The following is a guest article by Elgen Strait, head of Fox Institutional Research Services, a London-based provider of outsourced research sales and sales consulting services. More information is available at www.fox-research.com.
In our role as a London-based outsourced sales agent for independent investment research, we are seeing a radical shift in how asset managers are purchasing research. We believe the changes will on balance be beneficial for independent research firms.
Regulatory ‘wait and see’
The regulatory clouds have been gathering over the research industry in London for the last few years. Towards the end of 2013 we started noticing a steady pattern of “wait and see” amongst potential buyers.
Some asset managers specifically stated that they would not make any new research purchases until regulators finally and conclusively decide whether or not commission sharing agreements (CSAs) can be used to pay for research. Others have stated that they would wait not only for regulatory certainty, but also for other asset management firms to set best practices for dealing with whatever new regulatory regime appeared.
Against this backdrop of “wait and see”, some larger buy-side firms have attempted to get ahead of the regulators and move to a fixed research budgeting system. Last year many large asset managers paid for research in arrears via sometimes arbitrarily defined “votes” which would fluctuate in value depending on AUM and portfolio turnover.
This year we are seeing changes with some of the larger buy-side firms. Investment professionals have been given explicit research budgets that they are able to divide amongst the research firms they would like to work with. These mechanisms allow the investment professional to allocate a specific dollar amount to an IRP, and have resulted in the cost of IRPs research being compared directly to each other.
That said, there still appears to be an institutional psychological bias towards resisting comparing the price of independent research to the cost of bank research. After being told by an asset manager “Indie Research X looks expensive compared to Indie Research Y”, our response has been “Fine, but how does it compare to the bill you are going to receive for research from Bulge Bracket Bank Z?” Asset managers seem to have trouble answering this question and will in most cases attempt to deflect it.
For now, these firms are still paying for research via CSAs, but they are ultimately taking a big and important step towards a transparently priced research market: they are working within a predetermined, fixed research budget which does not fluctuate with the ebbs and flows of assets under management and portfolio turnover. Those firms that are prepared to work within fixed research budgets will be better placed to deal with any regulatory change requiring the switch from CSAs to hard dollars.
Improving sales environment
Institutional investors are asking for more clarity and granularity on the scope of services offered to them by the research houses. And yet, seemingly paradoxically, some funds have asked for any mention of “analyst access” to be removed from contracts in case it is misconstrued by the FCA to equal “corporate access”, for which it is now illegal to pay with commissions.
On balance, our take is that changes like this are a net positive outcome for IRPs. Whilst a points-based payment in arrears system may lead to the occasional bumper quarter for an IRP, most of the smaller firms that we know would rather service clients who have committed to payment upfront rather than take a chance servicing a firm that isn’t willing to commit anything in advance.
Many independent research firms have long been convinced that the slow but steady progress towards a fully unbundled world would ultimately benefit them. We now appear to be nearing the end of the painful transition period, and IRPs that have weathered the storm are waiting anxiously for the day when their product will be viewed and valued on the same playing field as the bulge brackets. Clearly we aren’t there yet, but we are inching towards that day.
Despite the challenges in the sector, London remains a great place to sell independent research products. For research firms with a global product , the regulatory uncertainty in the air close to home can be mitigated by the ease of conversing with investors internationally. As the clouds have been gathering over our heads in London, we have increasingly shifted our attentions to Asia and the US, and the daily rhythm of speaking with Asia in the morning, the UK and Europe around midday, and the US in the afternoon has become more pronounced.
And finally, we continue to see interest from potential new entrants to the research market. Savvy vendors of niche data sets and Big Data analytics services have begun asking for our expertise in selling to the asset management community. We expect to see this trend continue as the Buy-side’s search for Alpha continues to increase its appetite for new data sources and analytical tools.