Investment research is not as valuable as it used to be
Bundling and unbundling for fun and profit
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"There are only two ways to make money in business: One is to bundle; the other is unbundle."
It’s ironic that a statement this useful was uttered by an exec of a company most everyone has forgotten about. Because humans often skim the first sentence, I advise you go back and read it again.
It was said in 1995, during the last leg of the European investor roadshow for Netscape, a hot interweb thing called “a browser”. The team was in a rush to catch their flight home, and Jim Barksdale — the COO — took one last analyst question. It happened to be about the odds that Microsoft would decide to bundle its own competing product, Internet Explorer, with its dominant operating system.
He could have said: “The odds Bill Gates would do this are exactly 100%.”
But fortunately he said the above instead. I say fortunately because it gave us a tool to talk about more than just Microsoft (which, by the way, has just been forced to unbundle Teams from its Office Suite).
This week, for example, has been all about bundling and unbundling.
The first big story was that bundling is okay again. After asset managers spent all this time and money in 2018 adhering to MIFID II, the FCA is moving to abandon the rule on combining research and execution fees for stock picks. This has long been considered a 'Brexit dividend', though the European Union is now also looking to roll back these rules.
The reversal would technically make it easier for managers to procure investment research, particularly from the US. But here comes the twist, which makes it also a story about unbundling.
The FCA released a big consultation paper about the whole thing. Within it, they suggest the rule-change won’t make much of a difference, because:
"UK spending on investment research since 2018 has dropped by about 30% to 40%, but such falls were also seen in countries that don't apply MiFID and do not reflect the rise of in-house research at asset managers, the FCA said."
The FCA is saying that, regardless of regulations, managers everywhere purchased 30%-40% less investment research. Some of the value investment research was providing was no longer needed, presumably because managers found it elsewhere. Whether through news, or analysts-turned-bloggers, some parts of "keeping up to speed" and "analysis" were unbundled from the investment research proposition, making it less valuable.
We also know the alternatives had to be provided cheaply, because similar drops in consumption were evident both inside and outside the MIFID jurisdictions, and the ones inside would have had to pay for stuff explicitly.
So, while the FCA is allowing investment research to be bundled again, since 2018 a good chunk of the value in that research had been unbundled from it. And while the bundling here had been driven by a single entity (the FCA), the unbundling was driven by market forces.
It can work the other way around: market forces can incentivise companies to bundle, and then a single actor comes and pushes them to unbundle. We saw it happen this week on ESG and shareholder activism.
CityAM covered a new study, which reveals institutional investors' push to divest from BP and Shell is hitting a roadblock. Roughly speaking, the roadblock is called BlackRock:
"The campaign for institutional investors to divest from oil giants like BP and Shell hasn’t made any progress due to the way index providers dominate the market..
Only 60 institutional investors worldwide have sold all of their shares in BP and Shell, representing about three per cent and four per cent of their shareholders, a paper published earlier this year by David Whyte of Queen Mary University of London has revealed."
Because index providers have to track the market, and so much money has flowed into index funds, it didn't matter that a bunch of institutional investors divested, because index providers just stepped in to buy those shares. The author thus concluded:
“Shareholder movements in BP and Shell are not applying the pressure necessary to cease oil and gas development.”
So maybe the weakest link to apply pressure lies elsewhere?
Also this week, NYC pension funds struck a deal with JPMorgan Chase, Citigroup, and the Royal Bank of Canada. The agreements now require the banks to regularly disclose their ratio of clean energy supply financing to fossil fuel extraction financing and their underlying methodology.
Those pension funds are also chasing Bank of America, Goldman Sachs, and Morgan Stanley, in hope of establishing a new industry standard.
Which is to say, an unbundled industry standard. Instead of reporting an opaque combined measure on energy financing, now banks will have to report both.
