By: Peter T. Sidoti, CEO, Sidoti & Company, LLC
Background
Several years ago, I called an emergency meeting of our executive management team. The mood was somber, as I reviewed the headwinds our industry was facing:
- Commission revenue paid by the long-only buyside was dropping precipitously year-over-year, largely because active money managers were losing assets at an accelerating pace to passive funds, leaving them less able to compensate the sell-side for providing research insights.
- Services provided by our firm to the buy-side, which once prompted them to steer significant additional business to us, were no longer providing us a return on investment. Our firm had spent 7 figures hosting investor conferences in the prior twelve months, and the traditional strong uptick in trading we usually saw in the events’ aftermath had all but evaporated. Moreover (and especially after MiFid II regulations came into effect, making it dramatically more onerous for the buyside to compensate sell-side research shops) the amount an account would provide us for traveling to see them with a covered company’s management team was becoming uneconomical, sometimes barely covering our costs of hosting the day(s).
- The cost of providing equity research to a company was increasing, in large part because indirect costs required by more stringent regulations required us to devote more resources to editing, compliance and supervision, as well as data and technology. We estimated that we spent at least $30,000 – $35,000 a year all-in to cover a single name, and analyst compensation could not reasonably by reduced to offset cost pressure.
- Unlike many of our competitors that funded investment banking departments, our firm did not generate a level of syndicate business to meaningfully subsidize the costs of running a research department with over 250 names under coverage.
An Evolution in the Making
As our team huddled to find a solution to what we called the “broken equity research model,” we kept coming back to the fact that quality, independent third-party research still was coveted by issuers and investors, as it played an important role in helping ensure equities were fairly and efficiently…
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