With the spotlight shining so intensely on financial advice at the moment, one could be forgiven for thinking that it is solely this end of the asset management industry facing wholesale regulatory driven change. However Fund Managers and Institutional Brokers are also facing their own pressures, which could have significant read-through for their businesses and for the nature of financial markets as a whole.
International forces at play
While most of the change in the advice sector is being driven by domestic forces, the pressure at the broker/fund manager end is being driven by international regulation. On 3rd Jan 2018 the EU implemented the latest tranche of its “Markets in Financial Instruments Directive”, otherwise known as MIFID II.
One of the key components of this legislation is that it forces fund managers to separate out the fees they are charged for research vs those charged for trade execution. You may ask so what? Well traditionally fund managers have paid for both research and trade execution via a single bundled fee, paid for out of the fund itself…that is, it was paid for by the end investor. In the view of the EU, this lack of transparency meant that investors were often being ripped off, as large annual sums were paid to investment banks and brokers for often questionable value-add. The long and short of the change is that it is forcing fund managers to become significantly more accountable for their research spend, reducing the amount of money going into the pockets of investment banks globally for research.
It is also important to point out that while the changes are European driven, they impact most global fund managers, therefore the impact itself is global. There is also an expectation that sooner or later the same regulations are likely to be adopted globally.
Why this matters
With less money flowing to institutional brokers many investment banks have already started shrinking their research departments. If this trend continues, and there is all likelihood that it will, the number of sell-side analysts covering each sector will shrink considerably. Not only that, but the brokers that remain will become increasingly sensitive as to who they share their research with. For example, UBS recently withdrew its research from Bloomberg as a result of MIFID II, in order to gain more control over who can access it.
While the stated aim of MIFID was to protect the end investor, there is a real possibility that the actual effect will be to make markets less efficient, as a smaller and smaller percentage of market participants have access to high quality research. The impact is likely to be exacerbated by the rise of ETF’s, as more and more capital is invested without reference to company specific analysis of good quality.
For the first time in a long time, the pendulum may be starting to swing back in favour of using active managers with access to quality investment research over passive and semi-passive strategies. In our view, having a detailed understanding of the pros and cons of active vs passive management and when to use each remains a key component of constructing an optimal investment portfolio.
Resonant Asset Management Pty Ltd, ABN 41 619 513 076, trading as Resonant, AFSL No 511759.
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