Money management firms are grappling with a requirement under incoming rules that will change the way they access and pay for research.
The second iteration of the Markets in Financial Instruments Directive, a European regulation set to come into force Jan. 3, 2018, will reform the trading, reporting and research markets across European Economic Area countries. One of the most significant changes for money management firms is that they will have to separate research and execution payments.
Some firms have chosen to overhaul the way they use sell-side research altogether, altering their models so they take on the cost of this research themselves. Others have chosen to invest in expertise, bringing in-house teams of analysts and experts. And others said it is too early to speak to the topic, or declined to comment altogether.
Whichever route money management firms have chosen, regulatory demands have required these firms to scrutinize their own practices and the counterparties on whom they depend for research.
Sources said the issue is increasingly intense given the growing pressure on money managers and their costs.
“One of the long-standing conflicts in asset management is how research provided by banks and other sellers of bonds (or) equities is paid for and how much it should cost,” said John Bates, head of emerging markets corporate research, emerging markets fixed income at PineBridge Investments in London. “With the arrival of MiFID II we are going to see the sell side billing the buy side directly for research in all of its various forms. At the moment, the potential costs are starting to evolve and already the buy side is preparing for what could well be a major hit to their cost base.”
The regulation and its impact on money managers' margins was referenced by Martin Gilbert, CEO at Aberdeen Asset Management, speaking at the Pensions and Lifetime Savings Association's annual investment conference in March. He said money management firms are facing fee pressure and other headwinds, such as “higher regulatory costs, paying for our own research in (the) future.” Mr. Gilbert said Aberdeen already had announced it would pay for its own research rather than using client-dealing commissions. “That was because the (Financial Conduct Authority) said to me ... "you are using clients' money to pay for your research.' And I took the view at that point it was only going to go one way, and we may as well bite the bullet on that.”
And in a statement accompanying money manager Jupiter Asset Management Ltd.'s 2016 results, CEO Maarten Slendebroek said: “We will also take a consistent approach to the costs of research we use, by taking it all through Jupiter's accounts from 2018 with no change in the management fee, adding around £5 million ($6.2 million) of costs from 2018. During 2017, we will work with our service and research providers to implement these changes.”
While the changes are putting money managers under pressure, their clients might see benefits. Colin Pratt, investments manager at the £3.2 billion Leicestershire County Council Pension Fund, Leicester, England, said the unbundling of research “is potentially quite positive. There are signs that some managers will pay the research costs themselves, rather than pass them through to investors via commissions, and the downward pressure on fees caused by pooling (of local government pension schemes in England and Wales) means it is unlikely they will have the ability to increase their fees to offset the additional cost to them.” Overall, the regulation “may ultimately turn out to be more positive for the LGPS than it is negative,” assuming an easy fix can be found for a proposal to reclassify the pension funds as retail investors, said Mr. Pratt.
Some money management executives are taking the changes in stride, and see the regulation as an opportunity to reinforce their ownership of investment decisions.
“We are pulling more resources in-house,” said Colin Harte, London-based portfolio manager and strategist within the multiasset solutions team at BNP Paribas Investment Partners. That team recently hired an emerging markets specialist, for example. “We have been beefing up our own resources as we want independence of research. At the end of the day, we have to produce the research that underpins decisions — it is our responsibility. We have to own it. It is something I have always had a very strong view on, and that independence of research has a strong tradition in” the team.
Guy Davies, London-based head of equities at the firm, added the unbundling requirement is a complex area, with “significant efforts underway to prepare for this, across teams, functions and processes.” He said internal expertise is complemented by external specialists as and when necessary.
PineBridge's Mr. Bates said the move is particularly beneficial to his area of focus. “We have long believed that having our own views/research capabilities should be at the core of our investment process,” he said.
Emerging markets commentary is “often peppered with political views and biased opinion, which is often prone to wildly diverse interpretation. As an asset manager, having a handle on the fundamental picture is what creates alpha when the world is not sure.” In-house research capabilities also enable an unbiased view of a fundamental picture, “which at times could be the source of conflict when dealing with research from other holders of securities,” said Mr. Bates.
Schroders PLC introduced research commission budgets in 2014 “in order to remove the link between execution volume and research commissions generation,” said Sheila Nicoll, head of public policy at the firm in London. “Our spend on external research has reduced substantially over the last five years and we continue to reduce the external commission budget.”
The firm invests “heavily” in its in-house research capabilities, with more than 130 equity analysts across the world. Schroders also has set up a “data insights unit to add to these internal resources.”
Preparations for MiFID II have involved intense reviews of the way managers have approached external research up to now. PineBridge executives undertook a “comprehensive screening of our trading counterparties and their research offering,” revealing a handful of bulge-bracket international banks that “are able to provide important market data, which is very useful for asset managers, but there is no one-shop-fits-all in emerging markets, so the banks will have to develop bespoke solutions for their clients,” said Mr. Bates.
And Gildas Surry, senior analyst and partner in London at Axiom Alternative Investments, said executives at the firm — which has invested in in-house research over the past few years — view MiFID II and unbundling as “increased scrutiny on the way we deal with our counterparties.” To prepare for the change, it is working to understand its trading vs. research relationships with counterparties, breaking them into four categories: brokerage or principal matching institutions, which do not provide research; dealers with research, largely U.S. banks; dealers without research; and pure research providers.
There are other options, with specialized research providers spotting a gap in the market and developing offerings. Some will focus on supplying on-the-ground expertise in particular markets, said Mr. Bates, such as a provider of emerging markets macroeconomic research based in Latin America, or a Russian research house based in Moscow.
Ultimately, the decision will be based on relative value. “It is unlikely that an asset manager will pay top dollar for external research when it can hire the talent in-house for significantly less,” said Mr. Bates.
But that might be easier said than done, warned Nathan Gelber, founder and chief investment officer at investment consultant Stamford Associates Ltd. in London.
“When we look at managers during our assessment process, one of the key areas that are subject to our undivided attention relates to the internal investment research capabilities,” Mr. Gelber said “Outstanding research analysts are not available a dime a dozen.”
This article originally appeared in the April 3, 2017 print issue as, "Managers prepare for MiFID II by shifting gears with research".