US and UK Buy-side Firms’ External Equity Research Spending to Fall from $7B in 2006 to $6B in 2008 with Sell-side Dropping 30% of Analysts, Says TABB Group Report on the Future of Equity Research  

The Bundled Share of Total US Research Spending Will Fall 50% by 2008 Due to Pricing Pressure and Unbundling by Large Asset Managers

NEW YORK, NY, June 27, 2006 – After a decade of scandal and increased regulatory scrutiny for the equity research industry, a paradigm shift in how buy-side firms secure, value and pay for external research is underway.  TABB Group, in its newest industry report released today, “The Future of Equity Research: A 360º Perspective”, says that external spending on research by US and UK buy-side firms will fall from $7.09 billion this year to $6.03 billion by the end of 2008 as they begin to generate research in-house while paying greater attention to the external research they continue to buy from sell-side firms. 

According to Jeromee Johnson, senior research analyst at TABB Group and the report’s author, this is occurring at the same time trading commissions are plummeting at global investment banks, still under tightening scrutiny, forcing them to reduce analyst pay, cut the number of analysts and tighten the focus of their research coverage.  “We estimate that the number of sell-side analysts, roughly 16,200 in 2000 and currently approximately 9,300 will fall to 6,000 by 2008,” writes Johnson.  “However, the age of the independent research provider is here.  Prognosticators have been calling for it for years, long before the global research settlement.  Recently, we’ve seen a glut of independent firms come to market, creating an oversupply that we are still working our way out of.”  

Further addressing this dramatic shift, he says, “over the next two years the equity research business model will drastically change as buy-side and independent research firms will take over for sell-side firms in the majority of research production.”

The report also covers regulation and its impact on payment mechanisms used by US and UK firms.  Johnson explains: “For all the similarities in between the SEC and the FSA and their rules and regulations; for all the talk of working together and sharing information, up to and including the Memorandum of Understanding that was signed in March 2006, the two bodies have different approaches to Commission Sharing Agreements, despite the SEC saying they approve of how the FSA proceeded with CP176 and PS05/09, mandating unbundling and disclosure.”  He adds, “By making it harder to direct commission dollars to independent research providers, the SEC has limited the effectiveness of their other regulations, which have been intended to foster business for the independents.” 

The new TABB Group report analyzes the current state of the equity research industry, interviewing 78 firms on all sides of the industry, from primary consumers (asset and investment management firms) to research producers (independent research providers and broker/dealers with and without investment banking).  Based on recent, significant changes to research regulations by the Financial Services Authority in the UK, approximately 33% of the firms interviewed were UK-based.

Additional findings and forecasts include:

·         TABB Group predicts that from 2006 to 2008, internal spending on research will climb from $7.68 billion to $7.91 billion; spending on broker-generated research will fall from $5.60 billion to $4.25 billion; and spending with independent research providers will grow from $1.49 billion to $1.78 billion

·         TABB Group estimates that in 2006 combined internal and external research will top out at $14.77 billion with 52% of the total being internal this year, rising to 57% by 2008 

·         The bundled research share of overall research spending in the US will fall from 19% of spending in 2006 to 11% by 2008 due to pricing pressure and unbundling by large asset managers

·         Only 18% of large US buy-side firms are actively working on or are currently considering unbundling

·         While the overall external research market is shrinking, independent firms – those lacking traditional brokerage operations – are gaining market share, growing their business at over 9% CAGR between now and 2008

“There are changes underway in the investment research industry that are here to stay, such as transparency and disclosure,” adds Larry Tabb, CEO and founder of TABB Group.  “The buy-side will continue to invest in better monitoring and evaluation tools, driven by regulation and competitive forces.  Their attention to valuation will focus greater attention on the costs of their providers, creating continued pressure on the research providers, especially investment banks, which will continue to pare their offering, forcing traditional analyst coverage to become even more balanced, but also much narrower in its focus and scope.”  To compensate, adds Johnson, “the buy-side will continue to bring research in-house long term, increasing cost-of-ownership.  The independent providers will win business, but in the US it’ll be a struggle to pay them with client assets for the near future.”  

The 56-page report includes over 50 exhibits that cover the top 15 research providers by usage and those delivering the highest levels of client satisfaction; what buy-side firms are paying for research; how research is being used as a differentiator; which financial organizations are creating research offerings; how research is used in the investment process and is expected to change; the off-shoring (or outsourcing) of analysts and India’s role in this shift; factors in research selection; research sources by payment type; research evaluation systems and rate of evaluation; research price factors; payment models; SEC/28(e) direction; compliance status, costs and shifts concerning the FSA’s PS05/09; buy-side plans for unbundling; consumer thoughts on unbundling; and future regulatory trends.

The Equity Research report is available for purchase.  The report and a copy of the executive summary can be found at http://www.tabbgroup.com/research.

About TABB Group

TABB Group is a financial markets advisory and thought leadership firm.  Focusing on the intersection of the financial markets and technology, TABB Group has produced major studies on the future of trading technologies, the impact of the market structure changes on the use of real-time technologies.  TABB Group analysts are regularly cited in the press and speak at major industry conferences.  For more information, go to http://www.tabbgroup.com.