New York, NY – Over the past few years, bulge bracket firms have been losing research commission dollars to regional brokers, boutique investment banks, and independent research providers. However, one surprising development which took place last year was that large investment banks experienced a reversal as they posted market share gains versus the alternative research industry. One big question for 2012 is will bulge bracket firms continue to pick up share against their smaller brethren or will they resume their downward slide in the portion of the buy-side’s overall commission pool they receive for their research?
Market Share Gain for Bulge Research
According to Greenwich Associates’ 2011 U.S. Equities Study released last June, bulge bracket investment banks increased their share of institutional trading commissions to 68% in 2010 – 2011 from 65% in 2009 – 2010. The portion of total institutional equity commissions that the buy-side allocated to bulge bracket research remained unchanged at 64%.
Overall, the buy-side paid 59% of their equity commissions to brokers for their research and advisory services in 2010 – 2011 – a ten year high. This compares to 53% of equity commissions allocated to pay for research in 2009 – 2010. This means institutional investors spent $6.8 bln on research in 2010 – 2011, down from $7.0 bln spent on research in the prior year.
Most analysts suggest that this increase last year occurred because the buy-side needed to allocate a higher percentage of their commission pool to pay for critical research services provided by bulge bracket firms as their overall commissions available shrunk.
Bulge Firms Might Maintain their Share
However, we suspect that bulge bracket firms and the sell-side in general, might be able to maintain their increased share of the research commission pool in 2012 for a variety of reasons. This includes the following:
- Continued Tight Commissions: Most professionals we speak to think that equity commission volume will continue to remain tight in 2012. If this is the case, buy-side investors will need to allocate a relatively high share of commissions to pay bulge bracket firms for the research services they provide that is critical to the buy-side’s investment process.
- Pickup in IPO Activity: Another valuable service that the sell-side provides the buy-side is access to the IPO calendar. According to Renaissance Capital, IPO volume is expected to rise modestly in 2012 to 133 deals from 125 deals seen in 2011 (with Facebook being one of the likely 2012 IPOs). Asset managers who want access to these IPOs will need to make sure they continue to pay their investment banks enough equity commissions to receive reasonable allocations.
- Breadth of Coverage: Bulge bracket firms and other large broker dealers provide a breadth of coverage that becomes cost-effective for many buy-side firms due to the economies of scale that these larger firms possess. Consequently, larger research users could actually pay more in total to a range of independent research providers than they would pay a smaller group of broad-based sell-side firms. This becomes particularly relevant when commission dollars are scarce.
- Insider Trading Fears: In 2011 many buy-side firms decided that the compliance risk of using broker-dealer research was considerably less than that of using alternative research (a view that we disagree with). This led some institutional investors to focus their use of external research on sell-side firms. If these concerns continue through 2012, we would not be surprised to see some buy-side firms continue to allocate more of their research commission dollars to sell-side providers versus indie firms.
As we discuss above, the market share gains that bulge bracket investment banks experienced in 2011 could well continue in 2012 for a number of reasons. Such a development would bode ill for the alternative research industry as they will be forced to compete for the limited research commission pool that remains. This trend could be exacerbated by move of some agency brokers to jump into the research business in order to increase the amount of commissions they can charge their buy-side clients.