Nobody goes into business to lose money—sadly, for those in sell-side research services, this is often the reality when research is viewed on a stand-alone basis. The question is: how did we get here and what can be done about changing the business model of research services? Today and over the next few weeks, I’ll answer these questions, but first, let’s examine the evolution of sell-side research.
Equities margins have been squeezed to near zero and FICC trading could be facing the potential for a similar fate in the longer term. From the sell-side perspective, research services provided to the buy-side are given away for free, in return for what is hoped to be commission flow and IPO underwriting fees at a later date. From the buy-side perspective, the expectation is that investment banks provide research services to help clients better understand the fundamentals of the businesses in which they invest as part of a larger bundle of services. When it comes to payment, this is typically done on the back end, often through a vote process.
How did we get here?
Research services have undergone a negative shift thanks to a number of factors: increasing amounts of free information on the internet, a number of regulatory mandates, and the financial crisis. Information once unavailable to the general public is now open to all. Regulation FD makes the task even more difficult, taking away analysts’ “street cred.” The ability to gain an information advantage and to rise above the noise is increasingly more difficult.
Shifts are happening for the buy-side, too
Assuming even a watered down version of MiFID II rules regarding research payment are adopted, the creation of real price discovery for research is likely to force money managers to scrutinize the research services they purchase. This will lead to more selective consumption and a flight to quality. Add to this pressure the regulatory mandate, where managers face their own margin pressures. Put simply, there is currently too much research supply for liquid securities.
So, can quality research be adequately monetized? And, are buy-side professionals willing to pay for it? I’ll explore these questions more in my next post.
Until then, to learn more: