U.S. stock pickers are beating their European peers by an ever-widening margin, and one group of strategists says MiFID II’s research rules are the reason why.
With just days to go before the conclusion of an EU consultation that could once again re-write how money managers pay for analysis, Evercore and Frost Consulting have published fresh research arguing Europe’s regulatory overhaul is driving America’s growing dominance in equity investing.
U.S. managers who invest in stocks outperformed their counterparts by 265 basis points in 2019 on an asset-weighted scale, partly because they spent more on outside analysis, the research suggests. Last year’s survey showed the Americans won by 220 basis points in 2018.
Back then Evercore, which sells analysis, acknowledged it was “the most self-serving research note ever.” But their latest update looks timely, with regulators poised to decide whether MiFID’s research rules have inflicted unintended damage to the industry.
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“Our gut tells us the EU ends up reversing,” Evercore analysts led by Glenn Schorr wrote.
With MiFID II, Europe sought to put an end to the longstanding practice of investment banks offering research as an add-on to trading, which critics say obscured costs and led to overcharging. The 2018 rules compel asset managers to separate out what they pay for outside analysis from trade execution.
Once costs were fully disclosed, money managers ended up paying for research out of their own pockets to remain competitive. That ultimately led to “significant cuts in research budgets” as they sought to drive down the amount they were spending, according to Evercore.
They cite one estimate from a French trade group that the country’s managers reduced research budgets by as much as 75% between 2017 and 2019.
The analysts first compared the amounts that more than 5,000 funds spent on research as a percentage of their assets under management, and showed that regardless of their geographical or sector focus, U.S. managers generally outspent European rivals several times over. Returns data showed the subsequent American outperformance to be worth $245 billion.
“It’s hard for me to believe that a portfolio manager that’s cutting 50% or 70% of your research counterparties has no impact on any of your strategies,” Neil Scarth, principal at Frost Consulting, said in an interview.
Analysis of their performance — and fees — may reveal some surprises.
It’s difficult to directly attribute outperformance to a single factor. A skeptic might also note that the vast majority of active managers anywhere still trail their benchmarks.
All the same, French concerns over shrinking research coverage of small and mid caps are expected to lead to changes to MiFID II when authorities wrap up their consultation on May 18. Bloomberg Intelligence says managers “can expect more-relaxed research-unbundling rules.”
MiFID II may already be going global, however. In a buy-side survey conducted by Liquidnet from December, 70% say they’ve unbundled research worldwide, compared with 53% in 2018. Some 38% of U.S.-headquartered firms are already footing the research bill themselves.
“The cost of research is completely dwarfed by the performance differentials between funds that do well and funds that do poorly,” the Evercore analysts wrote. “This should be a central factor in asset owner thinking about research funding models.”
