Bear Market Likely To Leave Research Firms Wanting


New York, NY – Over the past few years, Integrity Research Associates has forecast a significant consolidation in the independent or alternative research industry – a development that has not materialized to any great extent.  Of course, a number of sell-side research departments have disappeared in the wake of the credit crisis as Bear Stearns was acquired by JP Morgan, Lehman Brothers was sold off in pieces to Barclays Bank and Nomura, and Merrill Lynch was acquired by Bank of America.

However, these recent mergers could be the first phase of a more widespread wave of consolidations as the current bear market leaves buy-side firms with fewer and fewer commission dollars to pay both sell-side and alternative research providers for their research.

Recent Market Trends

In the past, buy-side institutions have generated sufficient equity commission dollars to pay all of the bulge bracket firms, broker-dealers, boutique investment banks, and alternative research firms whose research they consume a sufficient amount to keep everyone relatively happy.

This contention is supported by the fact that the number of equity research providers remains surprisingly high, and in many cases, growing.  Based on data collected by Integrity Research Associates, there are approximately 518 U.S.-based fundamentally oriented sell-side and alternative research providers in existence today.  What is surprising is that this total does not include the hundreds of quantitative, technical, economic, primary, or specialized research providers that also supply their data and analysis to buy-side clients.

According to Greenwich Associates, the average number of research firms (brokers) used by asset managers in the U.S. grew 18.5% from 37.9 brokers in 2005 to 44.9 brokers in 2007.  During this same period, the number of brokers that money managers’ categorized as their most important research relationships grew 7.6% from 11.9 brokers to 12.8 brokers.

It must be noted that the Greenwich survey does not reflect the total number of research sources that buy-side investors pay as a number of alternative research providers work solely on a subscription basis and receive cash checks versus “bundled commissions” of “soft dollars”.

Equity Commissions Plunge

More recently a number of buy-side clients we have spoken with have expressed concern about the sharp drop in the amount of equity commissions they have generated as a result of the 28% decline in the U.S. stock market that has been evident over the past twelve months.  Some mutual funds and hedge funds confide that they might not be able to pay their research providers what they originally expected to.

In the past, when a client could not pay an amount the research provider deemed appropriate, the research provider had a choice.  They could either cut the client off, or they could keep supplying the firm, hoping they would be able to pay them significantly more as they recovered.

Unfortunately, the current commission shortfall is likely to be widespread as most asset managers have seen both atrocious investment performance and substantial declines in assets under management.  In fact, asset outflows at many hedge funds are likely to be quite severe this year as poor performance and loss of confidence has prompted many investors to move to more stable funds.  As a result, we suspect that the number of hedge funds that will shut down in the coming six months could top 20% of the overall marketplace.

Potential Consequences

The big question is, “How will investment banks, brokers, and alternative research providers respond if a large number of buy-side clients underpay them for their investment research?”  We suspect that some will try to extend grace to the clients who have paid the most in past years.  However, many mid-sized and smaller players might find themselves in a very precarious position as research revenues fall at the same time that execution revenue falls.

The team at Integrity Research expects that this development is likely to cause tremendous pain for both research providers and money managers.  First, we anticipate that the long awaited for consolidation in the investment research industry will finally take place, with boutique investment banks, broker-dealers, and alternative research providers merging or closing their doors altogether.   Second, a large number of smaller and mid-sized mutual fund and hedge fund managers will find themselves with less and less external research – either because their research providers decided to cut them off, or because some of them exited the business.

Another development we anticipate is that the largest mutual funds and hedge funds are likely to get larger as investment assets flow to these safe havens.  However, this may not be good news for many research providers as these larger buy-side firms will internalize a wide range of research functions traditionally performed by sell-side and alternative research providers.  Ultimately, we expect that these buy-side firms will be in a better position to negotiate for even lower prices for eternal investment research.


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  1. Transparency and Cost Benefit Analysis

    Today’s Integrity Research Associates’ ResearchWatch feature article discusses the impact of the past 12 month 28% equity market decline on the investment research market. As I read the article I was reminded of a few themes that generally come to mind when I think about the value of investment research.

    One of my thoughts is, active managers should be using their clients’ brokerage commissions to buy research that assists them in capturing alpha. The excess return garnered from a portfolio consistently capturing alpha and compounding that alpha is the source of the clients’ reward for an effective advisor / manager selection process. If an active manager / advisor cannot gain significant alpha and consistently returns compound portfolio valuations in the range of market returns (i.e. beta) clients should question if they have hired a ‘closet indexer’. And clients should begin to consider the alternative of investing in index funds which closely track the index’s they seek to replicate. Such index funds will generally be less risky investments than actively managed portfolios.

    Another thought that frequently comes to mind is, because markets are cyclical active investment manager / advisors must constantly review their investment research and investment information sources to evaluate which sources are helping them capture alpha and which sources have become irrelevant to their investment process and should be de-emphasized or “fired”. Very obviously, this process obviously requires cost-benefit analysis.

    I believe the necessity to evaluate investment research, and investment information sources, on a cost benefit basis is one of the better arguments supporting disclosure and transparency (pricing and identification) in institutional brokerage commission arrangements.

    Because it is separately priced (and openly negotiated) independent research has always been subject to such cost benefit analysis. In contrast, cost benefit analysis for bundled undisclosed full-service brokerage services is extremely difficult or impossible. It seems portfolio performance, advisors’ portfolio management processes, other fiduciaries’ oversight, institutional clients and regulators could all benefit from more transparent accounting and disclosure of what are currently the bundled undisclosed uses of institutional clients’ brokerage commissions expenditures.

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