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Financial Times

By Simon Mundy

Concern over conflicts dog equity analysts

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After 14 years in the City, Jonathan Pierce was one of London’s top-ranked banks analysts when he left Credit Suisse last year to become an economics teacher.

“The classroom’s brilliant – and the City’s not a bad training ground for it,” says Mr Pierce, who recently completed his first term of teaching at Wellington College in Berkshire.

Mr Pierce says he had always intended to move into teaching as a second career – setting him apart from a growing number of analysts who have been forced out of the industry since the onset of the financial crisis in 2008 as their employers cut jobs in a battle to remain profitable.

A depressed level of capital raising and takeovers partly explains the industry’s distress. But while corporate activity is expected to recover – albeit not to the levels seen before the crisis – brokers say there is no sign of a halt to the squeeze on the commission pools that they receive from institutional investors.

Research is seen as a core part of the stockbroking model. As well as commission from investors, a stockbroker’s strong research coverage can prompt companies to retain it as their corporate broker, leading to lucrative advisory fees on transactions. But if asset managers continue to push down on commission rates, senior brokers warn, the buy-side could ultimately face a shortage of valuable equities research as talented analysts are made redundant or leave.

“We joke about analysts not having any other skills apart from being analysts – but they do, actually,” says Will Wallis, head of research at Numis. “Increasing numbers of analysts are voluntarily bailing out and finding themselves other roles – whether in investor relations, consulting, setting up their own businesses.”

Traditionally, payment for the research sent to institutions was priced into the commission they paid on their trades. An “unbundling” drive over the past decade was intended to force institutions to split out how they pay brokers for execution or research.

But brokers complain many institutions still give little indication of how they allocate their commission pools, making it difficult to assess whether analysts are generating profits from the research notes they send out for no upfront charge.

“I have a great business model,” jokes one senior broker. “I produce a valuable product at great cost, give it away, and hope that people will pay me for it.”

Meanwhile, the total amount paid by institutions to brokers has been falling steadily – a result of factors including their own squeezed profits, fierce competition among the brokers and the growing share of trading volumes taken by off-exchange “dark pools”.

“It’s been a very long-term trend in one direction,” says David Currie, managing director of Investec’s UK investment banking division. “There is only so far it can go before [commission rates] reach zero.”

While the trend is causing a reduction in the number of analysts, brokers say it will take time before this causes serious concern on the buy-side with a widespread feeling that there is still too much sell-side capacity in the City.

The remaining analysts are under pressure to stand out from the crowd with original ideas and contrarian standpoints to win the internal votes from fund managers that partly decide how institutions’ commission pools are dished out.

“What we ask of our analysts is to be ranked by our target investors – that is the primary objective,” says Mike Trippitt, head of research at Oriel Securities. “And the printed research is only one part of the product – it’s also about building a relationship with clients.”

But some fund managers have come to value brokers’ research less, relative to the quality of their trade execution, after the departure of “a lot of really good, experienced analysts” in recent years, says Jim Conway, head of trading at Standard Life Investments.

While he says sell-side analysis remains a valuable resource, Mr Conway adds that institutional investors would respond to any serious deterioration in its quality by investing more in their in-house research departments.

The pressures are prompting some sell-side houses to challenge the traditional “integrated” broking model, arguing that specialising on serving either corporate or institutional clients enables a more focused service that eliminates potential conflicts of interest.

Redburn Partners, which focuses on large European companies, generates revenue only from the research and execution that it provides to buy-side houses.

The absence of corporate advisory and market-making activity means that Redburn’s analysts and sales traders can work “without pressure from bankers and traders”, says Jeremy Evans, Redburn’s senior partner.

Others eschew research altogether, such as Strand Hanson, an advisory house focused on the natural resources sector. The independence of stockbrokers’ research departments is often viewed as “questionable“, says Simon Raggett, chief executive of Strand Hanson.

“Research is a less tangible income generator than it once was.“