During the past few months, a number of conflicting developments have taken place in the research industry to create confusion regarding the likelihood of near-term research payment levels. The following article discusses these developments and provides our view of how research payments for the first half of 2020 are likely to change.
Decline in Sell Side Conferences
One of the developments that has prompted many market watchers to become concerned about the potential that sell-side research payments could plunge in the first half of 2020 is the fact that, sell-side conferences, roadshows and investor days have falledn steeply over the first six mopnths of the year.
According to data provided by Wall Street Horizon, during the first 5 months of 2020, total Wall Street conferences and events have fallen 22% when compared to the same period last year. This reflects a 44% drop in conferences run and a 30% drop in investor days. This was partially offset by a 45% surge in company conference calls and a 5% rise in roadshows.
However, the number of conferences may not be a very reliable measure of buy-side demand for these services. According to one sell-side firm, a conference they normally hold in early March, 2020 was terribly oversubscribed. This conference traditionally draws 350 attendees, whereas this year over 1,000 buy-side attendees attended the virtual event. We have heard these type of results from numerous virtual conferences and events. The big question is what buy-side firms will pay for virtual conference attendance, the same as for a physical event or closer to the price they traditionally paid for a conference call?
Surging Equity Commission Volume
One of the developments which runs contrary to the drop in sell-side conferences has been the sharp rise seen in equity commissions over the first half of 2020. According to NASDAQ data, US equity commission volume surged over 57% in the 1st Qtr 2020 from the prior quarter, and rose 48% from the 1st Qtr of 2019. At the same time, equity commission rates in both the US and Europe spiked during the 1st Qtr of 2020 from the prior quarter.
This development should not impact sell-side research payments for asset managers who have unbundled their payments from commissions, like those subject to MiFID II or other large asset managers who have voluntarily unbundled their research payments through the use of research budgets and CSAs. However, a number of US domestic only asset managers continue to trade and pay for their research in a bundled manner. Consequently, you might expect research payments from these firms to have risen sharply in the 1st Qtr of 2020.
Buy-Side’s Views on Sell-Side Research Coverage
According to Greenwich Associates, between 75-85% of buy-side PMs feel that both global investment banks and midsize/specialist brokers have significantly added value to their COVID-19-related research needs. In addition, almost half (47%) said they have obtained significant insights from industry experts and/or independent research providers, whereas only one-quarter of those surveyed said the same about alternative data providers.
It is not surprising that a large percentage of buy-side firms feel that global investment banks have provided significant value with their research during the global pandemic as many of these firms have widespread resources and a global perspective on business developments. It is also not surprising that almost half of the asset managers surveyed felt that specialized IRPs and industry experts were providing valuable research insights.
However, it is surprising that mid/sized brokers and sector specialists were rated so highly for their research. Perhaps this is due to the fact that these firms tend to cover more mid and small cap names compared to their bulge bracket brethren. We also suspect that sector specialists, included in this category, would be highly valuable given their deep understanding of specific sectors.
Market Outperformance by Many Research Firms
Historically, sell-side firms have not consistently produced research recommendations that have outperformed the overall market. However, that has not been the case during the first half of 2020. Based on data from 150 US sell-side firms provided by Invisage, the B/H/S recommendations from 43 US sell-side firms who produced a minimum of 10 recommendations outperformed the S&P 500 during the height of the COVID-19 pandemic (between February 1, 2020 to June 15, 2020), while 19 research providers’ ratings actually registered positive performances over that period.
It is also interesting to note that sell-side firms have been extremely active revising their research recommendations from February 1 through June 15, 2020. During this period, the volume of research recommendations has increased by 240% when compared to the same period last year.
Increased Research Engagement
During the past five months, buy-side analysts have dramatically increased their use of sell-side research as the COVID-19 pandemic and associated lock down has raised market uncertainty, and given buy-side analysts increased time to try to come to terms with these conditions. Consequently, the buy-side’s engagement with sell-side research has risen sharply.
According to Financial News, German bank Berenberg said that 80 of its London-based equity research analysts produced over 6,000 pages of research in the week following the UK’s coronavirus lockdown was announced. The bank’s head of equity research described this strategy as employing “shock and awe” to address what the bank perceived as an increased demand for insight.
Morgan Stanley’s chief executive said that following the pandemic lockdown, the bank’s research team had generated 1.5 million research interactions via research reports downloaded or webcasts and conference calls attended.
According to Citigroup, client interactions were up by 9% over the first 4 months of 2020 compared to the same period last year, while the length of time clients were spending on one-on-one phone calls with their research analysts was up 47%.
Goldman Sachs management also noted that from March – May 2020, they held more than 740 webcasts for 240,000 customers. In addition, during that same period, readership of the bank’s investment research increased 90% over the same three month period in the prior year.
Our Take
Given these various trends, one might come to the conclusion that the buy-side’s consumption of sell-side research and the value they placed on it was up significantly during the first half of 2020 due primarily to the market uncertainty brought on by the COVID-19 pandemic.
This conclusion is consistent with the feedback we received from a few CSA brokers who told us that their first quarter payments for sell-side and independent research was up 40% to 60% when compared to the same quarter last year.
However, a few global asset managers we spoke with gave us a very different perspective. One manager said that in the 1st Qtr of this year, their investment team agreed that they should pay unexpectedly more for the sell-side and independent research they were consuming.
On the other hand, another global manager said that they are expecting their research payments to be flat when compared to the same period last year. They explained that this is due to the fact that their first half research budgets effectively capped what they could pay their sell-side colleagues, despite the fact that they used more research resources.
Consequently, we suspect that buy-side research payments for sell-side and independent research for the first half of 2020 are likely to be modestly higher (+5% to +15%) compared to the same period last year, reflecting higher trading volume, increased research engagement, and high levels of buy-side satisfaction with their research offering. Due to MiFID II, it is likely that US research firms will fare better than their European counterparts.
The big question now is what the overall research service will look like going forward (virtual, physical or some hybrid), how research engagement will change, and how all this will impact research value in the latter half of the year as many sell-side and buy-side firms slowly return to their offices. It will be extremely interesting to see.