New York – During a recent trip to London it was clear that the research industry there is under intense pressure as commissions have generally fallen 30-40%. Nevertheless, for at least some alternative providers the environment is perversely positive as investors are forced to rethink the status quo.
Like in the US, commissions decreased significantly in London during the latter part of last year and the beginning of this year, until the recent spike in market volatility. Because commissions in the UK are tied to the market value of the stock rather than shares, the depressed levels of stock prices have accentuated the commission declines even more than in the US. The consensus among investors, along with commission management staff at major banks, was that commissions have been running nearly 40% below previous year levels.
Lower commissions result in lower payments to research providers. For those paid through a voting process, which has been increasingly adopted in the UK after CP 176, each vote is worth less, so unless you get more votes, your payments will be down along with the overall pool of commissions.
Commission management professionals say that the reduced research payments have been spread pretty evenly, from large investment banks to small alternative research shops. We spoke to large investors who said that they are tending to use bulge bracket research more because they can squeeze more out of them. At the top end, the investors with the largest relative commission payments can use the bundled pricing of the bulge firms to their advantage.
Nevertheless, we found a number of London-based alternative research firms which are expanding despite the adverse environment. The Financial Times published a story this past Sunday asserting that the financial crisis was helping independent research. The article featured Redburn Partners, an independent fundamental research provider with ambitions to replicate the success of Sanford Bernstein in the US or CLSA in Asia.
Redburn Partners has continued to expand throughout the crisis and now totals 130 employees. The firm was founded in 2003 by a group of executives from Robert Fleming & Co (Flemings) which was sold to Chase Manhattan (now JP Morgan Chase) in 2000. According to founding partner and Chief Executive Jeremy Evans, Redburn’s market share has tripled over the last three years.
Arete Research, another London-based fundamental boutique, is also mentioned in the FT article. Arete was founded by Richard Kramer, a star technology analyst at Goldman Sachs, in 2000. The firm has also expanded during the crisis, opening a Hong Kong office and now totaling 32 employees.
Further evidence of the growth of the alternatives is the expansion of EuroIRP, the London-based trade association for independent research providers. According to Rupert Eastwood, CEO of Japaninvest and current chairman of EuroIRP, membership in EuroIRP has expanded 25% over the last couple of years to 43 firms. Japaninvest itself recently received a minority investment from Societe General SA to provide co-branded Asian equity research as part of a trading and research partnership.
Part of the reason for the relative success of alternative research in London is environmental. The squeeze in commissions is so significant, and the impact of the financial crisis so severe, investors are taking a step back and reassessing their research options. Historically, alternative research has been most fondly embraced by the hedge fund community in London, but long only managers, which have tended to rely most heavily on bulge research, are beginning to consider alternatives. Alternative research often provides good cost/value, which is a more compelling proposition in the current environment.
Nevertheless, expanded market share does not necessarily equal growth, especially when the overall market is declining. Alternative research firms, although ostensibly faring relatively better, are not immune to the overall decline in commissions. While it is possible for firms like Redburn or Arete to grow, it requires new clients and new users. This is not an impossible task. Alternative research in London, and in Europe generally, has far smaller market share than in the US so it has more upside for growth. Not impossible, but also not easy. Sales and distribution, as always, is key.