The Rise of Company-Sponsored Stock Research and Its Role in an Investor Relations Strategy
Sell-side equity research has evolved significantly over the last decade. In the past, research was provided to the buy-side without an explicit charge and bundled within trading commissions charged by broker-dealers. With the advent of the European Union’s Markets in Financial Instruments Directive II (MiFID II), which took effect in January 2018, the landscape for equity research has changed even further.
Under MiFID II, investment research must be priced separately from other broker services, such as trading costs, to ensure transparency and make markets more competitive. As a result, asset management firms must now choose whether to pay for investment research.
While only a year has gone by, the CFA Institute conducted a Europe-wide survey of investment professionals in December 2018 and found that since the introduction of MiFID II:
- Asset manager’s research budgets declined, on average, by 6.3%. In fact, 57% of respondents noted that they source relatively less research from investment banks now.
- Approximately half of respondents on both the buy- and sell-side believe research coverage has decreased since the introduction of MiFID II – with the largest perceived decline in the coverage of small and mid-cap stocks.
Additional datapoints indicate that the process of unbundling research from execution services is going global and its impact is expected to be even more significant. In response to investor demand for greater transparency, a growing number of asset managers in the US and globally have decided to align themselves to MiFID II. According to a November 2018 survey by Liquidnet:
- 53% of buy-side respondents have already implemented a global policy to unbundle research and an additional 20% will do so within the next 5 years.
- 33% of buy-side respondents in the US have already implemented a global policy and an additional 23% expect to be fully unbundled within the next five years.
The result of these changes is a reduction in research coverage and evolving industry dynamics. Investor relations professionals in the US are now closely evaluating the best way to fill the gap in both research coverage and corporate access activities. One solution that firms are evaluating is paid-for research reports.
Company Sponsored Research
One of the notable outcomes of MiFID II has been paid-for sponsored investment research as the number of firms writing equity research commissioned and paid for by listed companies has increased. Sponsored research has long been common in the bond markets, where ratings firms are paid by companies to grade their credit risk. The expectation is that it’s likely to become more common for equities in the future.
There are certainly various pros and cons in the debate about whether sponsored investment research is an appropriate substitute for traditional sell-side research coverage. Supporters of the idea note that buy-side analysts may not have the time to analyze small companies as it would mean diverting time from researching companies with more liquidity and existing coverage.
On the other side of the debate, critics note the potential conflicts of interest as these firms are paid directly by companies for coverage. Many of these firms try to avoid this conflict by omitting price targets and rating recommendations. Similarly, these firms generally don’t provide traditional investment banking services where a favorable research rating could influence future business with a company.
Optimizing Your Investor Relations Strategy
It remains to be seen whether paid-for investment research will grow to rival traditional sell-side research over time. For now, it’s still early days and the jury is still out. What’s clear is that investor relations professionals will remain increasingly important to management teams to help convey a company’s story as they can no longer count on sell-side analysts to tell their story.
Companies will need to develop a strong investment narrative which will serve as a primary foundation for all interactions with investors. A firm’s communications approach will need to be clear and consistent across all platforms (presentations, releases, website, annual report, etc.) to encourage a larger following of investors and help the firm standout from industry peers.
In addition, companies can also consider outsourcing some of these activities to investor relations firms to help alleviate capacity-constrained internal teams. The best IR advisory firms have existing relationships with sell-side analysts and buy-side contacts that could help improve efforts to enhance the company’s visibility within the investment community. These efforts, if effective, can be more valuable than paid-for investment research.