2016 Global Trends in IR

BNY Mellon Depositary Receipts group has very recently published their annual report on global trends in investor relations. With 550 companies surveyed from 54 countries, it is probably the most comprehensive barometer of the current themes in our industry. The report provides large amount of comparative information on how listed companies are adapting to the changing marketing condition, touching on topics such as budgets, allocation of management’s time for buy side meetings, reporting lines, use of sell-side, measuring team effectiveness as well as insights into evolving areas such outreach to ESG investors and the use of technology.

Firstly as a qualifier, lets consider the demand side dynamics for global issuers. Despite the inevitable short and medium term swings in investor appetite for a given asset class, market or industry evidence that investors all around the world are diversifying and are increasingly adding a global component to their portfolios. Our own analysis point to over 4,000 institutional investors who hold emerging market securities, versus only 400 in early 20oo’s. BNY Mellon’s own estimates point to number of investors that hold DRs (or, roughly translated as those with global mandates) has increased from from 3,261 in 2Q10 to 4,533 in 2Q15. This figure will, we believe,  continue to grow, and present opportunities in areas where a- investors previously held most domestic bias and b- have considerable assets under management in active management and c- see diversification opportunities globally.

With this backdrop, a couple of things to note from the survey:

  • IR teams are working harder to address the growing global investment opportunity.  This is evidenced by 1- investor meetings taken by C-suite executives and IROs inside and outside their home markets have increased by 12.6% compared to 2013 (from 250.6 meetings in 2013 to 282.3 meetings in 2015). 2- companies almost doubling their IR budget allocation to travel, from 12.8% in 2013 to 24.3% in 2015, which in turn is interesting to contrast with the slight decrease in companies holding analyst/investor days (63% to 59%).
  • Top 10 sources of new investor demand in five years time, according to surveyed companies, will split evenly between emerging and frontier market. US, UK, China, Germany and Singapore lead the pact.
  • Technology tools, such as  conference call/webinar and video conference calls has been increasingly used in toolkit of a global IR officer (72% in 2015 vs. 63% in 2013 and 41% in 2015 vs. 34% in 2013). With the management and IR team time relatively fixed, and the buyside universe expanding – there is no element of a doubt that tools that help reach new investors can increase reach and efficiency, at a fraction of a price. We are strong advocates of using new tools to tell a company story . Can any one see how virtual reality or 360 videos can be applicable to the world of investor relations?
  • Despite the wave of regulations on how investors will pay for research and cooperate access, brokers continue to dominate the company non-deal roadshows arena, however with some signs of this changing. 10% of companies have organised NDRs themselves, up from 5% the previous year. Interestingly, companies rely a lot less on brokers nowadays to provide them with post meeting feedback, and rate quality targeting and introductions at upmost importance.
  • Growing ESG focus – The survey notes that there has been a strong increase (from 37% to 46%) in companies who have strategies in place to communicate with key investors on corporate governance issues on a regular basis, with top issues addressed being Board composition (76%), Transparency and disclosure (71%) and Remuneration (60%). Despite that the actual number of investors who reach out to ESG focused investors is still low (30%), however likely to rise. There is evidence to suggest that institutional investors are increasingly committing to ESG-focused principles in their strategies — whether that be through a more active engagement as shareholders or divestment strategies. 

Source: BNY Mellon Depositary Receipts Market Review 2015, BNY Mellon Global Trends in Investor Relations 2015

Evolving face of institutional equity business

A interesting Bloomberg article titled “Wall Street Cracks Down on Free Sharing of Analysts’ Notes” has crossed our desk last week ignited a discussion within our team about the the market for investment research.
The article points out how brokers, to some extent driven by regulatory pressures, are overhauling the process of producing and distributing of research and using online portals to track what gets read and by who- and bringing closer to be able to finally see how much investors are willing to pay for analyst report.
As a refresher, most of equity commissions paid by investors to brokers are split into two components: Execution and Non-Execution. Execution component pays for physical cost of trading and cleaning the transaction, and non-execution pays for other services such as investment research and corporate access. In a bundled commission environment, those two components are not separated and captured by the broker executing the equity trade.
CSAs (introduced in 2007) enabled fund managers to separating commissions into payment for executing trades from payment for research, however most argue they were not not sufficient to determine the value of services consumed, nor control spending. Furthermore the commissions (whether bundled or unbundled) actually belong to the asset manager’s end client however the asset manager has the full discretion of how to spend it.
The direction of regulatory travel is towards complete unbundling, something that we believe , will reshape the economics of institutional equity business, carrying with it serious implications to asset managers, sell side firms and IR teams.

