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At approximately the same time each year Peter Lee Associates undertakes its Debt Securities Investors and Australian Equity Investors research programs. Despite these clearly focusing on different asset classes our combined respondent base has some degree of crossover. And whilst, in this case, our focus was on either Fixed Income or Equities we occasionally ask the same — or similar — questions of respondents. And it always surprises us when we learn that feedback from such questioning differs markedly between asset classes — once we had finished collating both sets of results in 2016 we again found ourselves looking at two very different outcomes.
For some time we have been hearing that the way equity markets operate in the future will be more like that now operating in fixed income markets — investors are establishing in-house research capabilities and thereby reducing their reliance on research teams at broking houses; commissions are under significant downward pressure and appear headed toward zero; and other aspects of the business such as corporate access and deal flow, execution services, and account management are now seen as being much more important.
Having said that, research remains a meaningful component of the overall service provided by equity brokers — and institutions are still prepared to pay for it. In 2016, 44% of all commissions went towards paying for research product — this is down from 59% in 2010 but it continues to be the number one reason as to why an institution pays commission to their service providers.
So, for equity investors, whilst their proportional spend on research has decreased significantly, research continues to be an integral component of the service they receive from brokers. But when we do a deep dive into similar feedback from debt investors a different picture emerges.
The question asked of debt investors on this topic — “How do you reward banks for quality research and analysis in the Bond market?” — enables respondents to provide a qualitative answer, as opposed to the quantitative reply we receive from our questioning equity investors. And this is where the dichotomy emerges.
Just over 40 institutions responded to this request:
And the message from this? Banks can continue to produce as much good research as they like, but shouldn’t expect to be paid for it. And as post-GFC markets continue to evolve, perhaps it signals we are looking to a time when no-one produces research — debt or equity — because the providers know that the marginal value of doing so might actually be negative.
Sandhya Chand | Managing Director at Peter Lee Associates
#research #marketinsights #brokerresearchvalue
It is a little more than 10 years since the Principles of Responsible Investment organisation was established with a Mission Statement reading - “We believe that an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.”
As the recently completed 2017 Peter Lee Associates Investment Management research program shows, Responsible Investment - now better known in Australian investment circles as ESG - appears to be gaining quite a bit more traction amongst pension funds as a selection tool when looking at potential managers to run their money - and it’s not just the big boys moving in this direction either.
This increased emphasis on ESG became obvious to us when we asked fund executives how important is it that their investment managers integrate ESG in their investment process. More than half of the funds looking to award Equity Manager mandates regard such integration as very important or critical - whilst only 14% rate this factor as essentially unimportant. Although fund executives seeking Fixed Income managers do not generally rate ESG integration as highly (34%) it is still clearly a significant point of reference in their decision-making process - and has become more important over the past 5 years. Perhaps not unexpectedly, it is the Industry and Government funds who are leading the charge but when we break the data down by size of institution we are seeing funds with less than $1 billion embracing the methodology to a greater extent, than some of the larger ones - and given these are largely foundations, endowments and not-for-profits, who are more able to readily pursue impact investing, it does suggest the trend is not going away.
So how does this compare with previous years? Despite ESG having existed for just a short period of time it has been an aspect of the Investment Management landscape we have followed through our program so we do have back data.
Whilst the wording of our questions has altered over time, responses to them still provide an indication as to how ESG has increased in popularity as a factor used in determining where a mandate goes and how perceptions as to its importance have changed amongst fund executives and asset consultants. In 2009, only one-in-five asset consultants had ESG as a criteria for shortlisting managers for equity mandates — but over 60% concluded that ESG was gaining importance as an evaluation criteria irrespective of asset class. However, even by 2011 a high 34% of fund executives still ascribed little or no importance to ESG when awarding mandates.
The critical difference in the treatment of ESG in portfolios over the past decade is that while some funds continue to employ mandates with a specific ESG or SRI focus, increasingly fund executives expect investment managers to integrate ESG thinking across the entire platform of solutions.
