Correction: An earlier version of this article said that Charles Schwab no longer distributes S&P equity research. In fact, Schwab continues to distribute S&P equity research, even though the only research listed on its website is Morningstar equity research.
Since S&P Capital IQ, the research and market data division of McGraw-Hill Financial, downsized its equity research group, bitter rival Morningstar has been adding key new clients. Morningstar is aggressively marketing its significantly larger analytic team. For many of S&P’s important clients, the message is resonating. However, it is not clear which strategy will be successful in the end.
S&P’s Evaporating Analysts
Since the end of the Global Research Analysts Settlement’s subsidies for independent research, S&P has been steadily shrinking its 100-person equity analyst headcount.
Earlier this year, S&P laid off 50 equity analysts, shrinking its equity research team from 66 analysts to 16 analysts. At the same time it substituted quantitative analysis for analyst coverage for many of the nearly 1,500 equities it follows. S&P’s star ratings, instead of being assigned by analysts, are in most cases assigned by models, and much of the textual commentary is automated.
The move increased the profitability of S&P’s equity research product, so long as it can keep current customers happy. The move was a gamble that users wouldn’t mind the reduced analytic input and the increasingly automated reports. It appears that the gamble may not be paying off.
S&P’s rivals in the retail space, such as Zacks, Argus and Morningstar, have been moving to capitalize on S&P’s move. Argus hired S&P’s former research head to help with its product strategy. Morningstar has perhaps been the most active, touting its 105 analysts to all of S&P’s biggest customers.
Unlike S&P, Morningstar has retained the 105 equity analysts it staffed up during the Settlement. To recapture lost Settlement revenues, it has sought to expand its institutional business by focusing on smaller asset managers whose commission flows are too small to be interesting to investment banks. Morningstar can offer its equity research at a much lower price point than most investment banks.
Morningstar has also been expanding internationally, hiring staff in Europe and Asia, including a recently hired institutional salesperson in Hong Kong.
Now, after S&P’s dramatic downsizing, Morningstar has been also targeting S&P’s core client base, with some recent success. Charles Schwab, a long-time licensor of S&P research and once one of S&P’s largest customers, has added Morningstar research, which is now the only stock research featured on its website. Edward Jones now uses Morningstar as a complement to its own internally generated research. Wells Fargo, which once outsourced much of its equity research to S&P, now uses Morningstar.
When it downsized its equity research, S&P Capital IQ said it planned to refocus its equity research group to cover new areas and differentiate its research product. It is not yet clear what is differentiated about S&P’s research. Rather, the move appears to have been a cynical decision based on the assumption that most retail consumers of research are relatively indifferent between quantitative versus qualitative research.
And, despite Morningstar’s recent successes, S&P may be correct. Although Morningstar’s equity ratings incorporate analyst input as key factors, they are in the end quant models. [Note: Morningstar takes issue with this description: “While we have a rules-based system for assigning our star ratings, our analysts actually do control what those ratings ultimately are, since they determine the Fair Value Estimates (our equivalent of a price target) that we assign to each stock. The star rating basically just indicates how cheap or expensive the stock is relative to that analyst-assigned Fair Value.”] On paper, S&P’s equity coverage of 1,500 stocks is not materially less than Morningstar’s nearly 1,800 stocks.
Retail investors, and their advisors, often value a perspective that only an analyst can give. Analyst color can make the difference in the decision to transact a stock, and this is the key ingredient most S&P equity research lacks. However, the extra cost base associated with 100 analysts makes this a very expensive added feature, and Morningstar will need to keep hustling to make it pay.