In July 2016 I wrote the following article on the rise of independent research houses in Australia as though it were a newspaper story. I reckon it would be a great story if someone would pick it up and publish it, but unfortunately many journalists working for the old-line media in Australia today are not unlike Donald Horne's description of Australia's leaders in the mid-1960s: So lacking in curiosity about the events that surround them that they are often taken by surprise. - Stuart.
The Rise of the New Analysts
It’s been a feature of Australia’s equity market for some years now: Business is tough for the brokers and investment banks, and there are layoffs. The cuts happen across the board, but inevitably the axe falls heaviest on the research team. We estimate that the number of analysts working for participant organisations of the Australian Securities Exchange has shrunk by one-third since 2010, and for those still working in the industry, average compensation has probably dropped by a quarter.
There is, however, one interesting trend that shows signs of going the other way. We argue that analysts in Australia will in the future show up in increasing numbers at ‘independent’ firms that just do research and are not affiliated with any broker.
Independent equity research has been growing in popularity in other parts of the world for some years now. If this sector of the capital market could be said to have a take-off point, it was probably in the US in 2003. That was the year when Eliot Spitzer engineered the ‘Global Analyst Research Settlements’ to punish ten Wall Street firms for the much-publicised conflicts of interest in their sell-side research during the bull market of the late 1990s. The Settlements slugged the offending firms with around US$1bn in fines but also obliged them to spend US$432.5m over five years from 2004 on independent research. This prompted the growth of new firms like Argus Research as well as older shops such as Morningstar and S&P. By the time the Settlements came to an end in 2009 Wall Street itself had changed in response to technology haven driven down the cost of trading. The rise of agency brokers such as Instinet, BNY ConvergEx, and Liquidnet, which offered execution but no research, led to the sharing of commission dollars with independent research firms that continued the growth of the sector. Part of this sharing was fuelled by Commission-Sharing Arrangements (CSAs), where institutional investors would reserve part of their trading commission to pay a research provider other than the firm which executed the trade. This had the effect of ‘unbundling’ research from trading.
The UK entrenched this unbundling trend in 2005, when the Financial Services Authority published new rules requiring investment managers to disclose to their customers details of the split between what commission payments had been spent on ‘execution’ and what had been spent on ‘research’. This reform has made the UK independent research sector a particularly vibrant one. The rest of Europe will effectively go down the unbundling path from the start of 2018 through the so-called MiFID II regulations.
While a lot of the independent research firms that have grown up over the last 15 years have a business model oriented to sharing of commissions from institutional investors, a third factor driving the rise of the sector has been the willingness of listed companies to pay for their stock to be independently researched. This is an old model that was pioneered by the likes of Standard & Poor’s and Moody’s for credit ratings and has now moved over to equities. The model provided a more reliable way for research providers to get paid after commissions took a big hit during and after the Global Financial Crisis. It’s estimated that in Europe commissions probably dropped 40% between 2008 and 2014.
One of the features of the new world of independent research is that the firms tend to start out as sector-specific, reflecting the background of their founders, and then expand. So, for example, the London-based Oraca started out covering large cap telecommunications companies in Europe and then branched out into sectors such as cleantech and the Life Sciences.
Australia has tended to lag behind Europe and North America in terms of the rise of independent equities coverage, but we think that is about to change. First of all, there’s the relatively ‘over-broked’ nature of the market, where ASX participant organisations are cutting back on their research spending because the market is so competitive. Secondly, there’s the fact that Australia traditionally has a large number of publicly-traded small cap companies, most of which are under-researched or not researched at all. Thirdly, there is disillusionment with quality of research from traditional brokers where the focus is on maintenance research on large caps rather than breaking new ground with small companies, except where there’s the potential to do investment banking business with the company.
The independent equity research space in Australia was pioneered by Aegis Equities Research, founded in 1999. Aegis was producing equities research and market commentary on more than 200 ASX-listed companies by the time it was acquired by Morningstar in 2010. A number of former Aegis senior executives and shareholders have since built a successor business called Independent Investment Research. A more recent entrant to Australia was the UK firm Edison Investment Research, which opened a Sydney office in 2011. And 2016 has seen two new interesting arrivals in the space - TMT Analytics and NDF Research. In each case the founders used to work for brokers. And in each case the offering is sector-specific.
