(Bloomberg Markets) -- UBS analysts tore a Tesla Model 3 apart.
They teamed up with engineers to examine its parts and detail its technology. They did the same with BMW and Chevy electric vehicles. Then the analysts wrote five reports—totaling more than 200 pages—comparing the three cars (spoiler: Tesla won).
Clients of UBS Group AG might recognize such work as the hallmark of its Evidence Lab, which specializes in collecting proprietary data. That includes regularly sweeping the internet for prices of luxury handbags, surveying Chinese tourists, and using algorithms to interpret earnings calls.
That’s what research can look like these days as analysts stretch to hang on to business. From bulge bracket banks to independent shops, the industry is rethinking how to lure and retain clients who are keen to slash their research budgets. The backdrop, of course, is MiFID II and the flow of assets into passive strategies. The European Union’s Market in Financial Instruments Directive, which went into effect last year, unbundled research fees from trading commissions and forced asset managers to pay for the research they use. At the same time, the pot of euros they can devote to paying for star strategists’ musings and financial models is less full. Asset managers’ fees are shrinking as clients opt for cheaper passive strategies—which, by definition, aren’t interested in analysts’ price targets.
By the end of 2019, brokers’ revenue from European equity research will drop by $300 million, or 20%, as a result of MiFID II, according to consulting firm Greenwich Associates. “Given the smaller research pool, investment banks and other providers will continue to fight for every last dollar,” Greenwich’s William Llamas said in a report. “Success will be defined as ‘almost’ capturing the same revenue as in pre-MiFID II times.”
And it’s not just MiFID II in Europe that’s spurring the changes to research budgets. In the U.S. fees have fallen to about half of what they were in 2000, Morningstar Inc. found in a study released in April. Since the global financial crisis, the commissions funds pay to execute trades have also declined; even where research costs can still be bundled with trading commissions, deflationary pressure has intensified.
So what can analysts do to win and hang on to clients? Cue the podcasts and webinars, novella-length thematic analyses, secret bespoke reports, and instant-messaging platforms for quizzing analysts.
Proprietary data is a buzzphrase. Exane BNP Paribas SA produces its own Survey of Telecom and Media Preferences, which questioned more than 15,000 customers this year. UBS Evidence Lab, which became a separate business within the investment bank late last year, is moving toward selling its data directly to clients, says Dan Dowd, UBS’s global head of research. “The future of sell-side research is going to be deep industry expertise coupled with deep and broad primary data collection capabilities,” he says.
Technology has also remade how research is distributed. Sanford C. Bernstein, AllianceBernstein Holding LP’s research arm, is working with platform Podbean to produce podcasts in which analysts discuss their latest ideas, says global director of research Colin McGranahan. AlphaValue, a French independent research provider, has launched an instant-messaging platform for clients to communicate with analysts, says Maxime Mathon, head of marketing.
Citigroup Inc. has been doing more bespoke work—detailed research requested by clients—in part because asset managers are more willing to pay for projects with substantive, visible results, says Terence Sinclair, global franchise director of research.
Some of the industry’s exclusive reports have been unusually influential: In February, Exane BNP Paribas published a report for selected clients on the Luxembourg-based laboratory testing company Eurofins Scientific SE that prompted the company to make changes to its corporate governance. “What we have learned is that we now have to be more focused than ever on the specific needs of our individual clients if we want to maximize the value we add,” Ben Spruntulis, head of equities at Exane, said in an email.
Thematically, three topics are hot: ESG (environmental, social, and governance), renewable energy, and alternative data, says Mike Carrodus, founder of Substantive Research, which helps the buy side monitor content and pricing. Reams of thematic reports have been penned on broad, long-term trends: What does Generation Z like? What do we do about income inequality?
“We’re seeing a genuine demand for both macro strategy—economic and thematic content—and for a micro, forensic understanding of companies and what drives the stocks,” says Rupert Jones, head of European equity research at Barclays Plc, whose department produces both forensic accounting work and thematic reports.
Another focus for Bernstein: private companies going public. Investment banks can’t always cover them, and investors are often under pressure to make a decision, McGranahan says.
Amid all the innovation, there’s anxiety that cost-cutting has eroded the quality of the work. In the last five years, headcount for equity research at 12 major investment banks declined about 20% to an estimated 1,100 in Europe, the Middle East, and Africa, according to data from Coalition Development Ltd. Interestingly, a CFA Institute survey conducted in December shows 44% of sell-side respondents say research quality has worsened since MiFID II. Only 27% of their customers agree; on the buy side, 48% say it’s unchanged.
To find new sources of revenue, some Scandinavian banks and French brokerage Kepler Chevreaux are offering sponsored research, reports that are paid for by the company under study.
Industry consolidation is also accelerating amid a scramble for shares of the shrinking pie. Sanford C. Bernstein’s acquisition of Autonomous Research, which specializes in financial-sector coverage, became a poster child for consolidation. “We are active in believing the market should consolidate,” says Bernstein’s McGranahan. “It makes sense in an industry where there has been excess capacity.”
U.S. securities company Stifel Financial Corp. bought the equity research and brokerage operations of German group MainFirst Holding AG, which had taken over Raymond James Financial Inc.’s institutional brokerage business in European stocks. AlphaValue combined forces with Baader Helvea; the two now cover 600 European stocks in total. “Many investors—tier-1 or tier-2—understand if you don’t cover more than 250 European stocks, you’re not relevant to their budget,” says AlphaValue’s Mathon. (Tier-1 refers to the largest institutional investors.)
While MiFID II is supposed to level the playing field between large and smaller firms by separating the costs of research and trading, there’s evidence that the biggest global banks, including JPMorgan Chase & Co. and UBS, have maintained an advantage because of the breadth of coverage they can offer. “While there certainly may be nichey issues that we can’t help them address, in general, 90% of the things they’re interested in at any given point in time, we have terrific content on,” says UBS’s Dowd. Top-tier clients allocate 60% of their external research and advisory budget in Europe to global investment banks, Greenwich data show.
When MiFID II kicked off in early 2017, the priority for research providers was simply covering the bases, says Substantive Research’s Carrodus. As the dust settles, there’s a greater focus on quality. “We’ve seen now the first green shoots of a return to an interest in the discovery of differentiated work,” Carrodus says.
So, time to tear apart some cars, or perhaps moonlight as a deliveryman (as one Jefferies analyst did). “The best people are being forced to be really thoughtful, original, and differentiated in what they offer, otherwise clients just don’t want to spend time or budgets on them,” says Barclays’ Jones. “If you’re good, it’s a very healthy and cathartic change. If you’re not very good, it’s a difficult change.”
Lee covers European equities for Bloomberg News in London.
(Corrects to say that UBS Evidence Lab became a separate business within the investment bank in the eighth paragraph.)
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