superior to what is typically found on the sell-side. But, instead of focusing on new business development ideas to grow their revenues, we most often see independent research firms wasting time 1) disparaging the sell-side competition; 2) attempting to influence financial regulators as a means to improve their business outlook; 3) producing even better research and analysis (when their analysis is already superior to their competition).
Complaining that the sell-side is biased
While it is true that sell-side research written can be influenced by the banking fees paid by the companies under coverage, this matters little in a bull market when all stocks are rising. Moreover, the buy-side is well aware of the conflicts, yet most buy-side managers rely almost exclusively on sell-side reports. It is not enough for an IRP to claim that because it is ‘independent’ that its product is superior.
Buy-side analysts are not fools. So there must be a reason that they choose information produced by the sell-side. And what we have learned from our buy-side contacts over the years is that the reason for the success of sell-side research is that the sell-side better understands the needs of their clients, and the product they produce better meets their client needs. At least as it pertains to business development strategies, independents would do better to emulate their sell-side competition rather than disparage it.
Striving to influence regulators
When owners and managing directors of IRPs convene, they tend to focus on government regulations being the key problem preventing them from growing their businesses. In 2002, US independents formed Investorside to help with just this problem. However, Investorside closed in 2015 because it failed to keep its members engaged. Most members that we spoke with (we were also a member of Investorside from 2008 to 2015) were much more concerned with winning new business to drive their revenues than with regulatory issues.
Even today, this misguided focus on regulatory issues by the independent research community continues. “MiFID II has caused our revenues to decline!” is a common refrain amongst IRP owners, and many meetings and conferences have been organized to deal with this piece of legislation.
But we have a theory on MiFID II. The reality is that the buy-side is simply using MiFID II as an excuse for cutting research services that are not meeting their wants and needs. It is always a convenient budget cutting tool to have something to blame, and it is a lot kinder using MiFID as an excuse rather than telling research providers the truth, which may be closer to: “Your research services are not helpful to our work on the buy-side.”
But, why are we, as a community of independent research companies, asking government or the financial regulators to increase the use of independent research in the first place? If we were more concerned about the laws of business (i.e. ‘Put your clients first.’) instead of financial laws and regulation, perhaps the future of independent research producers would look a lot more rosy. Unfortunately, more time and energy is spent by independent research firms ‘preparing for MiFID II’ than on business development – and we all pay the price as a result.
Doing more research, and doubling down on increasing research quality
The most common misguided initiative taken by IRPs is to re-invest in their research and analytical capabilities. While on the surface this seems like a reasonable idea, in working with dozens of independent research providers over the past 15 years, we would say that it is rare that research quality is a problem.
As a whole, the quality of research produces by independents is very high. The problem is that while the quality of the raw research is very high, it is perhaps not put into a format that is user friendly for the buy-side.
On the other hand, the sell-side does a fantastic job packaging its analysis. Unfortunately, as our analysts have seen time and time again with the companies they cover: the best quality products are not always market winners. And, in the case of financial research, a supremely polished packaging job covering an often mediocre research product allows the sell-side to dominate market share in our industry.
So, if independent research providers are often failing in the ways that they are trying to grow market share, what should they do instead? We will review this in our next article.
The next article in the series discusses steps that independent research firms can take to increase market share.