As we enter the final third of 2011, the outlook for independent research remains difficult. We presented forecasts for 2011 at a conference this spring hosted by Investorside Research Association, the U.S. trade association for independent research providers. At the time, we predicted 2011 would be a tough year for independent research, but we were too optimistic.
At the time we expected 2011 to be flat, with pressures in the first half of the year abating in the second half, prompting a modest rebound. Instead, conditions have continued to decline, and we are now projecting spending on U.S. independent research to decline 11% from 2010, to under $1.5 billion. From the peak in 2008, spending is down over 30%.
There are three factors impacting independent research. First, overall spending on research–whether investment banking or independent–is challenged by declining equity commissions, which are the primary payment vehicle for research. U.S. equity commissions were down 8-10% as of July, although recent volatility in the markets has helped somewhat. As Greenwich Associates has pointed out, the impact of declining commissions has been muted for research, as investors have increased allocations for research at the expense of execution. But with research allocations at 60% of commissions, how much longer can investors continue to rob from execution to pay research?
Second, increased IPO activity is prompting investors to increase their commission allocations to investment banks to assure that they will continue to receive IPO allocations from underwriters. Often this is at the expense of independent research.
Third, heightened compliance reviews by investors in the wake of insider trading investigations is impacting a broad range of independent research providers, not just expert networks. The insider trading investigations into expert networks, which first became public in November, shows not signs of slackening. We had expected concerns to begin to abate by the second half of the year, but instead investor scrutiny has continued. Independent fundamental research firms, industry consulting firms, forensic research are impacted along with primary research firms.
More rigorous compliance reviews are making it harder for independent firms to attract new clients. The sales process, already a challenge for many independent firms, has gotten even longer and more involved. We hear from many independents that sales has never been tougher than it is in the current environment. For small firms with limited compliance capabilities, prospects are even worse.
Fortunately, the environment outside the U.S. is not as unfriendly to independent research, so firms which have a non-U.S. presence are benefiting from more favorable conditions in Europe and Asia.
How long will U.S. firms need to tough it out before conditions improve? We are expecting that conditions will improve next year, in the second or third quarter. Are we continuing to be too optimistic? Conditions are difficult to forecast, but independent research has a number of advantages going for it: non-consensus insights, innovation, and a lower expense base. Independent research is not going away, but it will have to hunker down for the time being.