Change in U.K. rules could lead to job changes for analysts

The Financial Conduct Authority, the U.K.'s watchdog for money managers and other financial services firms, this spring will clarify rules around the spending of client trading commissions.

The FCA wants to “clarify (its) rules that allow investment managers to use dealing commissions — paid from their customers' funds — to acquire execution-related and research goods and services,” according to its website.

Last October, the FCA announced it would be looking at how investment research is paid for and how money managers spend their clients' commissions in the U.K.'s £5.2 trillion ($8.5 trillion) money management industry.

Research by the regulator showed about £500 million of trading commissions were spent on funding corporate access — paying a broker, for example, to provide an introduction to the management of a company in which a money manager wants to invest — in 2012, which Martin Wheatley, CEO of the FCA, said should instead be paid for by the money manager.

Some experts say this pressure will lead to downsizing of analyst teams at investment banks and brokers because they may not bring in the revenue they once did, should the FCA change the way research is paid for.

“If the regulators banned the use of commissions to buy research, we would go to a priced research market,” said Neil Scarth, principal at Frost Consulting in London. “Research spending would go down and fewer (bank and broker) analysts would be employed.”

Whether the FCA goes to the extreme of banning the use of commissions to buy research as part of its efforts to put an end to their use to buy “non-eligible services” such as subscribing to newswires — which experts say is unlikely but should be considered — or opts simply to clarify the situation, the analyst industry will be forced to change in some way.

“Under any circumstances, brokers will have to specialize — the issue has been that, because research is not priced by banks, asset managers have not been specific about what they are paying for,” Mr. Scarth said. “A lot of research that asset managers are receiving they may not have specifically requested and they may not actually use. Highly rated sell-side analysts may become more important and expensive as managers will be able to attribute direct revenue to them in a priced research market.”

The result, Mr. Scarth said, could be more analysts looking for roles elsewhere. But it also would create more costs for the money managers. He said the consulting firm estimates that, globally, money managers spend billions of pounds on research. “The ability to buy external research creates pretty substantial economies of scale for the system — covering all stocks all of the time in-house is expensive and impractical for almost all asset managers. There is no doubt that asset managers will have to spend more time and money on monitoring the commissions that they spend and to make conscious choices about the research that they buy,” he said.

But the other option is to take advantage of the situation to build in-house capability.

“There is an opportunity for the buy side to build quality teams relatively affordably, and it would make sense if they could link specific research to fund performance,” said Chris Forbes, CEO at executive search firm Ph.D. Search & Selection in London. “(But) it has not taken off yet.”

This is one option for a U.K.-based, multibillion-pound money manager.

“There is an opportunity, and partly ... from changes in research commission, we expect to see more people leaving the sell side,” said the money manager's London-based head of equities, who asked not to be identified. “If research commission is not going to be paid for, brokers will disappear and that will put more onus on us as researchers. There is a real opportunity to start hoovering up bits of talent.”

It is not just the money managers considering the opportunity. “The bigger pension funds have been weighing up the idea of hiring researchers and analysts on and off for the last two years,” Mr. Forbes said. “None have built up any significant research capability yet, but they have hired a couple of senior managers and strategists from the sell side to look at that for them.”

On the fixed-income side, however, things are different.

Experts say while there have been moves from banks and brokers to money managers in the research department, the attraction has waned.

Godliman Partners LLP, an executive search firm that specializes in fixed-income hires, has kept track of analyst hiring over the past 11 years. “Overall figures to date in fixed income, across all functions, is down 47% over the year to date,” said Rupert Reed, senior partner in London, late last year. “The buy side is going through some sort of crisis of confidence.”

And the number of moves from investment banks to money managers has declined. According to Mr. Reed, hires from investment banks as a proportion of total analyst roles was 20% in 2013, with seven analysts moving from the sell side to money managers out of a total of 30. That was down from 26% in 2012, and a peak of 30% in 2011.

“After the crash, there was a surge in hiring — the buy side in part was looking to bring in better analysts to cover critical sectors like financials. The focus is now in portfolio managers. The small exceptions are analysts covering high-yield and emerging markets debt.” Mr. Reed said.

In early 2013, Pioneer Investments hired two investment bank analysts, Marina Vlasenko and Paul Cheung, to focus on emerging markets and high-yield debt. These hires bring the total number of analysts across the emerging markets and high-yield debt teams to about 10. Ms. Vlasenko joined from Commerzbank and Mr. Cheung from UBS Investment Bank. Infrastructure specialist IFM Investors hired Hannah Lindberg from Barclays Capital in June last year as an investment analyst, focusing on credit research and deal analysis with regards to infrastructure debt.

However, even if analysts from banks and brokers become available, experts are not convinced they would be able to make the move to the very different world of money management.

“Historically, there has been low crossover from sell- to buy-side, largely for three reasons: Culturally, the sell side is perceived as being more aggressive or assertive, which doesn't fit well with buy-side practice; the sell side tends to be more trading-oriented than long-term value- or fundamental-oriented — there is a suspicion on the buy side that it is too short-termist; and compensation levels are very different,” said Godliman Partners' Mr. Reed.

The trend of hiring analysts from investment banks and brokers into the money managers and pension funds in the U.K. is playing catch-up to the U.S., said Mike Karp, New York-based CEO of executive search firm Options Group.

“The practice (of using soft dollars to pay for research) in the U.S. has been really reined in over the last five years, he said.”