It is out in the open, out of the closet, there for all to see, the emperor has no clothes! Your fees have been bundled!
It is estimated that about 40,000 research reports are produced every week by the world’s top 15 global investment banks. We could therefore hypothesise and estimate that the top 50 produce roughly 140,000 reports a week.
It would be no doubt a daunting task to have to read through all these reports in order to extrapolate the nuggets of wisdom that could help you get a return on your investments or save you from making a bad investment. According to a recent report by Hong Kong-based Quinlan and Associates, less than 1 percent of these reports are actually read by investors. It is not a surprising finding considering the number of hours available in a day!
It is also widely recognised that investment managers are inundated with an oversupply of free and “duplicative” research reports (including sales notes), many of which are considered of questionable value. According to discussions with the buy-side firms, in preparation for the Quinlan report, it was indicated that managers with the greatest capacity to pay (i.e. large funds) appeared to derive the least amount of value from published research. What is not clear are the reasons. They are paying but not reading all the material, therefore producing no return on investment? They are reading the material but the number of potential actionable trades are limited in comparison to the amount of investible money they have under management?
For years banks have been bundling the cost of their research into trading commissions charged to their clients. Therefore, whether the clients read the research or not it is the clients who have been absorbing the cost of it. This has led to new rules, known as Markets in Financial Instruments Directive, or MiFID II, due to take effect in January 2018 aiming to make European securities markets more transparent. This may impact all of us whether or not we are located in Europe.
ESMA (European Securities and Markets Authority) cited a number of key issues with research that MiFID II addresses, including:
- Limited transparency around research costs and spend by asset managers (given there is little or no disclosure to end investors);
- Risks to end-investors’ best interests (given research is paid out of client funds); and
- The absence of a level competitive playing field (given that the lack of price transparency makes it difficult for independent research providers to effectively compete).
Most US and financial institutions worldwide will be impacted in 2018, and therefore indirectly all of their clients as well, even if they do not have any European physical presence. Any firms or their subsidiaries world-wide that are trading European instruments including equity, fixed income, or derivative income will be impacted as well as any that are performing any cross-border services that include Europe whatsoever.
When we became aware of this situation we decided to look deeper into the research being produced by the world’s top 50 largest wealth management institutions. We parsed through thousands of pages of these reports, many being qualitative, often confusing and ambiguous. They used terms such as “may”, “could”, “potentially”, “perhaps”, or “possibly”, covering every possible angle not to take a strong position. Our objective was to find patterns of consensus in as many different areas as we could, removing the possibility of duplications. In addition, we wanted to highlight the products which would be best used to follow these recommendations.
This project was an interesting exercise but not one without its challenges. Having a solid understanding of the financial markets, products and the inherent complexities we found that many of the banks lacked support for their hypotheses as well as market scope and product scope in their write ups. This required us to search deeper into additional research reports and interviews. We also found examples of contradictions within their own research teams.
It is clear that considering the new MiFIDII rules, the banks have begun to reorganise their research functions. They have started focusing on top-tier clients in order to minimize costs, and adopting a model where clients pay for research depending on what they need. There are still masses of data being produced daily so this situation will not be alleviated over night.
Recently global investment banks such as Standard Chartered, CLSA, Jefferies and Barclays, among others have begun reducing staff or have completely pulled back from equity research and sales businesses in some markets.
Having to suddenly pay for and understand how much they are paying, for research, Fund managers will most definitely become more selective and disciplined in their research spending decisions. They will now be able to compare and contrast research pricing among various providers. Greater transparency will also help end-investors to evaluate the value of one research firm in comparison to another and evaluate the return on their research investment spending.