Research is King

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New York, NY – According to a new report published last week by New York based financial services consultancy Tabb Group, the quality of a broker’s research has become the most important factor in determining which firms get incremental execution business – eclipsing liquidity as the driving factor.  Consequently, buy-side firms are looking to reward brokers the most for providing insightful research, profitable trading ideas, and access to the IPO calendar rather than supplying fancy algorithms, smart order routers, or great sales traders.


Tabb’s Latest Findings

In Tabb Group’s new report called, US Institutional Equity Brokerage 2010: Assets, Commission Management and Concentration, author Laurie Berke explained that “Head traders absolutely must differentiate between commoditized execution services, value-added execution services and payment for research and ideas.  As they are making greater use of low-touch algorithms, they are increasingly establishing a cost-plus model across high-touch and low touch execution channels to cover their bills.  This puts underlying execution rates for high touch providers under increased scrutiny, and it becomes likely that there will be an increased allocation out of the blended high-touch rate for non-execution product, leaving sales traders a smaller piece of pie.”

Brokers are finding that they can no longer attract increasing trade flow like they did in the past for solely providing certain services – including agency execution, algorithms, smart order routing, block trading, and capital commitment.  Instead, the buy-side is valuing those brokers who provide high quality research services. 

The result of these trends is that the execution to research ration is shifting, with buy-side clients paying more for research and less for trading.  One group that Tabb sees benefitting from these trends is bulge bracket firms.

This does not mean that smaller players are expected to disappear.  In fact, Tabb sees opportunities for boutique brokers who provide high quality execution, insightful research, and investment banking services.  These firms will have their greatest opportunity with small and mid-sized asset managers who are increasingly underserved by their bulge bracket brethren.

These findings were based on interviews with 66 head traders at traditional asset management firms, including most of the largest mutual fund and investment advisory firms in the US.  They manage an aggregate $12.1 trillion in AUM. 


Integrity’s View

The conclusions of Tabb’s newest report are both consistent and inconsistent with the findings of Integrity’s research over the past year.  We agree that buy-side clients are looking to direct more of their execution business to brokers who provide value-added services like research at the expense of agency brokers.

In fact, we suspect that this development is one reason why a number of “agency only” execution firms have been looking for ways in recent months to either create their own research services or partner with third-party research firms to offer more value-added content.   

However, we have not seen the increased consolidation at bulge bracket firms that Tabb has seen.  In fact, we have seen a number of small and mid-sized indie research firms and boutique brokers actually pick up share in 2009, while a few of the bulge bracket firms we have spoken with experienced falling commission volume during the same year.

Regardless, we do agree with Tabb’s basic contention that the buy-side is no longer able to “pay up” for brokers’ trading technology, the liquidity they provide, or the relationships of their sales traders.  Instead, as the market has experience shrinkage in overall commission budgets, the buy-side has been forced to focus on rewarding the brokers most who provide the services that will truly contribute to enhancing their investment returns – including research, investment ideas and access to the IPO calendar.

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  1. . There is one very significant distinction between the US and the UK that effects the conclusion that execution is getting even more concentrated with the bulge bracket. The number of CSA counterparties for the buy-side in the UK actually has gone up, although this doesn’t necessarily mean that execution volumes have been correspondingly equally distributed. Part of this was due to risk mitigation after the crash; clients opened up more pots with the intention of emptying them every month, so no balances. But part of it is due to local regulation; investment banks (the bulge bracket) can and do get checks from for research from any pot, because there is real unbundling. This doesn’t happen in the US due to a convenient interpretation of the Securities Act of 1940 requiring the institution to be registered as an investment advisor in order to be a check getter. So, at the end of the day, clients in the UK aren’t directly or indirectly forced to trade with an institution in order to get its research so they are more likely to have a pots with more brokers of their choice.

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