So it appears that, as PRI enters its 11th year, ESG has finally become a benchmark of sorts for pension funds. As this trend further evolves it will be interesting to observe if it has any ramifications for those who decide not to embrace it. Only time will tell, but clearly ESG is much more than a fad and has now become well entrenched in the psyche of the local investment management industry.
Having conducted Peter Lee Associates research programs for more than 25 years, we have access to much historical data and commentary which enables us to observe developing trends and potential changes occurring within an industry. After completing the 2017 Investment Management program and working through the responses we find ourselves being put on notice of a development that seems to be occurring with respect to the relationship that superannuation funds have with asset consultants.
Whether we are setting out to conduct research on an industry or just a subset of one we are always looking to receive both quantitative and qualitative feedback from respondents. Our questions are not framed in a way that encourages only a simple “Yes or No” response; in fact, they are designed to encourage respondents to elaborate on their answers. And these verbal responses form the basis of the “Verbatim” feedback we provide clients when we present our findings to them.
Whilst quantitative data provides an ability for us to show our findings in easy to understand tables or graphical presentations it is sometimes the verbal feedback that makes more of an impact on a client. A graph might show overall performance but comments suggesting that performance is slipping or needs improving, address underlying issues behind the numbers and can sometimes be more powerful way. In isolation one comment does not make much of a difference, but when the same line of thought continues to reappear - and in some cases each year - clients tend to focus on - and react to - the specific nature of an issue. And it is just such qualitative feedback from this year’s program that provided another angle to the changing relationships between funds and consultants - and had us looking back into our vaults to confirm our thoughts. How right we were!
Five years ago when we asked superannuation fund executives what was the single most important action their Investment Consultant should undertake to improve service, we generally received answers emphasising a need for more proactivity and responsiveness, less staff turnover and greater client knowledge.
Fast forward to 2017, when both the tone and demands of fund executives have changed noticeably. We still receive the staff turnover and lack of proactivity comments but more focus is now being placed on strategic imperatives, collaboration and sharing IP - such as dynamic asset allocation advice; greater look through to manager assessments and ratings processes; deeper analysis of general investment trends, market activity and developments; and improving clients’ knowledge of newer investment styles (ESG, renewables, global infrastructure).
So, while it is no surprise that the relationship between funds and consultants is changing, to remain an integral part of the investment process (asset allocation, manager hiring, due diligence, sustainability etc) consultants must step up and provide a much more customised and “unbundled” service to their clients, based on a greater focus on the needs of each fund.
Our quantitative data shows a slight tick up in the number of consultants used by each client. It might only be marginal, but more funds are now looking to add extra sources of advice and assistance - and are increasingly also turning to investment managers. This is a good indicator of the likelihood that client churn will increase and fees will remain under pressure, unless consultants provide an even more differentiated and client-driven service.
With most senior executives receiving a large part of their annual remuneration in the form of long term share based incentive schemes, it would seem only sensible they do everything possible to ensure their company’s share price performs. Whilst that would suggest a focus on usual metrics such as increased sales, improvements in productivity and general efficiency, and higher profits an aspect of their business that might fall under the radar is the performance of their Investor Relations program.
As we have written previously, a good Investor Relations person is seen as someone who continually provides investors with access to management, has an excellent knowledge of the business, is both transparent and honest, and provides frequent communication. So it goes without saying that any organisation able to deliver their IR in this way has to be perceived by the investment community as being better run and more on top of their game than a corporate that doesn’t - and, therefore, a more likely candidate for them to invest in.
One of the tasks of any IR person is to keep shareholders happy and ensure they remain on the register whilst, at the same time, encourage new entrants to step up and buy their shares. All of which helps ensure the share price doesn’t suffer from selling pressure and, as long as good results keep coming, possibly heads higher as the register tightens.
But how much is an investor prepared to pay for the contributions of the IR team to the share price? And at what point do investors say that that work is now fully priced into the shares? Recent research conducted by Peter Lee Associates sought to find an answer to these questions.
