Research unbundling summer reading

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Alphametry has put together a collection of articles to keep you up-to-date with the latest developments in research unbundling from your sun lounger.

Shrinking equity research coverage

Europe’s new MiFID 2 legislation has already impacted equity liquidity and coverage. The average number of analysts covering stocks with a market capitalisation of between £600m and £5bn at the London Stock Exchange fell 3 percent. Some small-cap stocks have been the hardest hit with trading volumes on London’s junior AIM market shrinking as much as 25 per cent in the first half of the 2018. Steven Fine, chief executive of City stockbroker Peel Hunt, says:

“I think it’s a direct consequence of the regulatory change, ... we will see a lot more of that going into the fourth quarter — less coverage, greater illiquidity in more stocks” (Financial Time on Twitter).

European stock exchanges are exploring ways to support smaller companies, in some cases by offering free research through partnerships with third parties.

Similar to credit markets, the sponsored or commissioned research model seems to be the only winner of MiFID 2 research unbundling. Corporates demand for coverage is growing and welcome by the hedge fund community (Bloomberg). New advisory shops are popping up and some brokers are also turning to a free research model such as SP Angels or DNB Markets (Reuters). Even outside of Europe experienced sell-side analysts are jumping ship like the newly founded Small Cap Consumer Research Cap (PRNews) and Diamond Equity Research in the US, or Pitt Street research in Australia (Markets Insider).

Sell-side research is being redefined

As predicted research departments of investment banks are getting squeezed. Bank of America Merrill Lynch has lost dozens of analysts from its London office. The European arm of Australian bank Macquarie announced plans to cut a “handful” of analyst jobs and reshape its coverage around six key sectors (Financial Times on Twitter). New Deutsche Bank chief executive Christian Sewing has announced he wants to cut at least 7,000 jobs by 2019. One in four jobs in its equities sales and trading business have been axed (Financial Times on Twitter).

While JP Morgan has disrupted the research market by charging as little as $10,000 for its global equity research portal (Business Insider), the appetite for “pricier” analyst access or interactions has failed to materialize, putting great pressures on cash equity revenue models. Consequences are already being felt. Richard Buxton, chief executive of Old Mutual Global Investors declared at the UK’s Investor Relations Society annual conference in June that

“the quality of research is getting thinner and thinner”.

Similarly, John Bennett, director of European equities at Janus Henderson Investors commented:

“The quality [of research] is coming down and I see much more focus on whether companies beat or miss quarterly targets. The dialogue about where the company is going to be in five years is falling away.”

Unprepared fund managers are still assessing research needs

The absorption of research cost by fund managers is triggering a consumption (r)evolution. Most have drastically reduced the numbers of research providers. Candriam has cut the number of brokers from 100 to 70 and Ostrum Asset Management (formerly Natixis Asset Management) has cut by 20 per cent, taking the number of external providers to about 50. Hermes Investment Management said it has only

"streamlined coverage on a desk-by-desk basis [and] year-on-year, this resulted in a small reduction in the number of sell-side research providers” (Financial Times on Twitter).

Larger fund managers such as Allianz GI have delayed purchasing decisions. After declaring to agree on stock research pricing by the end of quarter one, the €513bn asset manager is still

“in a price discovery period following [our] conversations during the first quarter” (FNLondon).

Alternative data is the "new" big data

As competition for research heats up, some banks are introducing technology to change the production game.  In a statement, Sunil Garg, J.P. Morgan’s head of international equity research in Asia and EMEA, says

"the bank has worked to ensure that its research coverage footprint is among the largest of all sell-side research houses by using alternative-data analysis techniques” (Institutional Investor).

UBS also credited use of alternative data through UBS Evidence Lab for their top research ranking (Institutional Investor). Commerzbank is experimenting with artificial intelligence technology that would automatically generate basic analyst notes (Financial Times on Twitter).

Large active managers are also increasingly incorporating alternative data in their investing processes. But this is more to augment their fundamental analyses rather than implement quantitative approaches.

“The data that does not fit into our analysts’ spreadsheets is the gap that we are trying to fill,”

says Mark Ainsworth, Head of Data Insights at Schroders (MarketsMedia). UBS Asset Management has set up a dedicated data science team to integrate the use of data into fundamental investment process (Risk).

But Alpha can also be found directly inside investment firms. Operational alpha or first order data should be a priority too, according to alternative data contrarian Matthew Rothman, MIT Professor, who was hired to lead Goldman’s “Data as a Service” offering. There is value in internal data and current investment firms' processes. Andrew Chin, head of quantitative research at AllianceBernstein, views its in-house data as “uncharted territory” and is looking to leverage the firm’s internal and proprietary data to distil for alpha (Risk).

In 2018, the majority of firms based in Europe but also in the US, from asset managers to hedge funds, are re-examining their research processes. As an anonymous head trader puts it,

“it’s a matter of survival” (MarketsMedia).