The business model of the brokerage industry as we know it is unsustainable – it adds no value and is due for a large and fundamental reshaping. Got your attention? Good, that will be the topic of a subsequent post, but first I have to introduce myself and answer your questions on my background and experience.
A few points right off the bat:
- I am writing anonymously for the time being as I work at a small firm, in a small market, focused on a very specific sector.
- I am growing more and more cynical of this industry by the day and I know this will come through in my writing – take it for what it’s worth.
Now some background: I am one of a growing number of people that have an engineering degree as well as an MBA, and have joined the finance community in the hopes of making the big time (read 'more money'); my thinking was the equations will be easier and the remuneration will be higher.
I am 6-12 months into an equity research position at a small (and struggling) boutique brokerage. The lifestyle in research is great for early risers and those who can think on their feet and produce coherent, intelligent commentary under tight timelines. I’m in the office 6:15-6:30am each day to prep for the morning meeting. Most of the trading-day hours are spent reacting to macro and company-specific news so that I can help provide 'insightful' opinion to my analyst, our sales desk, and institutional clients who are calling in.
Outside of these hours, or during down periods, is when the actual research, modeling, and writing gets done. There is a constant battle between putting out genuine research and filler research; filler research is meant to sustain other areas of the business while more innovative research is produced. Filler research has limited substance and depth while genuine research is a creative exercise that is far more time and effort consuming.
The brokerage I work at is dying a slow and painful death. It has enough capital to sustain for the time being, but make no mistake, it is dying. There is significant dysfunction, bureaucracy, and inefficiency, which far exceed the standard for a boutique-level shop. The sad thing is that those with the most on the line, and in the best position to make the changes, are the last to realize it.
Going forward in future posts, I hope to provide some color and generate discussion in a few areas (among others):
- First, I did get into the industry, so I can provide insight for those looking to transition from engineering to finance, or for anyone else who wants my opinion on chances/opportunities for breaking in.
- Second, the declining relevance of the sell side as a whole. I want to do a more detailed look into what has happened to make it become irrelevant, and the resulting impact.
- Third, how not to run a brokerage (or a small company for that matter). I am by no means an expert, but there are common dos and don’ts here that are glaringly apparent.
- Fourth, despite my cynicism I am learning a few things at my job. I’ll write a post or two on quick analysis of companies from both a top-down and bottom-up approach.
I look forward to sharing my thoughts with you all going forward.
Thanks for sharing. Good write up.
So, you're one year or less into this industry (and at your company) and you know the industry dynamics better than the guys running the shop? I think it's much more likely that you have a fundamental misunderstanding what the actual product of research is that people buy (clue #1: it's rarely your picks) or that your firm is in trouble, than it is that the industry "adds no value".
"Don't be a dick...Dick" - XXX :)
While I would agree that OP has a fundamental misunderstanding about what drives value at most sell-side brokerages (I would say its management access), I think he is right that boutique brokerages are hurting, and the issue is more structural than you seem willing to admit.
At my previous shop, it appeared to me that the greatest driver of value was management access, an area where boutiques are at a fundamental disadvantage (unless they're in an extremely niche sector). Bigger firms are more likely to have a pre-existing IB relationship with management at covered companies, and certainly have an advantage from an advertising perspective.
This is problematic because it drives lower trading commissions, which in turn drive lower comp, which in turn tend to drive lower talent. And all this against a back drop of decreased trading commissions, tough volume and headcount reductions across the Street. Unless the firm has an extremely differentiated product, it tough to compete with bigger players who are doing the same work with more resources (including data, which adds a ton of value to thought pieces and is cost prohibitive at firms without scale).
Just my $0.02, can elaborate if necessary.
Edit to remove typos
Wrong. It's not a complicated business. Anyone of reasonable intelligence can tell if an organization if screwed up or not within a few months; especially if this guy is an engineer and perhaps coming from a real corporation, it can be painfully obvious how f'ed up a boutique or any brokerage operation is....it's also obvious how it can be fixed which usually requires removing several douchebags
I wouldn't be surprised to hear that this boutique relies heavily on its research product, since it's bankers/franchise are worthless. When this happens, payout and influence usually becomes skewed to equity sales trash and then its all downhill from there...
Interesting that you answered a question that nobody asked. He said that the industry adds no value. My response is that it's more likely that he doesn't understand the industry enough yet or that his firm is in trouble than it is that the industry adds no value. Do you disagree with that?