We see those five questions are at the crux of the debate:

1- What has been happening to global trading commissions, which still drive the vast majority of supply of research and corporate access services?
Post crisis environment brought about the worst bear market for equities since the 1930s. Combination of depressed equity valuation, lower trading volumes, lowers fees generated from IPOs and primary market activity, a steady shift from active to passive investing meant a significant decline in available commissions for equity businesses providing research and corporate access. The effect was particularly severe outside North America where commissions are calculated as a percentage of the value of the share price. Emerging markets as a whole have also suffered their own set of dynamics which have further reduced comission dollars and meant instances of banks shutting down entire operations (ex. DB in Russia, CLSA in , Nomura in)
So what did this mean for broker revenues? Frost Consulting estimates that there has been a 43% reduction in global commissions for equity research, leading to a 40% reduction in budgets allocated by the 600 or so reduction in budgets allocated by the c 600 firms producing equity research from US$8.2bn at the peak in 2008 to US$4.8bn in 2013.

2- What would regulators like to see commission payments used for?
In short, just for execution. The UK’s Financial Conduct Authority wants brokers’ research to be treated as a cost to the manager and paid out of their own P&L rather than paid for out of client funds- a reform known as “unbundling”. This may eventually lead to a “priced” market for investment bank research which could transform the market in which consumers (investors) only receive the products they want and purchase in which personalisation, interactivity, niche focus will be critical for commercial success. The changes could provide an advantage for independent and specialist firms. In 2014, the FCA already banned using client commission payments for Corporate ACcess in the UK in 2014, a rule that is still looks that is yet to be adopted flouted

3- Are investors treating commission spending as if they were their your own?
Milton Friedman, the US economist, once said that perhaps the most wasteful form of spending is spending someone else’s money on somebody else: you are then “not concerned about how much it is, and not concerned about what you get get”. Perhaps there is a little bit of thoughts that can be applied to current discourse in the asset management industry. Regulators feel that allocation of spending (and hence the pricing) of broker services would have been different if investors had to pay for it from their own pockets. Surely, they argue, more considration would go into what is valueable, hence

In last year’s survey by the CFA Society UK, almost half of respondents think that Investment firms in the UK do not manage dealing commission – which is a client asset – as carefully as if it were their own money.

payments as if it were your own?

5- What do investors value most from brokers and how is that value priced?
Investors consume a number of services from brokers, and

Experts say that one of the trickiest aspects of pricing research is working out its value.

Reverse roadshow / investment trip to
Face to face management meeting at home
An Investor Conference
Call with reserach analyst
A report

Related articles
Bloomberg: Ballad of a Wall Street Research Analyst, Told by Brad Hintz

Equity Research Worth Paying For : A Look at Economic, Digital and Regulatory Changes

This is a guest summary post by Alphametry CEO Fabrice Bouland, of a recent senior executive roundtable about the future of equity research. You can download the full whitepaper version here.

An industry in trouble?

  • Global investment banks have seen shrinking revenues and in turn have been allocating increasingly smaller budgets to equity research. Several external factors affect revenues, among them:
  • Lower trading volumes caused by post-financial crisis industry deleveraging;
  • Fierce competition from electronic trading automation;
  • The rise of passive investing with exchange-traded funds (ETF) products rather than direct equity ownership;

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  • At the same time, supply issues such as mid and small-cap stocks poorly covered are adding a layer of complexity to the agenda.
  • The market as a whole is also very opaque in terms of pricing and service levels.
  • The delivery of content is about to radically change. The bulge bracket investment banks are starting to move towards digitization.

