The Financial Times published an interesting article on research by the chief executive of the UK’s Investment Management Association, the trade association for UK asset managers. The letter mustered a more vigorous defense of corporate access than the IMA has previously projected, but it also floated the notion of explicit pricing for sell-side research services. Pricing transparency for research is not something that asset managers have previously embraced, but perhaps the relentless declines in commissions are forcing a rethink.
As we noted previously, the IMA has appointed a blue ribbon panel to oversee a research white paper planned for an October release. The white paper is in response to regulatory concern about conflicts in the procurement of research and a spate of negative media on corporate access, mostly in the FT.
In his opinion piece, David Godfrey, chief executive of the IMA, asserts that even though asset managers rate corporate access highly in surveys such as Extel, it doesn’t necessarily mean that they are paying for corporate access with client commissions because there are many other research services on offer: “Investment managers receive research from the sell-side whose cost is covered from dealing commissions. But the brokers’ offering comprises a number of elements…”
Herein lies the dilemma. The IMA believes that asset managers are following regulatory guidelines and are not paying for ‘concierge’ corporate access with client commissions. But when one payment fits all, when the million sterling in commissions paid to Goldman Sachs covers all the research services provided, how do you really know?
For this reason, Godfrey’s article outlines a vision of an ‘efficient market’ for research: “It would be one where services were bought directly by managers. Brokers would set cash prices and managers would pay directly only where they believed the service and cost represented value. Payments met by clients would be accounted for directly.”
Sounds pretty radical, but asset managers have discussed price transparency in the past. Why can’t the sell side be more explicit in costing its services? Asset managers have repeatedly heard from their sell side research providers that asset managers aren’t paying enough. Presumably if the sell side has done all the profitability analysis, it could tell asset managers what it costs to buy energy sector coverage or the cost of attending a conference.
And the truth is that the sell side could do that, but up until now it hasn’t wanted to. The profit from the asset managers who overspend on energy coverage or conferences more than makes up for the deadbeats. The average price is so skewed by the high payers that the sell side fears that if they advertise the price then nobody but the high payers would pay it. And even the high payers might balk when it becomes clear how much they are overpaying.
Be Careful What You Wish For
So why haven’t asset managers insisted on price transparency before now? Until recently there were more than enough client commissions to go around. The squeaky sell side wheels could be periodically greased.
In the past we’ve proposed doing confidential surveys for asset managers similar to the McLagan compensation surveys to answer the question: how does my spending on Goldman’s research compare to my peers? The surveys never went anywhere because most asset managers only know that they pay x million in commissions to Goldman. Although this is broken out in the UK between research and execution, there is little further granularity. Estimating how much went to energy sector coverage or conferences takes too much guesswork to have much confidence in the result.
The ultimate killer was that many asset managers were afraid of what they would find out. They strongly suspected they were overpaying, but if they knew for sure, they might have to disclose it. Why rock the boat with the clients paying the commissions? The asset owners, the clients of the asset managers, show no concern about how their commissions are spent.
Nevertheless, Investit, a UK based IT consultancy, is jumping once more into the breach with a proposed Commission Analysis Survey. Perhaps this time they will meet a different response.
Recently, we were down in Costa Rica trying to find a taxi to the airport. It was 6am and the taxi stand was empty. Along comes an enterprising fellow in his car (definitely not a taxi), who sees gringos looking worriedly at the empty taxi stand and offers a ride. At the airport, we ask how much he would like for the trip and he responds “Pay me what you wish.” Did we overpay? You bet.
The current regime encourages asset managers to overpay for research. Although the IMA has bravely mooted a more transparent alternative, it also wisely hedged its bets. In his FT article, David Godfrey was careful to say that any changes would need to be coordinated internationally:
International markets, including the US, have a variety of frameworks that set out which services or benefits can be provided to managers from dealing commissions. Ideally we would want to work with international counterparts to promote positive change on a global scale on behalf of investors and our international asset managers. It takes time to change business models so the review would also seek to identify any improvements that could be implemented in the interim.
International harmonization is the perfect escape clause. Given the U.S. Securities and Exchange Commission’s lethargy on the topic of commission transparency, the IMA can be assured that any joint efforts with the U.S. would be a very long time coming.