Whilst most respondents (74%) suggest that IR makes no difference at all to how a company’s shares are priced by the market, 14% believe a poorly performing IR team can cause a discount and 12% take the view that good IR results in a share price premium. After eliminating those who think IR does nothing for the share price, what sort of premium or discount do the other 24% feel can be attributed to the performance of an IR team?
Interestingly enough the respondents who believe good IR does lead to a premium were split equally between one of 0 - 5% and 5 - 10% — but most of those who take the view that poor IR leads to a discount felt that that would sit somewhere between 5 - 10%.
What do we make out of this? Clearly good IR is seen as a positive as it assists the investors in understanding more about the company, its activities and its issues - poor IR would not offer such comfort and, in fact, might be seen as them trying to hide the warts and the concerns. Good IR works with the investors, holds their hands, keeps them appraised of developments. And if all those things are being delivered by the team one can only suspect that the share price more accurately reflects the success of the company being promoted by its IR people.
Each year Peter Lee Associates speaks to Institutional Equity market participants in order to better understand how they view the service provided by their preferred stockbrokers. Until last year our questioning focused entirely on discovering how research analysts, sales teams, and traders were perceived by their clients - this time we also added a few new questions to our repertoire.
Before the advent of such things as the internet, electronic market services, and social media, investors were forced either to go hunting for the news themselves or use brokers to do that for them. In this way they hoped they knew everything about the companies they invested in - and those they might be thinking about adding to their portfolio. But that task is now made much easier for the investor - and, perhaps somewhat perversely, more difficult for brokers - due to the technological advances of the past 15 years.
Throughout this cycle the role of investor relations people employed by corporates and other issuing entities such as Government authorities has also undergone considerable change. In the good old days IR was a much more straightforward role - roadshows, result presentations, Annual Report preparation, and occasionally meeting with foreign institutional investors who just happened to be in town on a fact finding mission that coincided with the Rugby World Cup, the Spring Carnival or something equally as important.
But today they, too, have fallen victim to the changed technology, a more stringent regulatory framework, and investors who, generally speaking, are much more intellectually focused and more highly trained than many of their predecessors. The IR industry has had to reinvent itself as a result and it was the outcomes of that metamorphosis we were looking to use our research to delve into.
What did we discover?
That little of what might have been contained in an IR job description 15 years ago would appear in a similar document today. So what is it that distinguishes the best IR people from the rest:
And perhaps the most important task is to, as one respondent succinctly put it - and I guess that this is not surprising as it is similar to what we consistently hear across a number of our programs - “engage with investors to find out what is important for us as investors.” And there you have it. Simple really.
In 2016 the real estate industry found itself in the sweet spot - low and falling interest rates, a relatively weak Australian dollar, a lack of quality property, improving global economies and buckets of cash looking for a home. So is it any wonder that respondents to the Peter Lee Associates Real Estate Services research program reported paying total fees across all aspects of the industry of $512 million, an increase of almost 76% on the 2015 number. And it is worthwhile noting that 60% of those fees went to the real estate firm regarded as being the respondent’s principal provider.
Now, given the size of the fee pool and the pot of gold waiting for those deemed good enough to rate #1 with their accounts, it’s not too big a leap to expect every real estate salesperson to be out there trying even harder to further penetrate their customer base. You would expect that, wouldn’t you? But that’s not what our research shows.
It seems counter-intuitive but in 2016 business solicitation activity was only marginally higher than in 2015 and remained well below the levels of 2014. And worse still was the fact that only 1 in 3 business pitches were regarded as being effective - i.e. not a waste of the respondent’s time. Why?
Maybe the market environment in 2016 made it easy to do deals and no-one needed to push themselves. Perhaps everyone was so busy transacting they couldn’t find the time to commit to - or prepare for - pitching activity. Whatever the reason, isn’t it reasonable to assume that customers still need to know what you can do for them - and if you don’t tell them who will?
So, for those of you out there thinking about how you might be able to grow your business - and, after all, at the current time there seems to be more than enough to share around - perhaps a good place to start is by learning how to properly pitch to your clients. And if you make the effort and they come away feeling you have been worth listening to, shouldn’t you be well on the way to sharing in the spoils?
