I enjoyed participating in AQ Research‘s recent conference on “The Future of Research”, last December 5.
I finally had a chance to edit and post my notes on the panel on Research Pricing.
Lisa Shalett, Chairman and CEO,
Sanford C Bernstein Paul Spillane, CEO, Soleil Securities
Chair: Albert Alonzo, AQ Research Lisa Shalett:
If research is really a discrete model, you could say that should have a fixed price.
But I believe research is actually really an advisory service, an interaction, part of a broader process—-part of the mosaic of ideas.
No money manager on the planet will say he has just one source for investing. Research should be priced in direct proportion to the value creation or value destruction.
By comparison, money management industry prices its service in proportion to its own value creation or value destruction. Unbundling and transparency are two separate concepts.
The idea that research pricing should be tied to volume or fixed is another concept.
I believe strongly that research should be tied to volume.
Paul Spillane: For us to be successful, we have to determine a fee. We are the only part of the finance business that provides product for free.
I don’t want us to be paid based on our stock-picking performance. 1-2 fund managers, and a batch of hedge funds, have given us a price schedule: you bring in a company manager, I’ll pay X. you provide an expert, I’ll pay Y. you set up road show for me, I’ll pay Z.
We’re trying to ascertain value of what we provide. Our analysts only get paid if customers say, “Pay them”. It’s all client-directed.
Alonzo: Independents have always been transparent, but sell-side have dragged their feet in complying with menu pricing. Shalett: Trading commissions should be going down slowly.
There’s no reason why they should be flat or rising. The wool is being pulled over the money management industry’s eyes.
Marginal cost of executing /clearing a trade is close to zero, and Sanford Bernstein is not even a scale player in this business.
If you want to save money on research & trading, start there first! Spillane: If you’re head of research at a bulge-bracket bank, you focus your effort on minimizing outliers, so no one can sue you.
You’re not focused on creating alpha. Money management industry is afraid to say what they’re paying for research. If a money manager says it’s paying 2 cents for research someone can sue. But if you say you’re spending it on execution, it’s harder to complain about it.
Look at Jefferies settlement. Shalett: Broader public policy question: what does research provide?
Buy side says they’re paying for liquidity, for there to be a dialogue. Trading cost curve has gone down 6 pct. annually since 1975, to 3.5 cents now.
The regulators want you to be democratic, give access to everyone.
Pricing mechanism should be scale neutral, to not overly advantage the largest money managers. Alonzo: Why do indies still get paid so much less than sell-side?
Spillane: Because we let them! We don’t know what we should be charging. We don’t have enough senior-level relationships. We don’t know if we’re being overpaid or underpaid.
You have to be willing to walk away from underpayment. Shalett: We don’t put a formal price on our services. But we use the concept of fair share.
We use polls, Greenwich polls. We’re paid 1/3 of what we should be paid, if you compare our ranking in polls with the total payments to research providers.
That hasn’t changed in 13 years. The reason is that the sell-side has a lock on being systematically overpaid.
Spillane: Lisa, you have the power to change this. Just shut them off. Shalett: We’d shut them off if Thomson would implement the change to make it easier to shut people off.
(laughter) Questions: What would it take for you to get out of execution?
Shalett: It will only happen if we can be confident that we’ll get paid 3x what we’re paid now. In Europe, implementing CSAs as follows: 8 bps for execution, 7 bps for research, plus 2 bps for proprietary research when paying sell-sides. These sell-side firms are holding the indies’ money for 90 days, paying no interest.
If there were a DTC, a Switzerland, for these commissions, I’d join it and exit trading. But I don’t believe in what’s being implemented today.
Alonzo: CSA gives firms freedom to use traditional payment mechanism. Is now the right time to push on pricing? Shalett: Depends partly on extent to which funds are generating substantial alpha.
Hedge funds are willing to pay unlimited amount for good research. Spillane: How do you get a return on capital that you can’t measure? If someone could provide a utility function for research, big banks would sign up and then focus on prop trading.
We’re entering dangerous part of cycle, because we’ve had good returns for several years.
This is first year in 10-15 yrs when more hedge funds closed than opened.
So it’s a tough time to talk about pricing. Shalett: Big banks are generating 30% ROE.
They’re good businesses. Mayhew: Will we see a more level approach between pricing of sell-side and indie research?
Spillane: We won’t move to unbundling until we’re forced to. We won’t subject ourselves to the soft dollar pool, which is only 7-15% of giant pool of commissions ($14-$15B in US).
I don’t want to be in the kiddie pool. Barry Hurewitz (Morgan Stanley): We have 500 analysts .
Average buy-side person with a $50M commission pool has 11 buy-side analyst. Lisa might have highest per-hour price on the Street, today.
I don’t see why you can’t just price your services explicitly; that’s what we do. Shalett responds: From 75 to 2000 (decimalization), trading was a commodity, because market was very concentrated.
Most volume going thru NYSE specialists, whether it came from MS or GS, or it was OTC (fulfilled by market-maker). Post-2000, you had fragmentation of liquidity, which meant differential execution quality.
Trading has become a more differentiated product.
Capital commitment actually mattered. Now, pendulum is swinging back.
Technology is reconcentrating liquidity. Buy-side can trade directly with the market.
Vast majority of executions are commodities, or will be in next 2 years.
So prices should be going down. It doesn’t make sense that prices go up.
CSAs favor some players over others. Macroeconomics don’t stand up to scrutiny, and industrial behavior is being perverted as a result.
Spillane: Morgan Stanley can’t price by the hour, because there are too many constraints.
Customers aren’t willing to set a price.
There are way too many internal pressures calling your #1 ranked analyst to come to a meeting, go to a conference, etc., to say simply that he bills at $3000/hour.