Gloom in Equityville

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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.

Shrinking Commissions

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.

Conclusion

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.

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2 Comments

  1. “After 5 years of declines, they are looking structural not cyclical”, very chilling words for anyone in the Equity Research business. It seems that we have reached the point in time when “history just might NOT repeat itself”.

    How does a Firm pay for an Equity Research operation when all of the subsidies are gone, and the function does not generate any direct Revenue to be considered a profit line in any Firm? What was once an honorable and desired profession (Equity Research Analyst) is rapidly being thrown into the dust-bin of Wall Street history. Who in their right mind would want to be an Equity Research Analyst, or, advise someone that this is a good career direction in this environment?

    The major Sell-side IB’s have a big problem on their hands. As stated in the Blog article commissions are heading down very rapidly and the funding sources from Retail or Investment Banking are probably gone forever. I would not at all be surprised if all of the Equity Research departments are “spun off” to be standalone operations and made to “make a profit” on their own merit and product.

    Amazing, just amazing IMHO!

  2. Despite gloom around commission payments for research, corporate access, and execution, payment for trade ideas continue to rise. Broker trade ideas have the following attributes that make them popular with both the buy-side and sell-side even in tough markets. Trade ideas:

    Pull together the totality of a broker’s knowledge about a stock – broker research, recent corporate events, the morning call, the economic briefing, and knowledge of market movements
    Are measurable in terms of effectiveness
    Are tailored to individual client portfolios, rather than blasted out to everyone, giving them unique value
    Can be actioned immediately
    Are only paid for if they are effective
    Remove significant costs in the investor’s stock-picking process

    It is perhaps performance-based payment that makes trade ideas so popular in a difficult market such as the one we have now.

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