Here at Peter Lee Associates we conduct research programs that focus on various asset classes — Equities, Fixed Income, Property, and Currencies — and across different industries — Stockbroking, Investment Banking, Real Estate, Investment Management and Commercial Banking. But, although the underlying questions will differ, a common theme runs through all programs we undertake: How can our clients better service the needs of their clients?
The advent of technology might have helped improve corporate bottom lines but in many cases it has been at the cost of a reduced customer experience. And this despite the fact that improvements in customer satisfaction levels form a part of a number of CEO’s KPI’s.
Let’s face it, customer service should not be rocket science — determine what the client wants and then deliver it to them. Not to be flippant but it’s a bit like ringing your local pizza shop and ordering a Cappriciosa and, strangely enough, finding that is exactly what’s in the box when you open it on delivery!
So whilst we come from the standpoint that says customer service should be rather straightforward we also believe that you will never get it right. Customer needs are always changing and it is the task of the customer facing people to change with them. But how does that happen?
Put simply, you need to continually listen to your clients and move forward from there. And that is what we at Peter Lee Associates seek to do. We listen to your clients and then present to you their thoughts and comments about how you interact with them. And whilst we take you through the views of your clients we also show how your competitors are faring with those exact same customers. We give you lots of numbers and data but also lots of simple, easy to understand graphics - all of which we spend time explaining in so you have no excuse for not “getting it”.
And having learned what the issues are we work with you to address those and help you to improve your customer experience — which, hopefully, means your share of both a client’s mind and, most importantly, their wallet grows.
As one of my very first employers used to say — The client is the only thing that matters in business; and if you look after them, the business looks after itself.
We wrote recently that institutions are no longer paying as much for broker research. But, as the 2016 Peter Lee Australian Equity investors research shows, as a minimum of 40% of all commissions are generated by what are principally research driven factors (known as tags) it is an expectation that institutional broking firms continue to provide the product.
Every institution has a preferred broker list — “the panel”— with whom they deal and, for any self-respecting broker, occupying a place on a panel is the holy grail. Panels generally vary by size and structure according to the quantum of funds managed by an institution. Our research this year indicates the average number of brokers per panel has declined over the past 12 months to 13.3 (previously 14.4) — the lowest level in four years. Whilst that may sound a large number, most panels are pyramidical in structure meaning that the nearer the top of the tree you are the more commission can a broker expect to receive from an account — our research indicates that across the industry almost 50% of all commissions are paid to firms occupying the top three panel positions.
Now, before you jump to the conclusion that that leaves a further 50% of the commission pool for the other 10 firms to fight over, consider this. In 2016 65% of respondents indicated using Commission Sharing Agreements and paying 12% of their commissions in this manner. Additionally they reported paying almost 40% of their commissions via tags — that is for such services as customised research, greater analyst contact, and ESG research — with 90% of that figure being distributed across all panel brokers.
So when you do the maths it becomes apparent that for those firms on panels but outside the Top 3 positions there is not a lot left to share — and then, remember, there are also commissions being paid via tags or CSA’s to some brokers outside the panel. Whilst our analysis does not go beyond this level of granularity it does appear that about 80% of all commissions are split amongst panel members, of which 50% goes to the Top 3. We do know that the fifth most important firm receives 8% and the 10th picks up 3% so the ability to fund a full blown research product becomes more constrained as your position declines. And then you run the risk of it becoming a downward spiral — less commission, less capability to produce the research the institutions want, even less commissions…and so it goes.
So what does that potentially mean for the industry? Unless you are in the Top 3— or at the very least not lower than #5 — it becomes very difficult to see how a firm might survive in any meaningful way. And unless you are happy to rein in costs, produce less product and be prepared to live off the scraps a lower tier firm finds itself being paid, it becomes an almighty struggle.
For many years the Australian broking market has been seen as ripe for consolidation — to date that has not occurred. It is an oxymoron but, as each year passes, given its current structure, the end of the broking world as we know it keeps creeping closer to reality.