This radical move was led by NYC Comptroller Brad Lander, who pointed out that despite green pledges, banks still poured $1 trillion into fossil fuel extraction since the Paris Accords:
“The transition from financing fossil fuels to low-carbon energy is going far too slowly – and thus far, it hasn’t even been possible for shareholders to track,” he said.
As if to validate his thinking, it was reported this week that investors are fleeing renewable energy funds, worried about growth and uncertain policies during an election year. All told, renewable energy funds suffered $4.8 billion of outflows in the first quarter of the year.
The market structure made it less attractive to invest in renewables. But unbundling this reporting standard has just created a new source of upwards pressure on renewable energy stocks.
The more banks become transparent on how much renewable energy they finance, the more projects they’ll scout to make the numbers look good.
Bundling. Unbundling. Bundling again. What a powerful lens.
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Treasure Corner: Category Kings
Last week we left with a real cliff-hanger, here at Treasure Corner.
We talked about how every time researchers ask whether the mentions of a fund in financial media helps with its flows, the answer is always some kind of Yes:
Fund flows are positively correlated with how much the fund gets talked about. It's true for general financial press, but even when just limited to professional financial press (like trade magazines).
On a general basis, Good To Know. But how does one make use of this fact?
The trouble is twofold. One, press relations are often the domain of the company’s PR team, which tends to be removed from day-to-day sales. Marketers don't necessarily cultivate relationships with journalists, even though the data suggests they should.
Two, reporters might be nudged to write about a company's product, but flows-through-press seem mostly beyond marketing's control.
Not so, say researchers. A 2014 article, titled WSJ Category Kings – The impact of media attention on consumer and mutual fund investment decisions (by Ron Kaniel and Robert Parham) dug further, to discover why these post-writeups inflows were happening.
To do so, researchers collected a backlog of data off the Wall Street Journal, which features regular quarterly lists, called "Category Kings”. The paper chooses a bunch of categories, then ranks the top-10 mutual funds in each category, based on the previous 12 month returns. The categories can change quarter-to-quarter, and the WSJ has been doing it for thirty years.
Analysis of this data against flows showed two things:
One, not a surprise but still cool to see, featured funds saw a jump in flows. Compared to funds that just missed making the list, those that did saw an average of 31% more flows the following quarter.
Two, that these inflows didn’t magically manifest after publication. Rather, the inflows were gradual over the quarter.
The researchers show that companies increase advertising activities (spend, ad size, number of ads) after publication, mention their ranking in ads, and get mentioned in news and business articles.
It’s not that buyers had simply seen the WSJ lists and rushed to change their allocations. What actually happened was that they were influenced by it after the fact, when making allocation and re-balancing decisions throughout the quarter.
These flows are down to marketing. The badge itself isn't enough, it's pointing to the badge and making sure clients notice.
Also Happening:
Nike CEO blames remote work for innovation slowdown. It's interesting seeing the debate over remote work being carried into earnings reporting. Nike has been struggling of late and losing market share to fast-rising competitors. And the reason presented was a slump in bold new ideas, because remote work was making it harder to come up with them.
It’s a believable story, right? You can easily imagine it happening. The relatability makes this narrative powerful. Expect to see other companies using it too.
Norway wealth fund will not invest in private equity. Bucking this year's rush, the Norwegian government decided against its central bank's recommendation to invest up to 5% of assets in private equity, about $80 billion.
A little while back we talked about an internal study on NBIM's work culture, which matter-of-factly mentioned the increased workload on NBIM staff due to the war in Ukraine and high oil and gas prices. Apparently, NBIM took in almost the same amount of money per month in 2022/23, as per year previously. I glibly wrote of this windfall:
"Oil plus a stable government is clearly a profitable combo."
Well, not so glibly, Norway’s State Secretary Ellen Reitan, had this to say:
"In unstable times, it is important to have calm around important institutions, and the oil fund is definitely one of them," she told Reuters. "It has been a success story, with a key factor being the calm surrounding its administration."