Mifid rules on research payments will harm investment boutiques

The intention of Mifid II, the vast set of financial rules due to be implemented across Europe in 2018, is to increase transparency and reduce costs for investors. As greater clarity is gained on the final letter of the regulation, there is concern that the long-term cost will far outweigh any gains.

The biggest concern relates to the rules that will require fund managers to pay for research from sellside analysts. Fund companies will be prohibited from receiving analyst research for “free” in return for placing trades with brokerages or banks, and will need to provide their investors with a clear breakdown of the cost of research.

The goal of these rules was to make asset managers think about the true value of the research they received, and to strip the implicit cost of that research out of trading fees. In short, increased transparency around the true cost of trading was intended to lower costs for investors.

Saracen has no issue on the disclosure of charges to investors. We spend the vast majority of our time researching potential investment ideas and updating research on existing shareholdings. We adopt a longer-term investment strategy, with average holding periods typically between four and five years.

As a result, we generate relatively low levels of trading commission. Transactions impose a cost on investors and, as we are in the business of generating returns, we do our best to avoid any unnecessary trades.

Boutique investment companies frequently produce their own research, but still enjoy occasional contact and interaction of views and commentary with experienced sellside analysts. This dialogue benefits both parties. Most of the distribution of research is electronic and has virtually no marginal cost of dissemination.

Under the proposed regulations, there are a few choices on how to pay for research.

At one extreme we have direct payment by the asset management company. Smaller investment businesses are typically less profitable, operate with lower profit margins and will have less scope to absorb these costs. Fund managers who adopt this tactic may end up passing that additional cost on to investors through higher fees.

Alternatively, there is a complex mechanism that requires asset managers to assess the value of substantive pieces of research, and to pay for it from what is known as a research payment account.

Last year some of our best investments were in selective banks and mining companies, which appeared inexpensive on our assumptions. It was useful, and maybe even “substantive”, to know that most analysts were very negative on these companies. How exactly should we have assessed the value of this research?

Smaller asset managers with low portfolio turnover generate a low level of commission. Consequently, they are likely to be less important clients for the sellside, unless all of their trades are channelled to one bank or brokerage.

Channelling trades to one or two institutions is unlikely to be in the best interests of clients, but it may enable the boutique fund manager to negotiate harder on the price of research.

The direction of Mifid II, whether intended or not, clearly favours larger fund companies who can pay for research from their significant commission budgets, which further raises the barriers for entrants to the investment industry.

These proposals will hinder, and possibly damage smaller boutiques, many of whom provide superior investment returns, fresh ideas and competition to the larger companies.

We have yet to meet another asset management executive who believes the proposed regulation is fair for smaller fund companies.

The UK regulator states on its website: “Financial markets need to be honest, fair and effective so that consumers get a fair deal. It is our aim to make markets work well — for individuals, for business, large and small, and for the economy as a whole.”

The Financial Conduct Authority also says it aims to “promote effective competition in the interests of consumers”.

It is quite clear that these new regulations fly in the face of this assertion. It is hard to see how the objective of transparency and cost reduction will be served by these proposals.

We hope the FCA will appreciate the disproportionate impact on smaller fund companies and would consider introducing a minimum qualifying level of assets under management before full compliance with the directive is required.

As it stands, the introduction of Mifid II in the UK will restrict innovation and customer choice over the longer term.

Graham Campbell is chief executive of Saracen Fund Managers, the Edinburgh-headquartered asset management company

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