Equity research morale has sunk to new depths as commissions continue to shrink. “Equities teams face shakeout” reads the headline of a recent Reuters’ article. The Financial Times speculates that investment banks might begin closing their equity research.
The mood among veterans is no better. There are rumors that JP Morgan and Deutsche Bank will be announcing significant cuts. Cheuvreux, the well-regarded equities subsidiary of Credit Agricole, is said to be closing after a deal with Citic Securities fell through. Royal Bank of Scotland shut down its equities research earlier this year.
As we reported previously, Ticonderoga Securities, WJB Capital and Kaufman Brothers shut down last quarter. In the UK, Evolution Securities was bought by Investec, and Collins Stewart Hawkpoint was absorbed by Canaccord.
“If the lower volumes of the last five years continue, the industry will inevitably see further withdrawals and reductions that will change the competitive landscape in the equities market,” said Sam Ruiz, who heads Nomura’s equity unit in the Europe, Middle East and Africa region, as quoted by Reuters.
Commission volumes shrank another 20 percent in the first quarter of the year, according to the World Federation of Exchanges. After 5 years of declines, they are looking structural not cyclical. Active management is losing assets to passive vehicles. “When I tell a client to buy a housing stock, they grab a homebuilder ETF instead,” complained a sales veteran recently. “It is hard to make a living as a stock picker.”
As we have reported before, the IBM Institute for Business Value has predicted that 85-90% of total worldwide assets under management will move toward indexing or repackaged types of beta instruments over the next decade. Although we are a long way from this number, the reality is that many active managers act passively, especially during times of uncertainly. Market participants say that turnover declines as portfolio managers trade fewer names and hug the indices.
Another secular cause of commission declines is the shift to electronic trading. Full service commissions are becoming extinct. Although clients will pay a premium for advisory, that premium is declining creating commission compression. Industry sources say that Goldman Sachs is automating as much as its cash equities as it can, relying on the strength of its banking (and the expectation of IPO allocations) for relationships rather than high cost advisory services.
Investment banks are creatures of boom and bust, hiring heavily during fat times and laying off employees during the lean. Layoffs are nothing new, but industry participants are wondering if this time is different. Instead of the usual cycles, are we beginning to see structural change?
The answer is yes, but don’t expect investment banks to suddenly exit equity research. What we are seeing are gradual, incremental changes. Death by a thousand cuts. Although there is extreme overcapacity in equity research, no bank wants to forgo their commission streams, declining though they are. So employees will get smaller bonuses, the businesses will be automated and downsized, and bank research will keep hollowing out, replaced by more robust buy side research and boutique firms.