E-piphany

Today’s article isn’t about inflation, or the bond market, or the Federal Reserve. It is more of a meta-article: an article about articles or, more precisely, research.

I started my career as a technical and quantitative analyst back when we were still doing point-and-figure charting on large sheets of graph paper tacked to the wall. After coming to Wall Street in the early 1990s, I went to JP Morgan in 1994 as a futures researcher. Subsequently, I became the lead US fixed-income researcher at Bankers Trust before gradually parlaying my research skills into a trading position at Barclays.[1]

In those years, and really until now, compensation of researchers was pretty reasonable. While few researchers – especially in fixed-income – earn seven-figure compensation packages, they still earn an awfully nice living and get to go home at night and not worry about whether their short options position is blowing up in Japan while they sleep. Researchers in general don’t need to wake up at 2am to talk to Hong Kong and delta-hedge the book.

However, there is a downside to being a researcher and that is that historically there hasn’t been a very good connection between the quality of the research (and the eyeballs it commands) and the bonus at the end of the year. On Wall Street, if you don’t have a P&L attached to your name then you don’t have much ammunition when it comes to the bonus discussion. If you can point to a trade that you recommended, the sales force sold, and the trading desk profited from (as well as, hopefully, the clients…since if the clients don’t profit they don’t listen to your next recommendation), and you can compute how much money you made the desk; or if you can claim responsibility for a bond tip that happened as a customer reward for help you gave them on some other matter; or you are a “star” analyst who is the “axe” on some company or market and clients clearly give the firm business so as to have access to you (this is more likely to be the case at a small shop that would otherwise not get such business), then you’re in good shape. But the vast majority of analysts have nothing to say when they sit down with management to discuss their bonuses, because the research bonus pool is essentially a gift from Sales & Trading and not an allocation from their own profits.

Enter the second chapter of the “Markets in Financial Instruments Directive,” aka MiFID II, a product of the European Securities and Markets Authority (ESMA).

I don’t claim to understand everything, or even very much, about MiFID II. I’ve spent a lot of time talking to people who understand more, but no one is really sure what the ultimate impact of MiFID II is going to be, just like no one was sure how bad Dodd-Frank would be for the financial markets. But I want to focus here on the impact of MiFID II on the provision of sell-side and, more to the point, independent research.

Part of MiFID II essentially requires broker-dealers (in Europe, but practically speaking it’s hard to ring fence a global B/D’s activities and clients to just one jurisdiction) to separate the fees for execution and for research. Previously, research – including access to research analysts, for good clients – was provided free to clients in almost all cases. The European regulator, observing that this meant that research must be an ancillary benefit to clients paid for by dealers from their trading profits, reasoned that bid/offer spreads must be wider than they would be if dealers didn’t have to bear this invisible charge.

It is a risible argument, even if it must technically be true. But no trader ever, I am sure, adjusted his bid/offer spread wider to cover the cost of research being provided. Traders think of the bid/offer as being a price for liquidity, period. So I would be shocked if the effort to split these charges resulted in (as is intended) lower trading costs for clients.

Anyway, the bottom line is that now if clients want to get research from their dealers they need to explicitly pay for it, and disclose to the clients what the client is being charged for the research. (We have vaguely similar rules here regarding how ‘soft dollars’ must be used and disclosed, but research that is “free” is not subject to that measurement and reporting.) And so dealers have been announcing what they will charge for research starting on January 1, 2018.

So here’s the interesting side-effect on independent research. Previously, it was virtually impossible for quality independent research providers to make a living. There are a very few who have succeeded at this – Bianco research, Medley, etc – but those numbers are small and those folks have been having a more difficult time of it in recent years. It’s really hard to compete with “free” research coming from the sell side. And so – to bring this home – people like me have had to give away content, hoping to someday recoup the cost of writing and researching by attracting more clients to other lines of business or to a paid research product. Honestly, I’ve tried ten different ways and haven’t figured it out, and I’m the only person I’m aware of with deep domain knowledge in inflation that’s putting out commentary or research.

MiFID II may change that. If buy-side institutions no longer get research for free from the Street, they may be more discerning about what they spend money on. Why pay dealer X for research that used to be free – and was worth about what you paid for it – when independent researcher Y is charging $100 for research that is twice as good? Buy side firms have been wrestling with this question, and there have also arisen several platforms for research providers to hawk their wares – Alpha Exchange, ERI-C, and RSRCHXchange, just to name three. In fact, my company is posting our research on those platforms as well, and in January we will see if anyone is willing to pay for it.

Here is where we make it really personal.

I never wanted to be a ‘blogger.’ I get value from the process of writing my thoughts down, and I get value from feedback from readers. Lots of value. But it takes a ton of time, and it’s hard to justify the time and effort to the fellow stakeholders in my company if there is no revenue attached, ever. And so over the years I have stopped allowing platforms to publish my articles (such as Seeking Alpha) if they weren’t willing to allow me to mention my company, for example; I have also gone from publishing daily (as I did for years) to once or twice per week.

I intend to continue to produce these articles, and distribute them freely on my blog (http://mikeashton.wordpress.com ), on Investing.com, Harvest, and TalkMarkets as well as other places where it is picked up from time to time. And I hope you like them. But my CPI-day tweets, and some other occasional content, will be moving to a new channel. You can go to PremoSocial and subscribe to get access to that “premium content” for only $10 per month. Here is the link.

You can help make sure that this column remains free, by subscribing to that channel. If you think my out-of-the-box viewpoint on markets and especially inflation is valuable, please consider signing up. If the response is very good, it may even justify my spending more time on the research-for-public-consumption (as opposed to R&D) part of the business, and writing more frequent articles. I am eager to see what the response is. Surely my work is worth more than zero. Anyway, I hope so.

Thanks in advance!

[1] I don’t recommend that path for any new graduate starting off on Wall Street. It is quite hard to get from the research desk to a risk-taking role and I got lucky.