SAVING EQUITY RESEARCH

  • Regulators are pushing for research spending transparency on several key areas, including:
  • Price disclosure;
  • Approved budget and reporting;
  • Forecasts of how much research to spend; and
  • Assessment of investment value versus spending.
  • Since its introduction in 2007, the use of commission sharing agreements or CSAs has gradually expanded as a tool of choice for asset managers to access independent research.
  • On the regulator’s side, it is UK’s Financial Conduct Authority (FCA) that is taking the lead on the unbundling efforts while others, like the French Authorities AMF continue its support of CSAs, only advocating to add more transparency measures.

” There is strong evidence to suggest the current model of using dealing commission to pay for research reduces transparency and creates a link between research spend and trading volume, without a clear assessment of the value this offers to investors”  – Martin Wheatley, Former CEO of the FCA, who stepped down July 2015

  • To replace CSAs, the FCA wants to implement the new Research Payment Account (RPA) scheme and will ban inducements.

THE PRICE OF EQUITY RESEARCH

  • Separating research from execution raises a simple question that will be exceedingly hard to answer: how much is research worth? In a survey from a Bloomberg Institutional Equities Event, respondents were asked what factors were the biggest challenges when valuing equity research:
  • 37% said transparency was the biggest challenge;
  • 25% said ‘a la carte’ pricing;
  • 21% pointed to pricing benchmarks;
  • 10% said disparate evaluation; and
  • 7% said regulatory clarity.
  • Pricing equity research was a hot topic in the Alphametry roundtable. Participants noted that as there have never been internal benchmarks for evaluating equity research and that the range of pricing will probably be very wide.
  • Are current investment research prices fair? Sentiments from the sell-side in the roundtable leaned towards a “name your price” approach. Some participants were interested in exploring commission-based models with various level of service.

Screen Shot 2016-02-07 at 18.47.12

  • Similar sectors like digital news media are changing their entire business models because content that was once paid is now free.
  • Another factor that plays into pricing is content longevity or shelf life. Roundtable participants pointed out that some content such as sector reports could be relevant for months.

INVESTMENT RESEARCH 3.0: AN INDUSTRY REBORN

  • Regulation is converging and investment firms are building global compliance platforms applying best local practices.
  • Research is going through its digital transition phase. As more content becomes digital, the industry is focusing less on the velocity of data and more on how large datasets can be analyzed.
  • Data volume is rising exponentially. Social data, web site usage, physical surveillance (e.g. shopping center parking spaces), and connected object will all be taken into account.
  • The industry is facing its largest organizational restructuring challenge ever in building up staff experience on the technology stack and using analytics to understand clients better.
  • Distribution platforms are playing larger roles and platforms that can deliver fully digital content with integration and interactivity have the upper hand.
  • All information-intensive industries such the media will be re-intermediated.

PARTICIPANTS

BNP Paribas, Citigroup Global Markets Asia, CIMB Securities, CLSA, Deutsche Bank EFA, Global Equity Flow, IBT, Morningstar Asia, Nomura International, Société Générale, Shenwan Hongyuan Research, UBS

To gain deeper insights of equity research digital trends and emerging economic models, download here your free copy of Alphametry roundtable whitepaper.

Investment Research: To Free or Not to Free?

Last week we published a blog in which we attempted to get to grips with some of the important questions that remain around the unbundling of commission for corporate access and trade execution. A Bloomberg article that came out around the same time entitled “Wall Street cracks down on free sharing of analyst notes” leads us nicely to the remaining piece of the unbundling puzzle, namely investment research.

The main objectives of the ongoing regulatory scrutiny of both research and corporate access are to eliminate conflicts of interest, increase market transparency and level the playing field. To this end, the revised rules on corporate access are fairly simple: if fund managers want their broker to put them in front of companies, they must pay for it out of their own, and not their clients’ pockets.

