New York, NY – In March 2007, a conference was held in London by AQ Research, on the topic of Navigating the Research Landscape. At this conference, three large UK fund management companies participated in a panel titled “The Rise of Research Procurement”.
A panel addressing the same topic will take place at the upcoming AQ – Integrity Conference which will be held in New York on June 15 (click through on the banner to the left for details). The following are edited comments based on this panel discussion.
The process was kicked off by the UK Financial Services Authority (FSA) publishing its consultation paper “Bundled Brokerage and Soft Commission Arrangements” (CP176) in April 2003. One fund management group’s experience was typical. CP176 was viewed initially as an ‘Operations and Compliance’ issue. That department formed a committee which set up an audit examining what was received from each broker, what sort of research it was, frequency and names. This process was of course very time-consuming.
The firm then decided to analyze what the research was worth and began to communicate this information to the fund managers. The fund managers now understand that: a.) they are in charge of the commissions used to pay for research b.) they can pay for it out of the P&L, c.) they are in charge of what they buy, d.) it costs money, and e.) they can have a say in what the price should be.
The dealing team is now free from any research-related decisions on where they should send their deal flow.
The evaluation method is determined by the investment manager as the consumer of the research. It is therefore up to them to sign off an amount of money that is reasonable in their opinion. They like to compare with independent research- for which there is a rate card. One important point is that their broker review system is now based on money, not points.
The difficult and interesting questions will revolve around how the sellside goes about pricing the research, valuing it, paying for it, and making the process sustainable (whether brokers or independents).
The FSA has changed the softing rules in the UK. Previously it was up to companies to define what they could pay out of a commission then make sure it tied in with the rules, which compliance officers used to check separately. Now the FSA says to companies ‘you may spend money on execution and research, here is our list of criteria which apply to anything you define as research, and it’s up to you to make sure the research you pay for out of commission corresponds with our definition’.
However, companies all interpret the rules slightly differently. For example, houses which used to soft are familiar with paying for market data services, whereas houses that didn’t soft may now consider it part of the commission payments for research, ‘if you can argue the case that it’s research’.
Question: How easy or difficult are the conversations with brokers about research, given that it was previously unpriced?
Answer: At the moment, the buyside tends to be able to dictate the price, but that relies on all of us being independently confident of the value of that research.
Question: Firstly – are you pricing your research on what the independents are charging, given that independents aren’t marketing as much? Secondly – if brokers are going to put bundles of research together, how would the panel find it most usefully priced?
Answer: There isn’t any enthusiasm to go down to menu level pricing unless the mechanism is already in place, as it is administratively difficult for both sides. Some FMGs price research internally by benchmarking independent research costs, but also by asking fund managers what it is worth to them.
Question: Although the buyside must be pleased that the CSA (Commission Sharing Arrangement) solves the administrative issue for disclosure, there could be a danger of throwing the baby out with the bathwater, in that the CSA is intrinsically unfair in terms of information power in favour of the bulge-brackets, which will inevitably eventually penalise the “sub-bulge-bracket providers” over time (and the IRPs), because the CSA brokers will have a monopoly on the information flows and prices which go through paying for these other providers.
Answer: The small-cap space or specialist markets need to be treated differently at times. One fund manager has simply tried to expand its CSA agreements with more than just the bulge bracket brokers. Fund managers want to maintain relationships with smaller companies so that they can be used when necessary.
Question: We seem to have moved on from valuing research in terms of cost towards valuing the ideas in the research. How many of investment managers to whom the panel has talked have come up with the idea of valuing the quality instead of the quantity?
Answer: It is hard to be consistent when you’re asking fund managers and analysts to value a service through comparing it to other different services, but this is beginning to happen.