ITG is a bellwether for commissions and, with its acquisition of Majestic Research and subsequent purchase of Ross Smith Energy Group, it is a publicly traded example of an agency broker seeking to profit from higher commissions generated through research. Unfortunately, while the commission environment seems to be improving, all does not seem well with ITG’s research operation.
ITG’s first quarter revenues increased 9% over the fourth quarter results. As in its 4th quarter call, ITG was cautiously optimistic on the commission environment. This quarter it cited improving inflows into equity assets, a hopeful sign for commissions:
“For the first time in 10 quarters, we witnessed positive domestic equity inflows with active equity managers experiencing an estimated $20 billion in domestic equity fund inflows… While these flows in and of themselves did not amount to a great rotation back in equities, they are improvement over the heavy outflows we’ve seen over the past few years.”
Business Line Results
This quarter marked the first time ITG released financial results for its lines of business, including research. ITG’s 9% revenue increase was driven by a 19% increase in electronic brokerage revenues from $58.3 million in the fourth quarter to $69.6 million in the first quarter. Research revenues, however, were down 7% from $27.4 to $25.4 million. For details, follow this link: http://investor.itg.com/files/doc_presentations/2013/ITG_1Q13_EarningsPresentation_02May13_FINAL.pdf
The official explanation of the decline in research revenues was bad timing: “Revenues from research sales and trading declined due in part to a decline in project based work and the timing of payment from research accounts that pay on a discretionary or voting basis.”
Product allocations are notoriously difficult for brokerages. If an asset manager directs more commissions to ITG, how much of that is attributable to increased volume and how much to the research product? ITG’s electronic brokerage group, its flagship operation, will believe that any increase will be due to its capabilities and relationships. And now that internal resource allocations are on the line, the passion gets even stronger.
A Zero Sum Game?
As we noted when ITG first announced its product profitability review in February, business line analysis is typically not flattering to research. Now that ITG has decided run its business based on product profitability, the existing culture will tend to favor electronic brokerage rather than research. The risk is that the win/win of trading and research turns into a zero sum game where trading will prosper at the expense of research.
When asked by an analyst about the decline in research, ITG CEO Bob Gasser suggested that some of the benefit from research was being booked with electronic brokerage: “I think the overall dynamic – some of that [revenues] shifted into the brokerage world, in some cases the electronic brokerage world has benefited from a higher rate card, if that’s the client’s preference in terms of how they want to interact with us, and pay for the various products and services they consume.” In other words, some of the benefit of ITG’s research is showing up in the electronic brokerage revenues.
Here is another clue that research is becoming a losing proposition at ITG: research management departures. Tony Berkman, who was the CEO of ITG Investment Research and previously CEO of Majestic Research, left ITG this month. According to his LinkedIn profile, Tony is now an employee at an unnamed hedge fund.
Terry Gardner, the ex-CEO of Soleil Securities, who was recruited to be the COO of ITG Investment Research after the Ross Smith acquisition, also left ITG this month. According to LinkedIn he is doing consulting.
Research operations are run by co-heads Jie Zhang (a 9-year veteran of ITG and Majestic before that) and Jim Jarrell (formerly president of Ross Smith Energy Research, which he joined in 1999).
The departures of Berkman and Gardner, both experienced research managers with track records of running large research operations, suggests that all is not well with ITG Investment Research.