The New Alpha Generators
With commission dollars from buy-side executions shrinking, agency brokers are moving into the research space to compete as alpha generators for a larger share of the institutional spend. The goal is to bring value-added content to portfolio managers and buy-side analysts in order to capture a greater share of buy-side dollars earmarked for alpha generation.
In most cases, the agency brokers are building out their research capabilities and differentiating their offerings by teaming with independent research providers that offer an alternative to traditional sell-side research. Over the past six-months, for example, electronic agency brokers Investment Technology Group (ITG) and Liquidnet each made minority investments in and struck strategic partnerships with independent research firms.
"It is about alpha generation, and whoever gets the investment idea first kind of leads the pack," relates Steven Greenblatt, head of Liquidnet's corporate strategy group. "It's a herd mentality within the buy side, and whoever leads the herd gets the lead on the most alpha capture." In January Liquidnet completed an investment in OTR Global Holdings, the parent company of alternative research firm OTR Global, formerly known as Off-The-Record, whose editors specialize in primary research and channel checking.
In addition, both Liquidnet and Instinet have entered the corporate access business, leveraging technology to connect portfolio managers and analysts directly with corporate issuers. Meanwhile, other agency brokers are pairing with investment banks to gain access to initial public offerings (IPOs), an area in which the bulge-bracket firms traditionally have had an advantage.
In May, Knight Capital Group formed a joint marketing alliance with Houlihan Lokey, an international advisory-focused investment bank, to provide investment banking, capital markets, and sales and trading services to Houlihan Lokey's clients. In turn, Knight's clients will get access to new issues. And in May, ConvergEx announced a strategic alliance with Marwood Group, a healthcare advisory and financial services firm based in New York.
As a result, buy-side traders are beginning to view agency brokers differently. "The primary motivation for going to these venues historically has been the superior liquidity. Now they're complementing their deep pools of liquidity with a product outside of execution," observes Seth Hoenig, head trader at Glenhill Capital, a long/short hedge fund with $1 billion in assets under management.
"For a firm like Liquidnet or ITG, their competitive advantage is providing anonymity in seeking a contra for an above-average trade size. Now they are offering products that complement the core business, and they're going to pick up incremental flow," he continues. "They're now going to be viewed as research and corporate access providers. It only enhances these firms' ability to grow and make their businesses stickier."
Seeking a Larger Piece of the Commission Pie
Industry analysts and agency brokerage executives say the decline in the buy-side commission pool is driving the trend. According to the latest Greenwich Associates (Stamford, Conn.) U.S. Equity Investors Study, released in June, the total amount of brokerage commissions paid by U.S. institutions decreased 13 percent to an estimated $12.1 billion from Q1 2009 to Q1 2010.
Noting that assets under management are down about 25 percent to 30 percent from their 2007 highs before the financial crisis, Laurie Berke, a senior consultant with TABB Group, points out that most buy-side firms have fewer commission dollars to pay the Street.
"There is an economic reason for agency brokers to look at the research side and tap into that," adds John Feng, managing director at Greenwich Associates. "Research and advisory services tend to be an important driver of revenue flow between the buy side and sell side."
According to Feng, "Roughly half of the total commissions [or about $6.5 billion] is being spent to compensate the sell side for their research, for their coverage and for their services in connecting portfolio managers with analysts and running conferences." Another third of the total goes to pay for corporate access, he contends. "That's why it catches peoples' attention," Feng adds.
ITG CEO Bob Gasser also stresses the need to compete in the alpha-generation space. "If you look at this past year, and you look at the way the client wallet has shrunk, it comes at the expense of the alpha-retention bucket; the alpha-generation bucket has remained relatively intact," he explains. "When you look at the long-term volatility of our business model and growth, we have to have exposure to the alpha of the client's wallet."
To gain that exposure, in January ITG acquired a minority stake in Disclosure Insight, an independent research provider based in Plymouth, Minn., that offers analysis of public company disclosures based on 100 risk factors. ITG will distribute the alternative research provider's content exclusively to large asset management firms. "We wanted to partner with a firm that didn't have analysts and didn't have a conflict," says Disclosure CEO John Gavin. 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
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