Research looks to be heading down a similar path. If, as expected, regulators demand that investors who wish to continue benefiting from broker research must pay an upfront, out-of-pocket yearly fee (which is not linked to trading volume or value), there are 4 possible outcomes:

  1.   Brokers will continue to fund research as a loss leader
  2.   Fund managers will fund research
  3.   Companies will fund research
  4.   Investors increasingly conduct and rely on their own research (in 2014 in-house buy-side research increased by 42%)

In reality, all of these things may happen to some extent. In 2000 the US SEC passed Regulation Fair Disclosure (Reg FD) requiring publicly traded companies to disclose material information to all investors at the same time, meaning in theory analysts are free to conduct and disseminate research to whomever they please. In the case of large companies, banks will almost certainly continue to pay as they chase business from companies as well as from investors. But this does raise certain issues.

As the Bloomberg article outlines, the main problem with expecting fund managers to pay for research themselves (besides the fact that they have been passing all costs on to their own clients for years) is that research reports are widely available online or from colleagues or contacts in the industry, free of charge. The sell-side switch away from “blasting out everything it produces” will take time, although it seems that technology will play an important role in restricting access and tracking readership.

One of ESMA’s criticisms of the current model is that buy-side firms are using their clients’ money to pay for research as part of an existing commission arrangement (meaning they basically get the service for free), effectively shutting independent providers out of the market. The regulatory amendments and the likely collapse of the current model should open the door wider for independent research providers, including some of those we highlighted in our previous blog with innovative models such as Stockviews and SeekingAlpha.

The other likely consequence of limited distribution of research reports will be for analysts to adopt a more tailored, targeted approach. This could be crucial for an industry which is often slow to adopt new practices and technology. It is often the cheaper, more agile, independent providers who are quickest and best placed to respond to technology-oriented opportunities in the market, although as the article highlights, it seems that the big banks are already starting to cotton on to the competitive benefits of this approach.

What impact will this have on company IR teams?

A more specialised, less generic focus will surely bode well for companies across the board but perhaps especially for SMEs and those in emerging markets, who have historically tended to be lost in the sea of free blue chip research reports. Former NIRI national board chair Brad Allen, writing for IR Magazine, advises company IROs of all shapes and sizes to strive to be “the go-to source not just on your company but also on your industry”, rather than relying on analysts and databases to tell the story.

The reality is that while the unbundling of corporate access and research services remains a hot topic in Europe and beyond, it will be a while before legislation is formalised now that MiFID II itself has been delayed. Even in the UK there is a definite air of ‘business as usual’ as brokers, analysts and fund managers wait to see who flinches first.

In the meantime, IROs would surely do well to heed Allen’s advice. In emerging markets especially, a proactive and innovative, technology-friendly approach will help them to address the far more immediate concern of an increasingly jittery investment community. Good IR alone will probably not be enough to stem the current flow of capital out of EMs, but companies who tackle this issue head on now will be well placed to capitalise when the tide finally turns.

Unbundling: 4 questions to consider

As UK’s FCA and European regulators continue to clarify their stance on commission ‘unbundling’ we thought it might be useful to quickly revisit the debate and attempt to answer a few questions at the core of the debate.

To recap (also see our earlier piece: Brief history of the dealing commission), most equity commissions paid by investors to brokers are split into two components: execution and non-execution. The execution component pays for the physical cost of trading and clearing a transaction; the non-execution component pays for other services such as investment research and corporate access.

Commission sharing arrangements (CSAs) enable fund managers to keep the two components separate, however until recently they have tended to be ‘bundled’ together into one commission payment. CSAs have been criticised for their lack of transparency in helping fund managers to determine the value of the services consumed and to control spending. Furthermore, even though the fund manager has full discretion in how the commission is spent, it is paid for by the fund manager’s end clients.

In Europe at least, we seem to be heading towards complete unbundling, which will likely have profound implications for asset managers, sell side firms, IR teams and entrepreneurs alike

1. How have global trading conditions affected made the supply of research and corporate access services?

The post-credit environment has ushered in the most difficult period for equities since the 1930s. This is due to a huge combination of factors: depressed equity valuation, lower trading volumes, lower fees generated from IPOs and primary market activity, equity market fragmentation and HFT, and a steady shift from active to passive investing. All of this has contributed to a significant decline in available commissions for equity businesses providing research and corporate access. Emerging markets have fallen prey to additional dynamics, which have further reduced commission dollars from trading and caused banks to scale back their securities operations and in some cases shut down entirely.

