First published in Tabb Forum, January 2021.
The investment research market has now undergone two major shocks to demand and supply within three years; firstly MiFID II’s research unbundling requirements in 2018, and more recently the move to entirely virtual engagements in response to COVID.
This has presented asset managers with a number of challenges. Their first priority was to ensure that the investment process wasn’t negatively impacted in the short term, but it was also clear that their newly created research valuation processes would be stress-tested by the disruption. That has indeed been the case, with a cycle of increased research consumption being more than offset by lower valuations per engagement when provider payments were calculated at the end of 2020.
From a regulatory perspective the global research market shows no sign of convergence. The EU gave beleaguered research suppliers hope over the summer with their much vaunted COVID relief rollbacks, but as we now know, the only change in research rules will be the ability to rebundle payments for research that covers companies with a market cap below €1bn. (The FICC research rollback never made the final cut, which – in my opinion – would have been the most actionable and useful part of the softening plan.) This small cap carveout will have a negligible impact – any savings would be outweighed by operational costs and complexity in the eyes of most asset managers.
At the same time, almost all firms in the US continue to pass research costs to their client base and the US Securities and Exchange Commission (SEC) is in no hurry to emulate MiFID II. In the US, research provider lists are longer, and whilst budgets have decreased over the last few years they haven’t reduced by the same proportions as their European counterparts. However, on both sides of the Atlantic buy-side firms are working with capped budgets, meaning they are allocating their research dollars increasingly carefully and transparently. They are keen to optimise their research spend and better manage their broker relationships, whilst recognising where their providers are investing.
Brokers are continuously making changes across their analyst teams as they concentrate on their comparative advantages and areas of greatest leverage. And now, asset managers are keen to track analyst moves and evaluate and benchmark their payments to research providers.
Our latest research looks at global developments in analyst moves since MiFID II came into force and our findings show that:
- In proportionate terms, since MiFID II came into effect, European brokers have shrunk their analyst teams at least three times more than their US counterparts. We have seen a 12% loss of analysts in Europe vs a 4% loss in the US.
- For both Europe and the US the majority of analyst losses took place in 2018 and 2019; increases in 2020 YTD do not outweigh the previous losses.
- Of the analysts lost by US banks from 2018-2020, 61% covered US markets, equating to 172 individuals. Of the analysts gained over the same period of time, 16.3% (equivalent to 46 individuals) are in the UK. In other words, US banks have shrunk their local teams but continued to invest in their international presence, increasing the number of analysts in the UK (who also cover Europe from the UK) and Asia, to cater to customer demand for research coverage outside the US.
- Of the analysts lost by European Banks from 2018-2020, 66% covered the US; this equates to 121 individuals. However, European banks increased their UK-based analyst teams by 8.2% over the same period of time. This means European banks have consolidated back to their core markets, providing pan-European research coverage from the UK and withdrawing from the US.
- From 2018-2020, US brokers in aggregate have grown their analyst teams covering Financials (+6%) and Real Estate (+10%), and shrunk in the other sectors, with Energy (-23%) and Industrials (-21%) being hardest hit.
- In 2020 alone, US banks have increased their analyst teams across six sectors, with the highest gains being across Financials (+18%), IT and Real Estate (with 9% each)
- In Europe, brokers have shrunk their teams across all sectors between 2018 and 2020, with Energy and Healthcare being hardest hit, with an 18% loss of analysts in each area
- In Europe, in 2020 alone, the downward trend continues with Healthcare shrinking 14%, Financials and Energy each losing 7% of their analyst teams and IT being the exception, showing a slight increase of 2%.
What asset managers need at this time, is an aggregated perspective of analyst moves across the market in order to evaluate where banks invest or disinvest, benchmark sector expertise gains and losses broker by broker, and ultimately decide how to allocate their research spend in relation to the areas and asset classes relevant to them. What’s more, firms need to be able to recognise new areas of quality and coverage inside and outside their existing research list, particularly in Alt Data and ESG.
The global pandemic has led to far reaching changes across both asset managers and their research providers, many of them structural and for the long term. The good news is, demand for quality research is higher than ever. The challenge for providers is that the buy side is more discerning and better informed than ever before.
The research findings in this article are provided by Substantive Research’s Analyst Mapping Tool.