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December 16, 2010

2010 Review: Agency Brokers Dive Into Research

By James Ramage

At the end of October, agency broker Investment Technology Group bought Majestic Research, a research provider.

The move is ITG's first in foray into alpha-generating, actionable research that is stock-specific. But it's also part of a growing trend in this year of low institutional trading volumes: agency brokerages offering research as another way to get paid, allowing them to reach further into investment management shops and gaining favor with portfolio managers.

Low volumes mean low commissions, and revenues. According to a Greenwich Associates sellside prediction for year-end 2010, commissions should fall around 15 percent from last year, and almost 25 percent from the record-setting levels in 2008. This means a predicted plunge from almost 14 billion shares in 2008 down to about 10.5 billion shares traded by year end 2010. The sellside offered its forecast to Greenwich Associates during the third quarter.

And with less money coming in, agency shops have come to realize they need to devise new ways to reach customers. In more extreme cases, some buyside shops have simply stopped trading with so-called execution-only brokerage houses. In short, these firms need to be on the research list or they're toast.

Liquidnet recently launched a program to arrange research meetings between clients and companies. At the end of March, Instinet introduced an electronic service that connects money managers to corporations looking for institutional investors. And earlier, JonesTrading rolled out a product that leverages its deep client relationships.

For these firms, providing stock-specific research or access to company management gives money managers more reasons to trade with them--at a time when firms find it harder to transact with execution-only shops in a tight commission environment.

Anecdotally, one trading executive whose firm provides corporate access said he's heard that investment banks have been pressuring clients for more business for their research. He said clients have told him the bulge bracket has been applying the "soft strong-arm." The bulge expects institutions to come running back to them for deal-based road shows, as stock and bond offerings rev up.

"They're saying, 'We're not doing this for free,'" the exec said. "And agency brokers like us have suffered to some extent, based on that. We haven't done anything wrong. It's just with commission pools shrinking, they've got product offering that we don't, and there's been pressure applied."

Firms with varied research offerings continue to grow, while the research coverage of small and midsize companies continues to shrink. Wall Street has seen an 84 percent head-count reduction in the sellside analyst ranks over the last decade, said Dan Dykens, co-president of Meet the Street, a subsidiary of Instinet, as well as its corporate access service. The culling has led to a severe shortage of coverage of small- and mid-cap companies, he added.

"We're in a declining commission environment," Dykens said. "And the way [sellside analysts] get paid today is to cover companies that trade much more volume. So, the analysts who are lucky enough to have jobs on Wall Street on the sellside have pretty much dropped coverage in unison on small- and mid-cap companies and migrated over to large-cap companies."

With fewer analysts today, a growing number of companies are going without sellside analyst coverage, and therefore are struggling to find interested institutional investors. Agency brokers such as Instinet and JonesTrading have noticed. And whether or not the deal calendar returns--which some say would could eat away at any inroads the independent firms make in their respective research businesses--agency firms say they can distinguish themselves in this area.

"We think we'll get a large share of the small- and mid-cap market, because there's really nothing for them out there," Dykens said. "They're being ignored, really, by the sellside."

"We're definitely focusing more on our sweet spot, which is small and mid-caps," said one JonesTrading executive, speaking of its corporate access strategy. "But you really never know who this idea will appeal to. We've had some surprising results."


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