This is a guest article by Will Richards, founder of research sales firm Financial Research Solutions. This article is the first of a two-part series on broker voting systems.
Broker voting systems can cause a fair amount of consternation for boutique research providers wishing to maximize their payments through the broker vote. The purpose of this article is to demystify voting systems, to compare the advantages and disadvantages of the vote to subscription sales, and to discuss how to maximize payment from the buy-side through the vote.
Voting systems are used by the institutional buy-side as a way to evaluate the ‘value add’ of research providers to their investment process and as a way to budget their resources for research be it through trading commissions, CSA allocations or a hard dollar research budget.
Generally speaking, voting systems are used by larger hedge funds or mutual funds because they allow for a more administratively streamlined procedure for larger firms who may have dozens of PMs and analysts, and hundreds of research providers. Instead of research procurement decisions all being handled on an ad hoc basis, all decisions around research are processed through the voting system streamlining the process in large firms.
By its nature, the vote tends to allow for a decentralized decision making process, with each PM/analyst obtaining the research that he or she wants without having to obtain approval from the larger team. However, buy side commission management staff may serve as ‘gate keepers’ to new research, and, in a declining commission environment, negotiate with research providers for research services received by the firm.
How the Vote Works
Voting periods can range from quarterly, to semi-annually to even annually, with quarterly being the most common. Votes are generally cast during the final few weeks of a voting period, or are cast during the first few weeks after the period is over.
Typically each investment professional is given a set number of votes to cast for the research firms which have helped them the most over the previous period. A more senior PM in a firm might be given a greater allotment of votes than a junior analyst. In some cases trading staff may also participate in the vote.
Once the votes are cast, they are tabulated and attributed to each provider. In some firms, each vote is given a commission amount and commissions are distributed to research providers accordingly. Votes are collected and tabulated, multiplied by the commission or dollar amount per vote, and a total amount is deemed to be awarded to each research provider.
However, in other cases, the vote may be used as a general guideline by trading staff for allocations. In many asset managers, the value of each vote increases exponentially as more votes are attained because brokers with broad and deep relationships with the asset manager are paid significantly more commissions than niche research providers with a more limited presence.
The amount of each vote may change from period to period based on the total trading commission activity of the firm or, as European regulators would have it, the hard dollar research budget of the buy-side firm.
Although broker voting is primarily used to allocate commissions to research providers with trading desks, with the majority of commissions going to large investment banks, voting can sometimes include soft dollar allocations through commission sharing arrangements or ‘step outs’. They can also include hard dollar allocations in some cases.
The voting awards are typically paid out to the research firms sometime over the next 1-6 months after the vote has been completed, although there can be further delays in payments for research providers being paid by brokers administering commission sharing agreements .
In some cases, asset managers provide feedback to research providers on which analysts, services and/or sectors were highly valued during the vote, but in most cases all research providers know is what their allocation was for the period.
Being admitted to the vote
Getting admitted to the vote can be a tricky process for any new research provider and more so smaller research firms. For reasons most likely having to do with not wanting to create expectations for a new research provider, many PMs and analysts are reticent in sharing details about their own firm’s voting system. Compounding the problem is that voting systems can be sufficiently opaque that PMs/analysts may not even be aware about how their own voting system functions, leaving them unable to help a new provider navigate through the process.
Lastly, and most frustrating, the following “chicken & egg” scenario can arise: PMs/analysts may not want to show support for a research provider that is not already ‘approved’ as a vendor, however the first thing required to gain this ‘approved vendor status’ is support from a PM or analyst.
Even after obtaining support from a PM or analyst, research firms often have to satisfy requirements of the buy side firm’s compliance and legal staff. Persistence and having multiple points of contact within the firm are vital to gaining admittance to the voting system.
Becoming an “Approved Vendor”
Once a research provider has been approved and admitted to the voting process, they essentially become a “Approved Vendor” to the buy-side firm. At a minimum, this means that the research provider has satisfied the asset manager’s compliance and legal requirements, and has some level of usage in the firm.
In some cases, the research provider may receive a coverage list that details (sometimes down to the ticker) the coverage for every investment professional within the buy-side firm.
This intelligence is extremely useful for determining other potential prospects within the firm and for identifying when PMs/Analysts’ coverage changes at the firm. By identifying and pursuing all possible prospects, and by staying on top of coverage changes, the research provider can ensure that the buy-side firm will remain a client year after year.
The next article will examine the pros and cons of broker voting systems compared with other forms of pricing. Click here to view previous article by Will Richards on outsourcing sales.