New York – A recent article—“Slicing up the Alpha-Generation Pie”– by Ivy Schmerken looks into the interplay between the agency brokers and the bulge bracket brokers as they compete for the buy-side commission dollar. The article points out that the bulge bracket is trying to crack into the execution market, while the agency brokers are trying to break into the research business. A recent Integrity survey of buy-side users of CSA/CCA brokers discovered that the agency brokers had a greater mind-share than the bulge bracket in the CSA/CCA space.
On the research front, agency broker offerings are vastly different than the traditional proprietary research offered by the bulge bracket. The agency brokers are putting together teams of alternative research providers, which presumably have a lower propensity for bias towards a particular stock. As we know, the bulge bracket must be mindful of their investment banking clients, making it difficult to put a sell recommendation on a large banking client’s stock. The agency brokers’ research products aim to create investable ideas through meetings, conferences and other research services to provide clients with non-traditional buy/sell/hold information that is nevertheless actionable.
Where we differ from the author is where she asserts there will be plenty of alpha to go around. In our view alpha is a scare resource. If we define alpha very simply as the intercept term of the characteristic line, where the stock or portfolio is regressed against the return of the market (say the S&P 500), then on a cap-weighted basis only half of the market cap will have positive alphas and the other half will have negative alphas. As such, alpha is (over time) a zero sum game.
From the investors’ perspective, a good research idea generates positive alpha. From a brokers’ perspective a good research idea is one that generates trade flow. In a perfect world, brokers with great research will benefit through offering positive alpha to their clients. As far as we can tell, the larger agency brokers, with inventive research offerings, will continue to grow their commission revenue at the expense of the bulge bracket over the near term. The longer term split is still up for grabs, but may continue to favor the agency brokers. One rationale for this is that regulation across a number of the full service broker business lines will continue to distract the bulge bracket from focusing on strategic issues in their research and execution businesses