Even the Financial Conduct Authority (FCA) now agrees research unbundling has become one of the most controversial and ‘debated’ aspects of Mifid II, with a recent promise to complete a full survey of the market for investment research by the end of the year.
Formerly provided with a nudge and a wink as a tacit exchange for dealing business, analysts have been forced to now present a case for their product’s value.
Fund houses, which near-universally agreed to stump up the cost of external research, similarly now have to answer to their accountants.
The quantity of research produced on UK equities has fallen 8% since the launch of Mifid II, a Numis analysis found in February. Less easy to measure is the impact of a sudden dose of competition on quality, however. Has price discovery forced analysts to up their game?
‘We have not agreed to pay everyone who previously provided research, based on our assessments of the value,’ said Simon Gibson, chief investment officer at Mattioli Woods (pictured below).
‘Not all research was or even now is of the same standard, however, the research we do get and pay for is very good and useful.’
Appearing at a recent roundtable on Mifid II, Peel Hunt chief executive Steven Fine said that while the sector remains in a state of flux, the immediate impact had been just the reverse, with staff cuts and an increasing workload of companies to cover for those who remained.
‘We believe that the optimum number of companies an analyst can have and remain credible is about 15,’ he said, adding that the number has almost doubled under Mifid.
Big banks had used the opportunity to consolidate, by pushing fixed price packages of bundled coverage that squeezed the margins.
This was a view echoed by other niche houses, who worry that much of the material sold is ‘a copy paste exercise of financial statements’ and that brokers no longer have time to engage in conversation with clients to back up their views.
‘In our latest analysis, average analyst coverage per large cap stock on the London Stock Exchange Main Market was down 7.4% over the course of 2018,’ said Keith Hiscock, chief executive of analyst Hardman & Co.
Numbers have fallen from 15.8 analysts per company to 14.7, he said. This was less acute in the already more sparsely covered mid caps, which saw a 3.1% decline to 6.4 analysts.
On the research buy side, managers seem more relaxed about the coverage they now have to pay for, however. This was supported by CFA Institute research, which earlier this year found the majority of consumers judged research quality unchanged, while almost half of producers said it had fallen.
Commercial pressures have seemingly pushed analysts that may have otherwise been complacent to demonstrate value, said Gervais Williams (pictured below), lead manager of the Miton UK Smaller Companies fund, adding that the pressure is now on them to stand out from the crowd.
‘Some of the better analysts are more visible, but the less good ones have lost out,’ he said, adding that this was also reflected in an increasingly dynamic market for sector talent.
Hawksmoor CIO Jim Wood-Smith, who was welcoming of the new regime, added that the reform has opened up the market for smaller research buyers that would formally have been locked out from some of the research of most interest to them by the limited trading volume they were able to place.
‘Before, the level of our business was considered small and we would have been laughed at but now everyone is at more level-playing field,’ he said.
‘Some brokers have taken the attitude that there is value in providing research to the discretionary fund management market. We now get access to a much better level of research.’
Williams added that this opening up is mirrored in an uptick in new research boutiques contacting him.
‘Many are start-ups operating with two, three people,’ he said. ‘You can get economics people who are providing an independent economics service too.'
As the dust is settling, fund managers may be willing to revisit their preference of large brokers. Eric Turnbull (pictured above), co-founder of research platform Eric (Electronic Research Interchange) said there are signs of a shift in fund managers looking for differentiation and looking towards the independent players, he suggests that ‘some broker research might be viewed ‘as similar in approach and content’.
‘With this in mind, search for and discovery of new research from different providers is becoming key for fund managers, as such providers with differentiated content may not have the reach or distribution networks of banks or brokers.’
But others are more pessimistic. Phil Harris, manager of the Equity Growth fund at EdenTree, said the move towards large cap research is not likely to stop and that the research market is gearing towards greater consolidation, likely wiping out the small players.
‘We are early in terms of things changing,’ he said.
‘There is hope for things changing for the better but for now I see the quality of research decreasing.’