TMT Analytics, founded by Marc Kennis, focuses on the tech, telco and new media space. A native of the Netherlands, Kennis arrived in Australia in 2014 and initially worked for BBY and Foster Stockbroking before starting TMT Analytics in early 2016. He had previously worked in investment banking in Amsterdam and built an independent equity research business there focused on the tech sector, but saw more fertile ground in Australia. For one thing, the speed with which the sector has evolved in Australia has created a need for more highly specialised research. For another, Kennis sees that the ASX has become a great breeding ground for new tech ventures. “I believe the ASX can become a new Nasdaq or AIM for my sector, but it hasn’t had time yet to develop the kind of equity research infrastructure that is commonplace in Europe and America. I believe TMT Analytics can fill that gap”, Kennis says.
NDF Research, founded by Stuart Roberts, is focused on the Life Sciences. Roberts had helped pioneer equity research on ASX-listed biotech and medical device companies while working at Southern Cross Equities in early 2000s. He stayed with Bell Potter for two years after that firm completed its integration of Southern Cross in 2011, then spent a year at Baillieu Holst before leaving broking in 2015. “The game had changed since when I started in 2001,” says Roberts. “The structural changes in the industry were making it tougher to make a buck for the clients”. Roberts worked for a while with two listed biotech companies before starting NDF Research in June 2016. Like Kennis, Roberts feels that his sector has been under-researched in recent years. “Australia is a great place to build a biotech company but once it goes public it gets almost no serious research coverage. I believe NDF Research can change that”. Like Kennis, Roberts can sense the demand from listed companies who don’t feel they are properly understood by the market and would value the research.
Both men have noted a minor prejudice in Australia against “paid for” research, but thinks this will change. As Stuart Roberts comments “This sector doesn’t work unless the people in it are committed to being genuinely independent. The best analysts at broking houses back in the day were the most independent – the ones who thought CSL was a strong buy back in 2003. Those kinds of analysts will be successful in this new era as well”.
Many people will ask why Australian investors need independent research. The Internet has created so much information relevant to investors that the traditional ‘middleman’ role of the analyst, so this argument goes, has been superseded. Kennis and Roberts both partially agree with that view, but argue that the Australian market still needs analysts. “The thing about skilled analysts”, says Kennis, “is that they are part communicator, part information aggregator, part interpreter of information and part financial specialist. There’s just so much information out there that without analysts to explain it and put it in context it’s difficult for even professional investors to handle”. Throw in the increasing technological nature of business today, and Kennis and Roberts argue that their profession will be around for a while yet. As Roberts puts it, “in the biotech area knowledge can double every eighteen months or so. Only the professionals can even hope to keep up with that”.
There is, however, one interesting trend that shows signs of going the other way. We argue that analysts in Australia will in the future show up in increasing numbers at ‘independent’ firms that just do research and are not affiliated with any broker.
Independent equity research has been growing in popularity in other parts of the world for some years now. If this sector of the capital market could be said to have a take-off point, it was probably in the US in 2003. That was the year when Eliot Spitzer engineered the ‘Global Analyst Research Settlements’ to punish ten Wall Street firms for the much-publicised conflicts of interest in their sell-side research during the bull market of the late 1990s. The Settlements slugged the offending firms with around US$1bn in fines but also obliged them to spend US$432.5m over five years from 2004 on independent research. This prompted the growth of new firms like Argus Research as well as older shops such as Morningstar and S&P. By the time the Settlements came to an end in 2009 Wall Street itself had changed in response to technology haven driven down the cost of trading. The rise of agency brokers such as Instinet, BNY ConvergEx, and Liquidnet, which offered execution but no research, led to the sharing of commission dollars with independent research firms that continued the growth of the sector. Part of this sharing was fuelled by Commission-Sharing Arrangements (CSAs), where institutional investors would reserve part of their trading commission to pay a research provider other than the firm which executed the trade. This had the effect of ‘unbundling’ research from trading.
The UK entrenched this unbundling trend in 2005, when the Financial Services Authority published new rules requiring investment managers to disclose to their customers details of the split between what commission payments had been spent on ‘execution’ and what had been spent on ‘research’. This reform has made the UK independent research sector a particularly vibrant one. The rest of Europe will effectively go down the unbundling path from the start of 2018 through the so-called MiFID II regulations.