Good read. Keen on knowing more.
This should be good. Tell me more about your grand realizations about the industry after 6 months of experience. I'm dying to hear.
I work in the Trading and Ops area of a boutique broker dealer and my firm is in the exact same situation.
Without IB deal flow, access to corporate management, and standout research analysts, it's always tough for boutiques to keep their head above the water. With tough markets & volumes, it's hard for the buy side to spread the wealth in commissions across the street - gotta be ranked in the top 5-7 to cover cost of capital...
In the UK the FSA is likely to start fining asset managers soon if they pay for corporate access.
Last year 29% of commissions in the UK were direct for corporate access.
Changes afoot and likely to spread..
I don't see this really affecting the reality on the ground. Maybe more the record keeping of what payments are for...
I love how the sell side is always talking about access to management as a selling point as if some fictional scenario goes like this:
Buyside Guy: "Derp, derp, I am so dumb that I manage hundreds of millions of dollars but can't figure out how to go to a company's website, look up the number, and leave a voice mail for management asking them to call me. Good thing I know how to go through the much more complicated process of starting a relationship with a sell side firm that involves paying high fees for this same commodity information. However, I enjoy wasting time and paying for free things because I am so dumb so I'm happy to do this."
... said no Buyside Guy ever.
You have two scenarios here:
1) Small under followed stocks that probably don't have much or any coverage anyway, in which case you definitely don't need or want the sell side to be involved (they might steal your idea and publish first)
2) Large stocks that have everyone and their mom publishing on the name in which case the price is probably nearly or entirely efficient, in which case there is no reason at all to call the sell side to begin with
1 & 2 above probably cover 98% of publicly traded equities in the US
I used to call the sell side sometimes on #1 when I was rookie buy side analyst but I gave up quickly because I would hear the most amazing things. Sell side guys would say, "Sorry, I don't know the answer to your extremely relevant question that will determine the direction of the stock price because I have only been following this stock for six months." To which I would reply, "Bitch please, I've been following this stock for less than two days, what do you even do with your time?"
Haha, nice.
Been on both sides here and actually there is a reason legit buy-side analysts want corporate acesss and access to sell side analysts and it has nothing to do with checking shit on an IR website. It has to do with getting the incremental color that comes from a face to face meeting AND perhaps most importantly is understanding what the rest of the buy-side is thinking since sell-side guys talk to many different buy-siders daily. Anticipating what sell-sider are going to do (upgrade, downgrade etc) is also an important way to get a slight edge.
Speaking with the FCA things will change next year as they're gearing up to clamp down, for now its being ignored. Large asset managers have very formal voting mechanisms so won't go around the rules if clamped down on.
@Ravenous, its more like this:
Buyside guy: derp, derp I get to go to x conference at y resort and meet management and go on a safari after? Awesome. Or derp, derp, so and so sellside brings all these management teams around to meet me so I don't need to get off my butt and see them. As I am a big institutional client this is often over a nice lunch and I have had these relationships set up for years. Should see who else they've got coming at the next sport/theatre/polo event my salesperson takes me to for a meeting.
Corporate access is handy for emerging markets however and frontier even more so
Large buyside institutions are price insensitive on paying for research through trading, but highly price sensitive to paying for it on a subscription basis.. Messes with the boutique guys. Changes to paying for research via CSA (CCA) & unbundling will hurt small guys even more before decimating large bank research shops unless primary issuance picks up (probably H2 next year)
6 months in the game and tell me what its like. Good shit bro, cant wait to hear how its 'changing'.
Trust me, no top buyside shops have strategies that focus on sitting down with the sell side to get access to management. Of course you talk to them and/or meet them, but what you're talking about suggests people are focused on getting into crowded trades and chasing momentum. There are some funds that do that and a few of them are successful but no top-tier shops are doing that.
It's adverse selection by definition -- if you're talking to big companies that are attending conferences because they have a well oiled IR machine, the relevant information for those stocks has probably been very well communicated to the Street. If you're talking to small companies at shitty conferences then they're most likely pitching at those conferences to try to raise equity or pump their stocks by being promotional. Either way it's not a good place to be. But more importantly, the best ideas are almost always the under the radar companies that have little or no sell side coverage and that do not talk to many investors. You're gimping yourself by definition if you have to go through the sell side.
It's a dying model and that's why so many brokerage firms are going out of business year after year. There will be more. The big shops will be okay because they have underwriting relationships that subsidize the research but the small shops don't have that.
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