Sell-Side Research is Not Dead Yet


New York, NY – This past week, head of global securities research and economics at Merrill Lynch, Candace Browning wrote a detailed memo to clients outlining the rationale for the investment bank’s widely expected move to restrict the availability of their research to their best clients.

In Ms. Browning’s memo, she rigorously defended the value of sell-side research – contending that “sell-side research is alive and well.”  While we must admit that the “golden age” of sell-side research is behind us, and that investment banks face considerable challenges in the coming years, we must also agree with Ms. Browning that sell-side research is by no means dead.

The Strength of the Sell-Side Lies in Their Assets

It is clear to us that one of the strengths that will contribute to the success of some sell-side firms’ research businesses lies in the brand name of these organizations.  In fact, we think the strength of these brands has enabled some of the world’s largest investment banks to be viewed as strategic partners despite the fact that they compete directly with many asset manager’s own businesses.

In addition, many of these large investment banks have been able to escape the negative impact of various scandals they have been embroiled in – due in large part to their highly trusted brands.  We suspect that this asset will continue to benefit these firms’ research franchises.

Another strength that should help some sell-side firms continue to succeed in the research business is the scale and scope of their global infrastructure.  It is clear that some clients (particularly those who invest on an international basis) value the size, depth, and expertise of a bulge bracket firm’s global research department.  Clearly, the cost to replicate such an infrastructure is prohibitive for all but the world’s largest asset managers.

A third asset that should benefit some sell-side firms’ research businesses in the coming years is the extensive distribution capabilities and the close relationships they have with large and influential money managers.  As we have said many times in the past, research is sold, it is not bought.
Many of the largest sell-side firms understand this fact, and they leverage their extensive institutional sales capabilities to “sell” their expertise, advice, and research capabilities.  Even if smaller brokers and alternative research providers could compete on research quality, they find it extremely difficult to compete in the marketplace due to the extensive marketing resources of many large investment banks.

The Strength of the Sell-Side Lies in their Financial Diversity

It is also important to understand that most sell-side firms have the added benefit of being able to support their research operations from a number of diversified businesses, including equity capital markets, investment banking, proprietary trading, and prime brokerage.  In fact, very few investment banks could finance their research businesses solely from institutional equity commissions.

In the wake of the Global Research Settlement, investment banks were prohibited from directly tying analyst compensation to their investment banking businesses.  In addition, research analysts were barred from participating in investment banking road shows.

However, these firms were not barred from using the profits from investment banking to help finance their equity research departments.  In fact, today the investment banking divisions of many of the world’s largest sell-side firms finance between 30% to 40% of the operating costs of their firm’s research departments.  This does not include the profits derived from proprietary trading or prime brokerage.

A related factor that should enable some sell-side research businesses to succeed is the fact that they can financially afford to hire some of the world’s “best and brightest” analysts.
Survey after survey suggests that, after management access, the two most valuable aspects of the research product are industry insight and access to analysts.  Consequently, institutional investors say they value the analysts’ experience and brain power.  As a result, you would assume that the buy-side would find the firms with the smartest most experienced analysts to be the most valuable.

The Strength of the Sell-Side is Based on Learning from Innovative Firms

For years, countless US management gurus explained that the strength of many Japanese companies was their ability to discover and implement innovative strategies, technologies, and business models in a successful manner.  We believe some sell-side firms will succeed in the future in the research business because they, like many Japanese companies in the 1970s and 1980s, were able to learn from other innovative businesses in their industry.

In 2002, Credit Suisse First Boston decided to acquire quantitative independent research provider, HOLT Value Associates LP.  The HOLT valuation software and global database was integrated within the bank, enabling the firm to expand its corporate consulting business and enabling the firm to estimate the fair value for thousands of companies.  In addition, the HOLT capability has allowed CSFB to profitably expand its research coverage of small cap companies.

A few years ago, Bear Stearns decided that their clients would benefit it they brought the “expert network” model pioneered by Gerson Lehrman Group, in-house.  As a result, the firm developed their own healthcare “expert network” called Primary Insight.  More recently, it is rumored that Goldman Sachs plans to do a similar thing for their clients.

In 2005, CSFB developed an innovative new offering by establishing a partnership with technology provider Relegence to release a new intelligence delivery product. The product called Relegence Connect combined CSFB’s mapping of company relationships and industry supply chains with Relegence’s content sourcing and filtering capabilities to help investors anticipate investment opportunities based on related news flow. Initially this system was used by CSFB’s research analysts, though the system was offered to CSFB’s best buy-side clients.

More recently, Goldman Sachs discovered the value that independent research and analytic tool providers could offer their clients.  Consequently, the firm introduced Hudson Street Services – a platform to market high quality third-party research to clients in an effort to increase the firm’s execution business and strengthen their customer relationships.

Of course, Goldman’s idea wasn’t new as other firms have tried a similar approach with mixed results, including Instinet, BNY JayWalk, and CitiBank.  It is likely that other investment banks will develop their own versions of the Hudson Street model in order to build their commission business by leveraging the burgeoning alternative research space.

Some Firms Will Become Buggy Whip Manufacturers

In the 1800s, one of the most prosperous industries in the United States was the buggy whip manufacturer.  And while a few companies still produce buggy whips, this industry has all but disappeared with the popularization of the automobile in the 1900s.

Similarly, we believe that a number of mid-sized, regional, and boutique sell-side firms will not be able to leverage the assets, resources, capabilities, and insights discussed above to maintain a thriving research business.  As a result, we suspect that a significant number of sell-side research departments could go the way of the buggy whip manufacturers.

This is particularly true as declining equity commissions, unbundling, and the proliferation of Commission Sharing Agreements threaten the very core of many of these businesses – forcing a number of firms to choose if they want to become undiversified research providers.

Thus, we expect that some sell-side firms will be able to maintain strong research franchises in the years ahead as they leverage their assets and capabities and learn from innovative new research businesses.  However, we also suspect that some sell-side firms will not be so fortunate in the coming years as their research businesses become less relevant to buy-side clients.


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