How two decades of technology reshaped and liberated equity research
In the News
As published in IR Magazine on May 3, 2019...
By Patricia Horotan, Co-founder and Managing Partner
A look at how equity research has evolved from the mid-1990s to MIFID II and beyond
Technology’s transformative and disruptive winds have swept across most corners of the financial markets. While these forces have altered the landscape for traders and investors, they’ve had a liberating effect on equity analysts.
This rings particularly true over the past 20 years, during which time technology has prompted an unforeseen improvement in productivity and capability that restructured the relationship between investment bank and boutique research providers and their institutional investor audience.
In the late 1990s, the mechanics of authoring and distributing research were crying out for innovation. Most analysts and their editorial teams had to manually enter content into aggregator platforms. It was an exceedingly tedious, time-consuming and error-prone process destined only to grow in complexity as more legal and compliance-related disclosure and disclaimer requirements were implemented.
It was around the turn of the century when, capitalizing on recent advances in computer processing, technologists began to develop tools to more efficiently and accurately publish research. Until then, technology had advanced at a slow pace, limiting research analysts’ ability to gather and distribute quality work and effectively putting those firms that couldn’t pay large numbers of staff at a disadvantage.
The largest banks responded by investing large sums into developing internal solutions intended to amplify their advantage in the market. Lacking the same resources, second-tier firms and boutique operations turned to third-party vendors that had begun to launch affordable tools designed to streamline the authoring and distribution process.
It was these smaller operations and otherwise unheralded analysts who benefited from the new technologies the most. Armed with the ability to showcase their expertise, broaden their readership and expand stock coverage, these providers could, for the first time, compete with the largest Wall Street players on output, despite having fewer resources.
Very quickly, a new marketplace unfolded, one where analysts could produce more research and do it more accurately, therefore freeing up time to focus on higher-value activities, like content.
Technology’s dynamic response to regulation
Research technology has often evolved in response to increased regulatory oversight designed to limit industry abuses and level the playing field for market participants. For many decades after its inception in the late 1950s, equity research bound itself closely to banks’ underwriting and trading businesses in vaguely unethical arrangements that reached their zenith during the dotcom era.
As the technology stock bubble burst, regulators and prosecutors rushed in to protect investors. In October 2000, SEC Regulation Fair Disclosure (Reg FD) compelled issuers that divulged material information to market professionals – such as equity analysts or stockholders – to make that information public.
Then in April 2003 reforms stemming from the $1.4 bn Global Analyst Research Settlement reined in banks’ publicity-hungry analysts, quelled conflicts of interest and loosened the communication and revenue links between stock research and underwriting. Collectively, these developments underscored the need for more quality research just as they tied research revenues even more closely to trading commissions.
This prompted technology providers to develop new tools to tackle these requirements. Vendors focused on addressing compliance and risk management in research production – for example, the ability to automatically identify and attach the required disclosures and disclaimers to research reports.
Meanwhile, on the investment side of the industry, advanced computing power was accelerating stock trading’s move from exchange floors to computer screens. Tightening the squeeze on trading costs and commissions, this rapid rise in electronic trading and concurrent fall in commissions prompted many senior research analysts to leave the industry.
The research herd was further culled during the global financial crisis of 2008-2009, as complex mortgage-based exposures on bank balance sheets took down Wall Street giants Bear Stearns, Lehman Brothers and Merrill Lynch when they plunged in value. Many investors moved out of equities and into assets they believed would hold their value better in turbulent times, and interest in winning stock-picks and equity-driven portfolio strategies waned.
The subsequent years of rock-bottom interest rates primed the equity markets for a rebound. To help meet the renewed demand for stock research, vendors focused on breathing new life into research with more engaging and powerful delivery methods. Platforms put readership into investors’ hands with pull versus push distribution platforms, and analysts enticed their audience with dynamic, responsive formats, like HTML5 websites. These delivery methods not only come with sophisticated modelling capabilities, but also let analysts track which – and how much of – reports their customers consume, allowing research departments to more efficiently allocate time and resources.
Mifid II ushers in new tools
Today, the equity markets have more than recovered. But new hurdles have surfaced that have renewed the research community’s attention on enabling technologies. The most formidable among them is the EU’s Mifid II.
When the new legislative framework took effect last January, it was expected to have a substantial impact on research providers and consumers alike, both across Europe and, eventually, the globe.
The legislation separated fees for research and trading from the ‘bundled’ commission arrangements that for decades had been common practice, freeing EU-based institutional money managers from their obligation to pay the same bank for research that executes trades on its behalf. Many expected that this unbundling would, in theory, encourage EU-based institutional money managers to explore the research of smaller banks and boutique firms.
So far it hasn’t. Market watchers say the largest investment banks have been benefiting as asset managers cut back on their research spend, inevitably prompting banks to shed analysts and drop coverage of smaller, less-liquid companies amid declining revenues.
One indisputable outcome is that Mifid II has sparked technological innovation. Vendors have flooded the market with Mifid II-compliant and best-practice solutions for content management and research evaluation, among others.
Innovation has focused on features that track interactions or protect intellectual property by ensuring only entitled customers are accessing their research. These tools help providers concentrate and direct their research efforts and dollars by identifying less actionable or poorly reviewed work, bringing new levels of efficiency to the research creation process.
Mifid II currently covers only EU institutions and research providers. But many firms in the US and elsewhere that do business in the EU have already made changes to comply with the regulation and capitalized on enabling-technologies in anticipation that some variation of this policy will soon affect market participants worldwide.
Using data-powered tools to enhance research
There are several technology trends that will inevitably drive the next transformation of the industry. Data is one that analysts are tapping into in order to gain an edge, and the availability of data is skyrocketing as we refine data-mining techniques.
Accessibility and analysis of data has begun to change the way investors study and observe how forces both within and outside of the markets move stocks. Using artificial intelligence and machine-learning tools, analysts can read enormous amounts of presorted and pre-processed data quickly to transform them into reports.
Other sophisticated investors are using natural-language-processing tools to mine market sentiment from multiple analysts’ reports on the same stock and plug it into trading engines that determine where, when, and how to place their orders. In this scenario, technology continues to enhance and highlight analysts’ quality insights and ideas rather than their ties to underwriters and traders.
A new application sure to make its mark is the distributed ledger framework, often referred to as blockchain. By its nature, blockchain enhances transparency and mitigates risk, making it a powerful tool for highly compliant industries like financial services.
All in all, technology has helped streamline how equity analysts have produced and distributed research over the past 20 years, much as regulations have reshaped the industry’s structure and reined in its excesses and abuses.
For institutional investors in equities, the need for alpha-generating trade ideas or innovative portfolio strategies will remain strong, regardless of whether those inspirations and solutions come from the world’s largest banks or an independent analyst. Expect technology to continue finding new and efficient ways to enable the best ideas to reach as many paying clients as possible.