THE FUTURE OF RESEARCH
Research is a hot topic right now, with MIFID 2 requiring that research providers ‘unbundle’ the cost of their research services from other services provided such as execution.
I attended the third Global Independent Research conference earlier this month, where some smart and stimulating speakers kept the audience on their toes. But the real talk was about what is going to happen after January 2018 when MIFID 2 takes force. How will that change business models and who will end up paying?
Active investors need to generate an ‘edge’ somewhere. Some do it via purely internal research, others use what has until now been provided for ‘free’ by investment banks and brokers, or they purchase from external independents. Most use a mixture of all three.
The first and most important question to ask is what really adds value. Given how competitive markets are today, research needs to be without hidden agendas, to be somewhere near best in breed - it’s not possible for all research to be value-additive - and above all relevant, by which I mean addressing the same problem the investor is trying to address.
None of the three sources of research can hit all three of those points: in-house cannot by definition be best of breed across all sectors; broker or investment bank research clearly has the potential to be conflicted; and independent research is only likely to be relevant to an individual client part of the time.
Then there are the problems of how to evaluate value-added versus cost and how to keep control of costs for margin-pressurised investing institutions. Earlier this year, seven or eight digit figures were being floated about as the cost of research from large investment banks. To the independent sector, those will seem laughable for research which is clearly potentially conflicted. But if research is simply seen as a cost, it will be a race to the bottom and investors will take poor decisions when choosing what to pay for.
So what of the future?
Will asset managers follow the model of paying for research themselves? If so, we can expect cost control to feature large. The implications may be i) a smaller number of deeper relationships, ii) use of fund managers research resources where an asset manager uses third party funds, and iii) more in-house research. Or will they continue to include the cost of research in the fees they charge funds? In which case, there will be less transparency, probably less strict cost control and, I’d expect, established relationships continuing for longer. There is also the question of whether to access research through the consolidating platforms or on a pay-per-view basis. The former make a wide range of research available to choose from and the latter allows users to target expenditure on relevant research respectively. Neither help in identifying what really adds value and is worth paying for. Here I rather like the idea of giving each fund manager a fixed sum per annum out of their total remuneration. The fund manager could either spend it on external research or, if they thought nothing was worth paying for, they could keep the money themself. That might concentrate minds; however, it would be hard to implement in large firms and wouldn’t help evaluate in-house research.
In my crystal ball, the model will evolve slowly and will still involve research from different sources. There will be consolidation of alpha-generating analysis, whether via platforms or under ‘umbrella’ brands. Indeed branding will become more important as relationships become fewer but deeper. Pay-per-view may fill some of the gaps and be a separate but viable model for some lower cost operators. Objective data will become more in demand than subjective opinions. Will it lead to more alpha being generated? I very much doubt it. Will it lead to cost savings? Again, I very much doubt it, except in the sense that fund managers will shoulder the burden on their own profit and loss account rather than their clients.