The following is a guest article from Tom Leddy, former head of research product marketing for Donaldson Lufkin Jenrette, Credit Suisse and JP Morgan. Leddy recently partnered with Integrity Research to deepen our expertise in research marketing and product development.
As I follow the news about changes underway in Europe resulting of MiFID II and the pressure to develop transparency and move toward unbundling of research and the creation of more pricing transparency, I can’t help but think how we’ve come full circle in the value proposition for research.
When I started and developed my career several decades ago on the sell side as a leading person in the marketing of equity research, I think about my role at Donaldson Lufkin Jenrette. Not only was I to spread the word about our excellent research, but I also suggested how critical and valuable that research could be to the buy-side. We coined the phrase at DLJ “The House That Research Built” because at that stage we had little to nothing else to offer but that great work. We spent years working on how exactly to commercialize our message and develop a sense of fair pricing that would make DLJ the very prestigious and profitable entity it would inevitably become.
The ability to generate and utilize trading commissions to pay for equity research solved many problems relating to the establishment of a payment system that worked for all concerned in effectively utilizing the commission dollars already As DLJ developed its banking business, we coursed through the applications of research not only for asset manager clients, but for investment banking to identify profitable sectors and companies, and to help create an identity for those companies with clients who might be interested in their stocks.
For many large investment banks, notably Merrill Lynch in the early days of research, a further application and value came from a retail system of brokers and ultimately high net worth clients that involved helping those clients make money in the stock market through research assisted information, ideas and recommendations. Each of these applications has undergone dramatic change over the years.
The Chinese Wall that was demanded for firms with investment banking, the questioning of growth prospects for individual broker-assisted businesses, and the reduced profitability of those who maintain many research assets, analysts and products, continue to be among the most critical issues for those asking the question “why research?”.
The one constant throughout the growth and the long, ongoing shrink in the equity research businesses is the unassailable position of the truly superior analyst who adds unique, proprietary and perceptible value to the clients and the firms they serve.
Today’s world, with additional mounting pressure from MiFID II, which may affect a broad base of US equity research firms beyond the major global banks, compounded by the dismal showing of this year’s cash cow IPO market, has only underlined the need to show more exacting value, transparency and to move to a new pricing model for research that works for both the buy-side and sell-side.
Integrity Research, where I serve as a partner, has written extensively on all the developments impacting the evolution of the business. Integrity has highlighted ongoing client concerns to identify true value and distinguish it from maintenance research and non-essential products that wreak havoc on the incredible shrinking equity division and the equity research business itself.
Are we therefore surprised that the chaos and cost pressure have spawned the growth of research independents?
At a time when almost all areas of the equity research business have seen a meaningful diminution in compensation, the top analyst in many cases has remained among the highest paid and lest affected of the remaining groups.
In fact, one might make the case (and some clients do) that the truly top analyst may actually be able to demand more than their firm is begrudgingly paying them. Many kingpin analysts have already realized this as they distance themselves from larger banks where their compensation does not equate to their perceived value. Not surprisingly, many of those analysts feel some of their compensation goes to the “also ran” analysts and the running of bloated research departments still maintained by many for arguable reasons.
MiFID II, and the demands it makes for specific pricing, opens the kimono to a host of possible realizations that may have many reeling from the results established.
The golden standard, the top analyst, may well learn they are worth even more than they currently are constantly pressured to prove, causing more dislocations among the key research players and continued growth in independents who are already paid for exactly what they deliver.
In a “what goes around comes around’ situation, we are once again coming to the point, as I did so long ago when I started at DLJ, where the true burden is to prove first that you have top research and then what value that has, perhaps very specifically, to its users. Ultimately this means convincing those who are listening that the best assets, not surprisingly, are the best analysts.
Overall analyst ranks may shrink, but the top players should retain the top shelf position. Perhaps with more hard numbers being generated from advanced pricing models from the users and suppliers may make their compensation the subject of new discussions…on the upside.