One question many asset managers have been asking in recent months is how large should their research budgets be in today’s post MiFID II environment? While the answer to this question depends on a number of factors, it is also critical to understand the differences between what managers can include in their budgets.
Factors Driving Research Budget Differences
Generally, the smaller the assets under management of a manager, the larger that firm’s research budget will be as measured in basis points. This is clear from the data presented in the table below showing the average of research budgets of 19 European asset managers who publically disclosed this data.
Some investment strategies are just more research intensive than others, requiring that asset managers involved in those strategies make a larger investment in research. For example, research expenditures associated with emerging markets, biotechnology or technology portfolios generally run much higher than research expenditures for large cap growth portfolios.
Another factor which can drive a firm’s research budget is the number of investment professionals on staff. While this may be somewhat counterintuitive, most buy-side firms with larger research teams generally spend more on external research than firms with smaller research teams. This is typically due to the fact that buy-side analysts consume third-party inputs and insights as a core part of their research process. Consequently, firms that adopt an analyst intensive investment process generally have larger research budgets than those that require fewer analysts.
Regulatory Definition Impacting Research Budgets
However, research budgets of asset management firms headquartered in Europe appear to have lower research budgets than asset management firms headquartered in the US. Based on a recent survey we conducted of large US based managers, we discovered that even though the managers we interviewed were 85% larger on average than their European counterparts ($515 bln vs $278 bn in equity AUM), the US managers had a 46% higher research budget on average (1.9 bps vs 1.3 bps).
The key question is why are US research budgets higher than European research budgets? Do US managers actually spend more on research than their counterparts across the pond? Has MiFID II driven European research costs that much lower than in the US? The answer is, probably not. However, the difference in US versus European research budgets is likely based on a variety of factors.
The first reason US managers generally spend more on research than European managers is because of the regulatory prohibition against paying for meetings with corporate management using research commissions. Under the Section 28(e) safe harbor, US asset managers are allowed to use client commissions to pay for meetings with corporate management. Based on past FCA rulings and the MiFID II language, asset managers generally cannot include corporate access meetings as research expenses.
The second key reason for the difference in research budgets between the US and Europe is that asset managers are not allowed to pay for data related services using research commissions in Europe. In the US, many asset managers pay for this kind of content, including alternative data services using client commissions. Under MiFID II, European asset managers must pay for data out of their own pockets.
Of course, the continued use of bundled commission arrangements in the US could also be keeping research costs in the US higher than they are in an unbundled Europe. Unfortunately, the difference between what can be included in a research budget in Europe versus the US makes it difficult to determine how large an impact unbundling is having on research budgets in Europe versus US research budgets. It’s like trying to compare apples and oranges.