Holding The Cost Of Research To Account
Edward Stockreisser, Chairman of the Asian Independent Research Providers Association.
We’ve been talking about changing the way research is funded and charged for five years. Unbundling is now prevalent, even in Asia, as much as people say it is not. The fundamental thing about Asia that people often misunderstand is that Asia is actually made up of about seven or eight different countries, with their own cultures, regulated bodies etc.
It is true that Commission Sharing Agreements have taken place and customer execution costs are being driven down enormously, but as Chairman of Asia IRP I feel that independent research and the importance of research in an unbundled world (or just a sharing world) isn’t being looked at in enough depth. There’s a huge disconnect between the portfolio manager, the trader, the broker and the research side of every sell-side or independent research provider. Ultimately, no one cares if research is independent or not, they just want good research. The trader wants the orders, the broker wants the flow, the sell-side just want to run effectively as a leader in their research department and the research provider just wants to get paid. But there’s no factor central to this that makes any one care over and above their counterparties. So this is why research has not been looked at.
Development of ‘best research’
The best research is impartial and unconflicting; where the research provider isn’t hampered by a Chinese Wall or a compliance department restricting what can or can’t be said. But, ultimately, best research just means the best ideas. Industry-wide, the average readership of research is about 10-12%. So if you are paying US$100,000 and only gaining 10-12% readership then that means one of two things: Either, the US$100,000 you’re paying is just for that 10%, which means the total value of the research is US$1million — which is obviously an issue. Or it means that money is being wasted and the US$100,000 you’re spending is being thrown away. So how do you re-adjust that readership ratio? At the same time execution costs are being driven down, so let’s drive down what’s being paid to those research firms that aren’t the best in the region.
Changing the culture
It’s got to be about an increase in transparency, for people to ask themselves and their fund managers or money managers “where are you spending this money?” and “who’s given you this idea?”, “why are we not short Apple in September?” — those kind of questions need to be asked, and not just because there might be an IPO going on somewhere else. It’s got to come from bottom up — it’s all about being very ‘macro’.
The services need to be standardised. Research has absolutely zero value until it is being used. I don’t believe that you have to charge the same price for the same level of service. The value-based system is about how much value you have in the investment process which may be about timing, it may be about macro. It’s that return given by each individual. At the moment there is no mechanism to see each individual’s return. The number of research writers has risen in the last ten years from about 15 institution-level people globally to over 500. So if the concept of best research does exist, how do you access those 500 independent researchers, most of whom are the highest-rated people in the surveys and how do you make sure that they all get paid? And how do we ensure that a pension fund or portfolio is getting access to that expertise based as far afield as it might be. How do we access those ideas? We are not using research sufficiently and the research we do have we are not using properly.
People have been talking about soft dollars etc. at conferences for a long time, but what are they actually talking about? You have to remember why CSAs and unbundling came about; because of the level of unacceptable and unnecessary expenditure in the industry that investors shouldn’t have been paying for. We don’t actually talk about that underlying reason, we just talk about the procedure and process that means that brokers now are all scrabbling around for business. Research providers are all trying to get paid.
There needs to be much greater transparency in the system. People must be accountable for the amount of research they’re consuming and commissioning. Research writers need to be able to work without having to spend months travelling to access investors. There also needs to be a mechanism whereby they can get paid efficiently which would allow this conduct of best research to be as applied as ‘best execution’. This is all about transparency but currently there’s doesn’t appear to be any incentive or mechanism to give that greater degree of transparency.
The right tools
There are some systems that allow you to pay an analyst on the sell-side but there is no impartial system there for the greater good of the industry. PMs don’t care which brokers their traders use. The brokers don’t care what research provider the PM has paid for. There are many examples of researchers who may have worked for six months and not been paid only to find that the relevant trader was paying the wrong research provider in the first place. There is a disconnect, which is not the fault of the trader or the PM – it is just the mechanism that’s at fault. At Asia IRP and Europe IRP and from the investor side, we are trying to regulate and implement these things, but it’s all about pushing the CSAs.
Asia IRP is trying to create the Asia’s first independent research forum.
You can see it happening already with the sell-side talking about reducing their research funds because it is a loss maker. Now it’s not my concern as to whether independents get paid or not but what happens to the minds on the sell-side that are being cut from the banks? In 2008 the most senior experienced minds were hit by the financial crisis. They are either going to become independent or retire. You are then left with research departments run by the more cost effective, junior, less experienced research providers who are not able to offer the concept of ‘best research’. And at some point, with the market shrinking the way it is, the industry is going to have to find a transmission mechanism to bind itself together.
It’s not just about driving cost sharing. But it’s about re-pricing things that we value and things that we don’t, which have been bundled together for so long.