We’re already halfway through 2018, plus six months into MiFID II, and research unbundling has been the catalyst for significant transformation across the industry.
New rules, economics, players and the growing role of technology are already paving the way to a new investment research industry. In this brave new world, who will emerge victorious – it’s becoming patently clear that not everyone will be crossing the finish line in the race for innovation.
1 - Deflationary content pricing
Armed with too little data about actual research information needs, European asset managers made a clear economical choice earlier this year: no more “pricey” independent research providers. Instead they opted for cheap sell-side portals subscriptions and, for the largest funds, tough negotiation rounds to keep analysts access. Where most surveys anticipate a 20% to 30% decline in research spending, we have collected even more alarming data in the past few months. A bank portal for global equity research costs as low as $10,000 per year at a firm level where several hundred thousand dollars use to pay for a bundle execution and research service. In this case, the execution bill is far from making up for the difference. Other independent boutiques have slashed their pricing by 50 to 80%. A research and corporate access service previously billing around $1m per year, not trades for $250,000. Some of the marketplace’s new economic models are also pushing prices down. Similar to how Netflix revolutionized the way consumers access film and TV content, buy side can now access more written content for a lot less money. A model which is sustainable only if a critical mass of consumers can be achieved quickly enough.
The research industry in Europe seems to have dropped a lot more than anticipated. This is a huge cause for concern, especially considering the initial objective of MiFID II - to favour the development of a healthy investment research industry.
2 - Ramping aggregation
Consequently, the cost associated with the way research is currently produced is less sustainable. Relying on your own marketing and distribution resources will only make things worse. In a nutshell, research business models need to adopt a new distribution strategy to survive.
In the past six months, two developments have been counterintuitive. Tier-1 providers are pushing to distribute their content exclusively on their own websites. This is a step back from a user experience perspective. The email inbox used to play a semi-decent research aggregator role when PDFs where attached and sent to individuals. Not any more, URL links now drive the user to numerous portals. Consuming and remembering dozen of passwords is an everyday nightmare for portfolio managers to the extent that some providers have been cut for not being able to access their research portal easily enough.
Secondly, research as we know it is going through a temporary economic anomaly. If no other businesses subsidize its production -whether regulators are able to prove it or not-, two possibilities remain in a deflationary pricing environment. Firstly, there will be more high-end, differentiated services customers are willing to pay up for . Attached to a premium strategy, the cost might have to adjust anyway with a less labor intensive production. For research, this means moving away from a classic maintenance model with less analysts and more automated tasks. Commerzbank is experimenting with artificial intelligence technology to see if it can write basic analyst notes automatically to trim research costs .
The other road is to dramatically increase the customer base. This would require distributing an unchanged product through a maximum number of channels such as aggregators or marketplaces to make up for declining prices. In the information industry, economics and consumer demand inexorably pushes towards aggregation. Only the timing seems unsure.
3 - New consumption patterns
Fund managers are already seeing some quality evaporation in research content and a “minimum service attitude” from their brokers. Plummeting sell-side pricing has pushed back a much needed debate on research deliverables. Because of poor or non-existent research evaluation frameworks, this sounds like a logical consequence. Research interactions consumption behavior is also changing rapidly. Portfolio managers, through fear of potentially hefty prices being charged by brokers, have stopped calling their analysts three times a day. Some have even stopped attending corporate events, to the great surprise of large cap issuers which never anticipated to see their biggest shareholders' seats empty!
Inevitably, a new round of research provider rationalization is widely anticipated which will contract the sell-side research offering further. Overlapping classic equity maintenance is going to directly affect the number of providers as soon as next year. Asset managers are already planning to keep a maximum of two to one providers for their basic needs per country or industry. Banks offerings are likely to be more focused in terms of geography and product. Part of the sell-side is already seeking partnerships in fear of consolidation.
4 - Emerging alternative research
In the midst of MiFID2, why have independents lost so many clients? Why are asset managers increasingly unhappy and dissatisfied with sell-side research? Is it just an adjustment period driven by pricing forces?
Regulation is forcing active managers to value their historical research franchise. What’s clear is that this cost-benefits review shines a light on emerging competing research products. Research has barely evolved whereas the world of investible assets has changed dramatically. Factors affecting a company valuation go way beyond the simple analysis of its financials or strategy. The digitization of people and business activity is generating a new type of valuable data. A type of data not only relying on lower latency to gain a competitive edge, but also carrying new and deeper insights when exploited in the intelligent framework of investment decision-making. The rise of alternative datasets is one of the first manifestation of how research is about to change. A research mostly data-driven and no longer delivered as non-machine readable reports.
5 - The rise of artificial intelligence
Research budgets buy information, rarely knowledge. The research product may no longer be exclusively research reports but also the technology layer which is able to extract intelligence from them automatically, quickly and at scale. Since the buy-side has always heavily relied on the sell-side when it comes to technology, most active investors are stuck in a technological gap. Today’s emails, shared drives and spreadsheets support the investment process even if these tools were not historically designed for investing. Tomorrow, they are unlikely to create the next investing winners. Capturing and processing more and more sophisticated and voluminous information seems the way forward. This is probably why Axa Investment Managers has recently announced that it would be cutting 200+ jobs and ploughing some of the savings into more advanced data collection and analytics .
MiFID2 research unbundling regulation has appeared to go wrong with many commentators blaming the "unintended consequences” for the poor state of the research market. The bigger picture is that active management might be at a historic turning point. The progress in investment technologies is about to experience a quantum leap forward. The expected deluge of data coming their ways will unleash an unprecedented potential.
How asset managers are considering tomorrow’s technology is already affecting today’s research.
 It is worth noting that, in the retail space, Apple is probably the only company able to sell the same product at a higher price every year or so. All other companies face deflationary pressures.
 Financial Times, Commerzbank sets AI to work writing analyst reports, 2018, June 25.
 Wealth Manager, Axa IM puts 40 UK roles on the line following restructure, 2018, June 18.