Fund Managers Find Little Value in Broker Research

Shanny Basar

Nearly two-thirds, 61%, of fund managers said they find little or no value in broker research, which is not encouraging for current providers as new regulations will force the buyside to pay for research and assess its value.

In a report Quantifying the future, Rebecca Healey, head of European market structure and strategy at institutional dark pool Liquidnet, and Niki Beattie, founder and chief executive of consultancy Market Structure Partners, said the relationship based on written research and conversations between the buyside and sellside is unsustainable. The report was commissioned by TIM Group, the independent trade ideas network.

Beattie told Markets Media: “More and more of the buyside are doing their own research and spending money on new data sets, such as social media or satellite imagery. There is a mismatch between what the sellside is producing and what the buyside wants.” The study found that 56% of fund managers interviewed are now paying fees for other third-party data sets.

MiFID II, the regulations covering financial markets in the European Union from 2018, requires asset managers to either pay for research themselves out of their own revenues or set up research accounts for clients with agreed budgets.

Beattie said that as fund managers allocate budget to increasing numbers of data sets, they will be forced to be more discerning about the data they take, the suppliers they rely on and their evaluation metrics. She pointed to one fund that takes a lot of trading ideas but only pays the top 25% of performers, which can be months after they have used the research.

Colin Berthoud, co-founder of TIM Group, told Markets Media that the firm already tracks the performance of a stock relative to the market for the timeframe of that idea, which is typically two weeks to three months. “We are seeing demand to integrate our performance statistics with broker votes,” he added.

Anticipating MiFID II, a new report from consultancy Greenwich Associates, found that European fund managers have already started to adapt to the incoming regulation but many expect more dramatic change over the next 12 months. The respondents expect to shift to paying for research from their own revenues or to pass charges along to clients as an incremental fee. The consultancy interviewed 197 European equity portfolio managers and 178 European equity traders between March and May 2016.

John Colon, managing director of the market structure and technology practice at Greenwich Associates, said in the report: “The results imply a perhaps 10% decline in overall research budgets which, though painful, does not herald a collapse in the market for research.”

In Quantifying the future, 77% of respondents said they expect to put automated processes in place to manage and measure broker contributions due to MiFID II, including some outside Europe.

Greenwich Associates added that institutional cash equity commissions from traditional active investors in Europe have fallen 8.5% in the past year and are only half of peak levels in 2008. Institutional cash equity commissions were approximately $3.44bn for the 12 months to the end of the second quarter of 2016 and  on average, institutions allocated a 53% of commissions to research/advisory services. Service and access were the most valued, especially by the larger fund managers who were most able and willing to pay.

Colon said: “However, this is a simple average that obscures a downward trend among larger institutions, as commission spend attributable to research/advisory fell from 58% of overall commissions two years ago to 50% this year. Among larger UK institutions, the decline is even more pronounced, with research advisory now accounting for only 46% of overall commissions.”

Larger asset managers have also reduced their broker lists from an average of 28 to 24 and more cuts are expected next year.

MiFID II aims to ensure that the provision of research does not induce fund managers to trade inappropriately through setting up research payments which are independent of the trading desk. However Esma has also allowed existing commission sharing payments to be used to separate payments for best execution and research.

“The proportion of European institutions utilizing CSAs climbed to 59%, including nearly 85% of U.K. institutions, while the proportion of total commissions flowing through CSAs increased from 39% to 44%,” added Greenwich. “More impressive is the jump from 40% to 49% in CSA commission flows among larger institutions.”

Greenwich found that fund managers expect a significant decline in use of research from global investment banks and a significant increase from independent research providers, including non-global investment banks.

Nearly three-quarters, 69%, of respondents in Quantifying the future thought that the best quality recommendations in small and mid-cap now come from local and regional specialists. The report said: “Some cited new sets of broker-compiled data that they pay for, for example summaries of short positions or agricultural data feeds.”

In addition nearly all, 94%, thought that funds using quantitative techniques relying on new tools, techniques and expanded data sets would continue to increase in popularity.

“Once a niche business, quantitative investment management is on the rise and provides the best hope of countering the shift to passive investment,” added the study. “Along with the rise in pure quantitative funds, fundamental managers are expanding their investment strategies into more fluid, quasi-active models, requiring entirely new tools and techniques and expanded data sets and sources.”

The UK Financial Conduct Authority was critical of the active management industry in a 200-page report on the industry last month. The regulator concluded that limited price competition means that investors often pay high charges and on average, these costs are not justified by higher returns. The limited price competition means that fund management has enjoyed sustained, high profits over a number of years, despite clients not making their desired returns.

The FCA illustrated the impact on costs on a £20,000 investment over 20 years to show the impact of charges. An investor in a typical low-cost passive fund would earn £9,455 (24.8%) more than an investor in a typical active fund, and this could rise to £14,439 (44.4%) once transaction costs have been taken into account.

The regulator said most active equity funds charge fees of between 1% and 0.75%, which has not changed over the last decade. Fees do not fall as the fund size increases so economies of scale are captured by the fund manager rather than being passed onto investors. As a result, asset management firms have consistently earned substantial profits across the FCA’s six-year sample, with an average profit margin of 36%.

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