By Fabrice Bouland, CEO, Alphametry
The market for investment research has undergone prolific changes since MiFID II kicked off in January this year. Indeed, despite endless discussion and debate prior to the 3 January deadline, the lack of preparedness for research unbundling was palpable. We are now in a situation where this new regulation has bought the investment research market to an almost grinding halt – how long before we begin to see the adverse effects of reduced access, falling quality and unsustainable pricing on what MiFID II was ultimately put in place to protect – the investors themselves?
Commercial agreements for research portals had been put in place following a price discovery process in the latter half of 2017.But even on 3 January and to the present day some market players are still in discussions with, and even trialling, historical providers to keep pressure high within the negotiation process and better understand which providers and analysts deliver the most value. Because of this we have seen the European research market all but freeze over since the start of this year with many of the independent research houses calling for a reprieve from MiFID II rules and some predicting that asset managers are going to face a price shock as research trials come to an end in the next few months.
Besides freezing the European research market, hopefully temporarily, the first few months of MiFID II unbundling have been highly informative about two things – how is research really used and how is it evaluated?If nothing else, these first few months of pain may serve as a valuable wake-up call and prompt the entire industry to seek and implement more effective ways of evaluating and accessing the research they need.
At the end of last year and with MiFID II looming large on the horizon, European investment firms conducted last minute surveys among portfolio managers to gage opinion on which research providers were most valuable and required.
This process resulted in a consensus being established and the research franchise perimeter left mostly untouched, albeit that plummeting research prices driven by global investment banks offered quite a lot of breathing space at that point. As a consequence, cheap, in many cases almost free, bank portals were contracted and most of the higher-priced, independent research was cut off from investment managers. In more extreme cases, some smaller investment firms took the bold move of doing without research at all. A risky strategy to ascertain, one would assume, if investment research provides any value at all to the investment process.
What MiFID II has ultimately shown us is the historical ambiguity investment managers have always had with research. There has never been an easy way to answer fundamental questions like ‘what research is needed’, ‘how much should we pay for it’ and ‘how do we measure the value’. This lack of structure has been pulled well and truly into the spotlight under the new EU regulation, as well as the financial services sector’s slow take-up of new technology which would help it answer these questions.
Active management seems very ill-equipped to survive the information age. The lack of information technology systems coupled with investment styles relying on opinions and assumptions rather than a structured, analytical approach prevents discretionary managers from benefiting from new alpha-generating research, like alternative data. Interest is high but successful implementation still low so what is the solution? A new approach to research evaluation and access is clearly needed, if we can break free from the current state of paralysis in which investment managers are not getting access to the tools they need.
Any industry which does not understand where value is generated in order to deliver its business proposition shows structural signs of competitive issues. If no data can be found and used around the investment process most essential inputs, it invariably means that the tools needed to materialize it are either non-existent or inefficient. Utilising new technology could address the ‘problems with research’ that we are seeing in the current market.
Although things have got off to a slow start now MiFID II is in practice, the opportunity for research platforms that draw from multiple sources and enable the asset manager to fully evaluate particular providers or analysts is significant for both buy and sell side
Evaluation must be bottom-up and data-driven if firms are going to establish where reduced budgets need to be focused, and which providers deliver the best ROI. New research platforms provide the opportunity for managers to better understand what they consume, as well as helping providers hone in on providing the most valuable and relevant content. In the longer term, the benefits of real-time data on research must surely be the main driver of research budgeting decisions, it is just unfortunate that the new regulation and its enforcers could not have provided more impetus for change and have, so far, succeeded only in creating a market which is actually less beneficial for investors who need high-quality and relevant research in order to get the best returns.
A big opportunity for asset managers
Estimize’sCEO Leigh Drogen lay out a practical vision of discretionary managers’ future in a series of insightful articles – he concludes that in order to survive, you need to quantify.
Implementing the right technology is, in many ways, easily achievable. Technology providers, led by Fintechs, can drive the structuration, new workflows and analysis of data and research information. Software applications can now enhance investors’ capabilities while giving investment firms a data-driven overview of their business process at the same time. But in almost every firm, new tools or processes remain a delicate and constant trade-off between the portfolio manager and the c-suite, where the former must produce and the latter measures and makes investment decisions.
Technology can also enable both performance and underperformance to be reviewed analytically, rather than through the lens of an opinionated and biased conversation between portfolio managers and analysts. The software is the minimal framework to the future of investing, where qualitative inputs can be easily quantified and married with any other numerical inputs on a timescale.
To lead their investment firms into the future, management must draft new organizations which fit within a digital world. An organization where the portfolio manager plays centre field and no longer libero, and has access to the best possible yet user-friendly software. A multi-talented team to leverage new alternative data and markets. An investing team where decisions are no longer hierarchical but consensual. A team where financial incentives are aligned between the fundamental analysts, quants, data scientists, computer engineers, risk and portfolio managers.
It’s clear that something needs to change in order to free up the research market as it currently stands.
Role of regulators
So how do European regulators intend to address what is arguably and currently a worse market than we had before in terms of research? As time goes on, we will undoubtedly see the adverse effects of reduced access unless firms take action to change their approach to evaluating and using research.
Similarly, the sell side must be complicit in any solution. By sharing reports and other data on cross-industry platforms, in addition to any direct relationships they may have with buy-side firms, they will play a key role in opening up the market and boosting quality.
Asset managers may have opted for the safe bet by absorbing research costs so as not to lose clients in the short term and then looking for the cheapest option in terms of provision, but we are starting to see the outcomes of this as the months go by. It’s clear that the impact of this new world where cheap but limited access to research works for now, will not sustain asset managers’ client bases in the long term. The need for high-quality research and interactions will not change but under MiFID II access to this vital resource has been cut significantly.