While a lot of the independent research firms that have grown up over the last 15 years have a business model oriented to sharing of commissions from institutional investors, a third factor driving the rise of the sector has been the willingness of listed companies to pay for their stock to be independently researched. This is an old model that was pioneered by the likes of Standard & Poor’s and Moody’s for credit ratings and has now moved over to equities. The model provided a more reliable way for research providers to get paid after commissions took a big hit during and after the Global Financial Crisis. It’s estimated that in Europe commissions probably dropped 40% between 2008 and 2014.
One of the features of the new world of independent research is that the firms tend to start out as sector-specific, reflecting the background of their founders, and then expand. So, for example, the London-based Oraca started out covering large cap telecommunications companies in Europe and then branched out into sectors such as cleantech and the Life Sciences.
Australia has tended to lag behind Europe and North America in terms of the rise of independent equities coverage, but we think that is about to change. First of all, there’s the relatively ‘over-broked’ nature of the market, where ASX participant organisations are cutting back on their research spending because the market is so competitive. Secondly, there’s the fact that Australia traditionally has a large number of publicly-traded small cap companies, most of which are under-researched or not researched at all. Thirdly, there is disillusionment with quality of research from traditional brokers where the focus is on maintenance research on large caps rather than breaking new ground with small companies, except where there’s the potential to do investment banking business with the company.
The independent equity research space in Australia was pioneered by Aegis Equities Research, founded in 1999. Aegis was producing equities research and market commentary on more than 200 ASX-listed companies by the time it was acquired by Morningstar in 2010. A number of former Aegis senior executives and shareholders have since built a successor business called Independent Investment Research. A more recent entrant to Australia was the UK firm Edison Investment Research, which opened a Sydney office in 2011. And 2016 has seen two new interesting arrivals in the space - TMT Analytics and NDF Research. In each case the founders used to work for brokers. And in each case the offering is sector-specific.
TMT Analytics, founded by Marc Kennis, focuses on the tech, telco and new media space. A native of the Netherlands, Kennis arrived in Australia in 2014 and initially worked for BBY and Foster Stockbroking before starting TMT Analytics in early 2016. He had previously worked in investment banking in Amsterdam and built an independent equity research business there focused on the tech sector, but saw more fertile ground in Australia. For one thing, the speed with which the sector has evolved in Australia has created a need for more highly specialised research. For another, Kennis sees that the ASX has become a great breeding ground for new tech ventures. “I believe the ASX can become a new Nasdaq or AIM for my sector, but it hasn’t had time yet to develop the kind of equity research infrastructure that is commonplace in Europe and America. I believe TMT Analytics can fill that gap”, Kennis says.
NDF Research, founded by Stuart Roberts, is focused on the Life Sciences. Roberts had helped pioneer equity research on ASX-listed biotech and medical device companies while working at Southern Cross Equities in early 2000s. He stayed with Bell Potter for two years after that firm completed its integration of Southern Cross in 2011, then spent a year at Baillieu Holst before leaving broking in 2015. “The game had changed since when I started in 2001,” says Roberts. “The structural changes in the industry were making it tougher to make a buck for the clients”. Roberts worked for a while with two listed biotech companies before starting NDF Research in June 2016. Like Kennis, Roberts feels that his sector has been under-researched in recent years. “Australia is a great place to build a biotech company but once it goes public it gets almost no serious research coverage. I believe NDF Research can change that”. Like Kennis, Roberts can sense the demand from listed companies who don’t feel they are properly understood by the market and would value the research.
Both men have noted a minor prejudice in Australia against “paid for” research, but thinks this will change. As Stuart Roberts comments “This sector doesn’t work unless the people in it are committed to being genuinely independent. The best analysts at broking houses back in the day were the most independent – the ones who thought CSL was a strong buy back in 2003. Those kinds of analysts will be successful in this new era as well”.
Many people will ask why Australian investors need independent research. The Internet has created so much information relevant to investors that the traditional ‘middleman’ role of the analyst, so this argument goes, has been superseded. Kennis and Roberts both partially agree with that view, but argue that the Australian market still needs analysts. “The thing about skilled analysts”, says Kennis, “is that they are part communicator, part information aggregator, part interpreter of information and part financial specialist. There’s just so much information out there that without analysts to explain it and put it in context it’s difficult for even professional investors to handle”. Throw in the increasing technological nature of business today, and Kennis and Roberts argue that their profession will be around for a while yet. As Roberts puts it, “in the biotech area knowledge can double every eighteen months or so. Only the professionals can even hope to keep up with that”.
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