Less Money to Pay for Independent Research?

A few years ago, experts were predicting that sell-side research was near death, while independent research was undergoing a rebirth. Fast-forward to the present time in which a number of economic forces are weighing on the institutional investors and hedge funds, making it harder for them to allocate commission dollars (or cash) to pay for independent research.I spoke with David Eisner, CEO of TheMarkets.com, the consortium owned platform for aggregating, distributing and tracking sell-side research, yesterday for his views on current institutional research trends. Because there's been a severe drop in assets under management (UAM), there is a significant decline in the buy-side's capacity to pay fees for research, observed Eisner. On the hedge fund side, which has been the driver of technology and data spending, there's not only a smaller amount of AUM due to market declines and redemptions, but there are managers who are way below their high water marks, which means they have to earn back what they lost before they can earn incentive fees.

"We've seen large cutbacks on research staffs on the buy-side and a reliance on others," said Eisner. At the same time, TheMarkets.com has seen a huge uptick in usage of the street's research, he noted. The industry saw fast growth in independent research came over the past five years at the time the Global Research Settlement negotiated by former Governor Elliot Spitzer was implemented. "The predictions in 2002 and 2003 were that the settlement was going to be the demise of Wall Street research as we knew it and it was going to be the ascendance of independent research," said Eisner.

However, the Global Analyst Research Settlement is set to expire in July of 2009. Under the settlement, for a five-year period, many of the leading sell-side firms were required to contract with no fewer than three independent research firms and make that research available to their customers. Payments for independent research were to total $432.5 million, according to the SEC's fact sheet on the Global Research Settlement. Big brokerage firms (fined a total of $1.435 billion) were required to buy independent research under the advice of a consultant and then provide that research to their clients at the same time they provided them with their own research reports. Now that the five-year mandate is expiring, some retail brokers, who feel this independent research was a benefit, may continue providing this research, "though they'll do it on their own terms," said Eisner. But many of the firms have indicated that they no longer expect to provide this content because their clients no longer care," said Eisner.

The upshot is with the regulatory mandate lifted, combined with the lower AUM's on the buy-side, Eisner expects there to be dislocations emerging in the independent research space. He notes that some IRPs are adopting a brokerage model and some are becoming hedge funds and adding a banking element. On the other hand, there's a trend that could work in favor of the independents - top analysts are leaving or will leave the big sell-side firms because they feel they can't earn a fair compensation because of scrutiny from the government. This trend could add to the number of independent research firms, "but unless that pie is growing, it's likely to eat into the share that each of the existing independent research providers had of the pie."

However, TheMarkets.com saw institutional usage of sell-side research "go crazy" in 2008, especially during the fourth quarter of 2008. "In a highly volatile environment investors were craving for whatever bits of data they might get their hands. Data may indeed be the key. The brokers are continuing to create this data and the buy-side uses the data in forming their own investment decisions, says Eisner. It's not that the buy-side is interested in the sell side's recommendations to buy or sell a stock, said Eisner. "Today investors are really interested in getting behind the research and the data that the analyst has collected in order to test their own thesis against the Wall Street analyst," he says. Data is the key: the buy-side is more interested in the underlying assumptions and the data that the analyst had access to in creating its conclusions.

Last month, TheMarkets.com asked institutions what areas of industry they would focus on in '09. At the end of a recession, he expected the buy side to look for earnings and sectors that were on the verge of a turnaround. Instead, the buy-side responded that they were interested in financials, energy and healthcare, which coincidentally are the three biggest areas of government focus. These are the top 3 industries that the government is planning to reform. "There's a massive refocus of the investment community toward Washington, D.C.," said Eisner.With the Global Research Settlement expiring in July, and declining asset values on the buy-side, there is less money available to pay for independent research. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio