Sell-side research market share is expected to fall in the next three years--to 32.9% from 58%--as buy-side firms produce more of their own research, according to consultancy Integrity Research Associates in its second annual U.S. equity research industry study. Revenues will fall 28% to $3.9 billion over the next five years from $5.4 billion in 2004 and $5.9 billion in 2003. Sell-side research costs will to slip to $1.42 billion over the next five years from $1.60 billion last year due to continued outsourcing, and reduced coverage of mid- and small-cap companies.
Additionally, the report says equity commission rates will decline 44% to 1.8 cents per share by 2009 from 3.2 cents in 2004 due to competition from ECNs, alternative trading systems and algorithmic trading. Commission revenues used to pay for research will decline 48% over the next five years to $2.79 billion from $5.2 billion in 2004.
Uncertainty around client commissions and upcoming Securities and Exchange Commission rules on unbundling, a lack of viable business models and budgetary pressures are behind the struggles, the report notes.
The quality of research, however, is likely to improve as the sell-side begins to unbundle its research costs from its execution fees. The added transparency will shift firms to justify the cost of their research. Moreover, a shift to hiring more experienced analysts that focus on specific sectors will also strengthen. “Clients want industry experts who deliver insight into the market. To do this requires a commitment and there seems to be fewer firms willing to maintain their investment in both human capital and technology. Firms that deliver quality and differentiation to their clients will be rewarded with higher market shares,” said Matthew Carpenter, director of U.S. equity research at Citigroup.
“Some investment banks will decide to exit the research business based purely on economic rationale. Others will choose to remain in the business as a loss leader, hoping to generate business in other areas,” Integrity CEO Michael Mayhew states in the report. Wells Fargo exited the research business last year (WSL, 8/5) and some sell-side firms may follow in their footsteps, the report says. John Parks, co-head of U.S. equity research at CIBC World Markets said: “We do not know the new research model, but one can’t automatically assume that these are bear times and everyone is going to go out of business.”