In the trade execution space, there has been strong anecdotal evidence of a shift away from bulge-bracket brokers towards agency-only houses. Equally, in the equity research space, the advent of commission sharing agreements, which allow the buy-side to pay for research with commissions rather than order flow, has opened new doors for independent research providers.
Independent research houses seem to be finding particular success in the US. “Some small boutiques have sprung up and are basing their model on being paid directly for their research. They have got low overheads, no trading apparatus and they seem to be doing very well,” says Bernie McSherry, senior vice-president for strategic initiatives at US agency broker Cuttone & Company, which partners with independent research firms to provide its clients with market insight. “In fact, we are seeing small independent firms popping up more frequently.”
Colin Berthoud, founding partner of financial technology provider youDevise, developer of the Trade Idea Monitor service, agrees that more independent research providers are emerging in the US, adding that they are particularly active in the small-cap space. “The large buy-side firms do not necessarily have analysts trawling the entire market and so seek input from the smaller independent research providers,” he says.
In Europe, the majority of trade ideas still come from brokers rather than independent houses, argues Berthoud, but he adds that there are a handful of new entrants joining the market each month.
However, what CSAs give independent research providers with one hand, they arguably take away with the other. Research houses are often paid from a buy-side firm’s CSA pot on a quarterly basis, which means firms can face a long wait to reap the fruits of their labour.
If that were not enough, a research firm may need to attain a particular status at a buy-side firm before it sees any commission at all. The amount buy-side firms pay research houses is typically determined by a ‘broker vote’, where portfolio managers and other key users of the research are asked to rank the providers on how useful their input was.
“You have to get on the voting list, then win the vote, then wait to get paid, which can take as much as nine months,” says Iain Johnston senior managing director and founder of independent UK research house New Street Research. “This is not a problem if you are a well-established, well-funded business. However it isn’t helpful for the newer entrants.”
It can also be difficult for an independent research provider to work out how much it will be paid. “Different buy-side houses value research in different ways and there is very little consistency across the market,” says Johnston. For example, some buy-side firms may value access to the senior management of a company they are investing in, which they could arguably get themselves by contacting the investor relations department, as highly as proprietary research. Equally, argues Johnston, the amount of research commission a buy-side firm generates is not necessarily commensurate with its assets under management.
While vexing for the research providers, any lack of clarity about valuation of and payment for research could ultimately harm the buy-side. “If a firm is not properly valuing and paying for research, the research houses will stop servicing them,” says Johnston.
There is some evidence, however, that the buy-side’s research valuation techniques are becoming more transparent and quantifiable.
“Historically the process was, ‘Here’s a list of brokers, tell us your top 10’ or ‘Take 100 points and allocate them between your top 20 brokers or research providers’,” says Robin Hodgkins, CEO and founder of Cogent Consulting, a provider of commission management technology. “Now it can get down to finding out from the brokers exactly what meetings and one-on-ones at conferences occurred and building up part of the model based on actual metrics as to what services those research providers gave.”
Nevertheless, Hodgkins feels that independent research providers in particular should forge stronger ties with the buy-side. “Independents must understand that there is a strong need to communicate the value of the services they are providing to the buy-side to get the best possible vote for their services,” he says.
Improving research valuation should be a win-win. As well as giving the research provider a better of idea of how much commission it will receive, it should also result in better service for the buy-side.
“Some firms are crystal clear on why they are paying you, who they are voting for and who they value. It gives you a roadmap and a lot of times it can help you penetrate an account better,” says Rich Parker, managing director and head of equities at US agency broker and research provider Concept Capital. “The clearer the buy-side can be, the better it is for everybody – and some of them have done a really good job.”
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