While financial services is by no means as lucrative or as controversial as it was a decade ago, increased regulations and geopolitical upheavals have brought the industry into the public eye in a new way. The recent announcement of potential steel and aluminum tariffs in the United States, and the resulting resignation of Gary Cohn, an ex-Goldman Sachs (GS) executive, have brought back political tensions and the banking industry as never before.
But a much more important development has originated in Europe, known as Mifid II. The “Markets in Financial Instruments Directive #2”, or “Mifid II” for short, is a variety of regulations in the European Union that impact all banks, funds, and institutional investors that operate in the EU. One of the most profound rules for institutional investors is also so obscure that many in the public haven’t heard of it: the decoupling of research and trading.
We have discussed this before at Zolio, but now that the rules are a couple of months old and into effect, it is clear that the implications of these rules in practice are still unclear. Since the rules went into effect, more institutional investors that purchase securities and use brokerage services to do those purchases have reshuffled their research budgets. For some, budget cuts have already gone into effect; for others, albeit a minority, more spending on research is on the table. But for all of them, a reconsideration of what sell-side research is necessary is currently underway.
Again, financial services can traditionally be seen as having two parts: the buy side, where analysts and portfolio managers use money controlled by their employer to buy and sell assets, and the sell side, where analysts and portfolio managers sell research to the buy side. It was and remains common for buy-siders to become sell-siders and vice versa; the two groups continue to talk daily, and research output continues to flow onto terminals, into email inboxes, and investment bank content portals.
But there is a reckoning that is just beginning.
Not since the Great Recession, when outflows and devalued assets caused research budgets to plummet, have buy-side analysts and P.M.s taken such a close and cost-conscious look at exactly what value they get out of sell-side research. In a way, this has resulted in an existential crisis in the industry, where buy-siders are asking themselves what they really value in this research—and sell-siders are forced to ask themselves, in all honesty, what really makes their research different and unique?
One of the most interesting and un-noticed results from this phenomenon is the quiet privileging of qualitative over quantitative research. The two sides have always battled it out in finance, and throughout most of the 2010’s, quantitative research and the new riches of algorithmic trading seemed to dominate the industry. But since returns from quants have diminished significantly over the last few years, and now that qualitative research is the more obvious distinguishing feature of high-quality versus low-quality research, we’re seeing the value that analysts get from sell-side research fundamentally change.
For new entrants to the industry, this is extremely confusing. What’s more, it also means that the skills that the financial stars (at least on the sell-side) of the future will be very different from the stars of the past. DCF models, complex calculations, and statistical modeling are, after all, rote work. Machines can do them. But ideas, insights, unique perspectives, and creative methods of understanding markets—these cannot be replicated by A.I. (at least not yet). And for that reason, the softer skills involved in due diligence, and not financial modeling, are becoming more important than ever for new analysts in the industry.