So what does all of this mean for broker revenues? Frost Consulting estimates there has been a 43% reduction in global commissions for equity research, which in turn has led to a 40% reduction in budgets allocated by the 600 or so firms producing equity research, from $8.2bn at their peak in 2008 to $4.8bn in 2013.

2. What would regulators like to see commission payments used for?

The UK Financial Conduct Authority (FCA) wants broker research to be treated as a cost to fund managers to be paid out of their own P&L rather than out of clients’ funds (‘unbundling’). This may eventually lead to a ‘priced’ market for investment research in which consumers (investors) only receive the products they are willing to pay for. It seems reasonable to assume that this will lead to greater personalisation, interactivity and niche focus. Such changes could offer independent and specialist firms an edge, as well as present opportunities to the long tail of companies often overlooked by sell-side analysts. In 2014 the FCA banned the use of client commission payments for corporate access in the UK, a rule which made waves in the investment community but has yet to be fully adopted or implemented.

3. Are investors paying commission responsibly?

Milton Friedman, the US economist, said that perhaps the most reckless form of spending is that which involves someone else’s money as you are “not concerned about how much it is, and not concerned about what you get”. Perhaps this thinking can be applied to commissions. Regulators feel that the amount of money allocated to (and by extension the pricing of) broker services would be somewhat different if investors had to pay for it out of their own pockets, and that more thought would go into the true value of these services. In last year’s survey by the UK CFA society, almost half of respondents agreed that investment firms in the UK do not spend their clients’ commissions as carefully as if they were their own money.

4. How do investors assess and quantify value?

Despite the ubiquity of research and corporate access services, there is no uniform pricing model and industry experts agree that it’s a tricky subject. As Matt Levine points out in his column, one of the main challenges is that equity research, at least from a regulatory point of view, is classified as material, non-public information. As such, institutions have a responsibility to distribute it ‘fairly’. Something will have to give.

Many would argue that while these services provide a broad benefit and ultimately make markets more efficient (by helping to disseminate information and underlying analysis more widely), the model only benefits a narrow segment of the market. Asset managers are investing more and more in their own in-house research teams, and in some cases in dedicated corporate access desks. Numerous independent research providers and start-ups have also entered the market to fill the gaps and propose new models. Many of them, like us, believe that technology can play a complementary role and perhaps solve one or two issues along the way.

Benefits of Being a Small Investor

This is guest blog post from Tom Beevers, ex-Portfolio Manager at Newton and now CEO and Co-Founder of StockViews.

Off the Beaten Path 

Throughout the financial world being large is considered an advantage – banks, brokers and insurers all benefit from significant economies of scale. But for an investor, being small offers a huge advantage. Because your investment universe is not limited to large-cap stocks, you are free to go places where large institutions would never tread. And because Wall Street ignores these investments, the chances of finding a real opportunity are much greater. Unfortunately this advantage is not always recognized or capitalized upon by smaller institutions and individuals.

In a Business Week article in 1999, Buffett explained how profitable these lesser-known investments can be:

“You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map – way off the map. You may find local companies that have nothing wrong with them at all…Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.”

Investors can be apprehensive about exploring these opportunities because they are associated with “high risk”. It is true that there are some risks specific to small-cap investment, but this doesn’t preclude an investment. You simply need to be aware of the risks and factor them into your decision-making.

