Reshaping Research
| Date: | November 2005 |
| Author: | Clare Vincent-Silk |
| Price: | £500 to non-members of the Investit Intelligence Member service |
Reshaping research, the consequences of transparency
Unbundling of commission legislation has changed the way investment management companies use research. This research looks at who provides research, how it is used, how it is measured and paid for - and how this may change the relationship between the buy-side and sell-side.
When conducting this research, Investit interviewed 13 investment management companies, four investment banks, three independent research firms and 11 system vendors.
The changing landscape
Many investment management companies remain reliant on research provided by investment banks and brokers. Historically, the banks produced research for their own trading desks and offered this out to encourage increased execution business. Recent unbundling of commission legislation has changed this. CP176 and PS05/9, now mean investment managers have to 'unbundle' the commission paid to investment banks and provide their clients with a clear indication of the cost of executing a trade and the cost of any research the investment management company receives as part of the deal. Investment managers' clients now want to know if the research they pay for as part of their management fees is adding value to their portfolios.
What does this mean for investment management companies? If they are accountable for proving sell-side research adds value to client portfolios, they need to be able to properly measure this. There is great interest in the ways both internal and external research can be measured, both quantitatively and qualitatively. In-house research may be measured through a number of means, for example by building hypothetical 'analyst portfolios'. But how can you measure external research in order to determine the split of commission between research and execution? Investment management companies will need more robust systems to put a value on the research they buy.
Unbundling legislation will also change the way buy-side dealing teams work. More accountability creates pressure to find more efficient methods of dealing. The growing use of alternative trading systems, crossing networks, direct market access (DMA) and algorithmic trading reflects this.
The way forward
Unbundling legislation impacts the relationship between the buy-side and sell-side. Fund managers are going to have to become more selective buyers of research. Commission sharing agreements are part of the system that enables the easy separation of research from commission - and their use is growing. If the number of CSAs increases so too will the use of execution only dealing and independent research. Banks are unlikely to cross-subsidise from product to product, or across different clients. So, research may become a scarcer commodity; for some this will mean the cost of research may rise.
Once clients are made aware of their total costs for research and execution, will they continue to want these costs charged back to their portfolios, or participate rolled into the management fee?
The regulator's drive for transparency in commission payments isn't going away - the NAPF is already encouraging pension fund clients to ask their investment managers for clarity. While the immediate requirement may only be a small table to explain costs in a client report, the regulator has set out what it expects this transparency to achieve. And if it does not achieve this, the regulators will be back.
Table of contents
| Management Summary | 1 | |||
| 1.0 | Introduction | 3 | ||
| 1.1 | Scope | 4 | ||
| 1.2 | Methodology | 5 | ||
| 2.0 | The Changing Landscape of Research | 7 | ||
| 2.1 | The research web | 8 | ||
| 2.2 | What is research? | 10 | ||
| 2.3 | The research industry background | 14 | ||
| 2.4 | Research prices and costs | 16 | ||
| 2.5 | The regulatory debate | 18 | ||
| 3.0 | Producing and Delivering Research | 23 | ||
| 3.1 | Models for production | 24 | ||
| 3.2 | Turning research into investment decisions | 30 | ||
| 3.3 | The role of independent research | 32 | ||
| 3.4 | Models for support | 34 | ||
| 3.5 | The email problem | 39 | ||
| 4.0 | Measuring Performance and Paying for Research | 41 | ||
| 4.1 | Measuring success | 42 | ||
| 4.2 | Paying for sell-side research | 46 | ||
| 4.3 | The pricing of sell-side research | 47 | ||
| 4.4 | Commission sharing agreements | 48 | ||
| 5.0 | The Effects of Change | 51 | ||
| 5.1 | The effect on investment banks | 52 | ||
| 5.2 | Outsourced dealing | 55 | ||
| 5.3 | The effect on independent research companies | 56 | ||
| 5.4 | Research as a competitive advantage | 57 | ||
| 6.0 | The Way Forward | 59 | ||
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