Wall Street Hates Small Caps

Why does Wall Street ignore these opportunities? Largely because the big brokers don’t make money from small caps. Clients can’t trade in small-cap stocks since it takes several days or weeks to build up a position. These investments are never going to generate large execution fees for the broker. In any case, many institutional managers aren’t themselves interested in going off the beaten path. There are a number of (mostly bad) reasons for this:

  1. Fear of illiquidity. Most experienced fund managers can remember at least one disastrous investment they made in a small cap stock. They remember everyone rushing for the exit, like something out of Jurassic Worldand the pain of that memory is still etched on their brains. Not being able to exit a bad investment is something that investors just can’t stomach.
  2. The fact that the stock isn’t covered by Wall Street brokers actually scares some managers. They’re deeply uncomfortable with the idea that nobody is formally “responsible” for it (i.e. nobody to blame if it goes wrong). The idea that a stock isn’t being watched at all times just gives them the heebie-jeebies, and in extreme cases can bring on an existential crisis.
  3. More obscure stocks suffer from management teams that are less polished. They don’t have a glossy pitch deck or a quarterly roadshow and they usually mess up the earnings call (though it’s not like anyone’s listening). For fund managers used to the slick marketing machine of the S&P500, this is like going from HBO to Ukrainian State television.
  4. Fund managers hate high volatility. Many of them are so obsessed with daily movements in the stock that they get freaked out by a few down days. Eventually they sell the stock in question just so they can get a decent night’s sleep.

The Gift of Volatility

The very things that scare most institutional managers provide an opportunity for the intelligent investor.   The intelligent investor always welcomes volatility because it provides a greater chance for a stock to diverge from its intrinsic value. Without that volatility you might never get a sufficient “margin of safety”.   Sometimes with a small-cap stock, you look at the chart and it’s clear to see that a large institution has been selling down a massive stake.   In the ensuing panic, other institutions have capitulated and the price has been depressed further. This is a gift for a smaller investor, who can pick through the carnage looking for a bargain. To borrow from Buffett’s baseball analogy, this is when you swing!

Exploring the Universe

Of course finding these opportunities is not easy. There’s an almost infinite pool of small cap stocks in a diverse range of industries and it’s impossible to study all of them. A substantial amount of work needs to be done before you can conclude that the stock is materially over-priced or under-priced. This is why I’m passionate about the ability of crowdsourcing to uncover hidden opportunities. Even the largest research firm can’t hope to uncover a fraction of the best opportunities in the market. But an army of smart people all looking at stocks that Wall Street has no idea about – this is something that crowdsourcing was made for.

Small-cap Risks

Of course smaller cap companies have risks. They typically don’t have the breadth of products or depth of management expertise and they’re constantly under attack from larger competitors. However, like with any investment, these are risks that can (and must) be factored into your analysis. On the flip side, smaller cap stocks have advantages that large caps don’t – growth is easier to generate from a smaller base, and they are better adapted to change in a fast-moving industry. Financial dogma tells us that small caps must be more “risky” because they are more volatile. This is bunk – the measurement of beta is a very poor substitute for understanding the risk profile of the company. As Warren Buffett has said “risk comes from not knowing what you’re doing”.

But for a small cap strategy to work it will take time. Anomalies among small caps can remain for a long time precisely because they are not well covered. What’s needed here is something that’s in very short supply on Wall Street: Patience. While these investors are waiting for the anomaly to close, the vacuum of information leaves them vulnerable to fear and uncertainty. They crave validation from the market and when they don’t get it they begin to question if they took the wrong path. I leave you with the words of Benjamin Graham, the father of value investing:

“Traditionally the investor has been the man with patience and the courage of his convictions who would buy when the harried or disheartened speculator was selling. If the investor is now to hold back until the market itself encourages him, how will he distinguish himself from the speculator, and wherein will he deserve any better than the ordinary speculator’s fate?”  Benjamin Graham, Security Analysis

Tom Beevers is the CEO and Co-Founder of StockViews, a platform that crowdsources high quality equity research. Original post appeared on StockViews blog.

State of Corporate Access

Last week Ipreo published the fifth edition of its Global Corporate Access Survey where it monitors various elements of interactions between the company and the investment community.  At the heart of the survey is the ever changing relationship between the company and the sell-side, and its role in providing a crucial service that in the investment making process. Sample size for the survey was 400 issuers with a heavy US component (58%).

So, what do companies value most from their brokers?

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Source: Ipreo