B. Riley FBR Inc. is taking one approach to compete in a research world facing revenue headwinds, and one of its former equity analysts is taking a different track.
Barton Crockett recently left B. Riley FBR to start his own firm called DCFStocks LLC, which could target not only institutional investors — the traditional audience for equity research — but also retail investors. His move came around the same time B. Riley FBR announced it would drop coverage of 70 stocks, predominately larger-cap companies, to allocate more resources toward smaller-cap names. B. Riley FBR's strategic move and Crockett's decision to build a new firm represent two paths forward for equity research as revenue tied to the business comes under pressure. One is focusing more on underserved research coverage, and the other is forging ahead as an independent shop.
B. Riley FBR believes it can more effectively find attractive investment ideas among smaller-cap stocks, B. Riley Financial Inc. Chairman and CEO Bryant Riley said.
"My view is that the larger the market cap, the harder it is to differentiate valuation," Riley said, according to a transcript of a March 5 earnings conference call.
Finding ways to offer differentiated coverage can help research providers stand out to investors, and attracting more interest is important because payments to the industry have been shrinking, said Integrity Research Associates Principal Sanford Bragg, whose firm advises financial professionals on the global research market. Asset managers have been looking to cut costs by eliminating duplicative coverage they subscribe to, a trend driving Integrity Research's expectation that 2019 research industry sales will fall 5.5% year over year to about $13.8 billion. A January report from the firm projects that North American payments will fall 5.0%, while European payments will drop 8.5%. Both of those regions saw year-over-year drops in payments in 2018.
The projected drop for Europe is more severe because of fallout from the region's MiFID II regulation, which went into effect in January 2018 and requires asset managers to separate research payments from trade commissions. Regulators intended MiFID II to bring more transparency to financial markets by unbundling trade and research payments and giving investors more clarity around how much they pay for each.
The U.S. has not followed suit with similar rules, but many in the industry say that buy-side behavior has changed on both sides of the Atlantic.
"Larger hedge funds have used the cover of MiFID II to change their trading strategies," B. Riley FBR CEO Andy Moore said in an interview.
He said a product of the "decoupling world" is that the buy side is less likely to trade with a desk just to compensate that firm for its research. Instead, investors are trading where they can find the best execution.
"They will migrate to liquidity," he said.
For this reason, Moore expects his company will continue to actively trade large-cap stocks even without research coverage. He added that he doubts the reduced research coverage will lead to dramatically lower investment banking business because some 90% of the firm's underwriting revenue comes from small- and mid-cap companies.
Moore said research is critical to sourcing and placing shares of smaller, less liquid stocks. And because small-cap stocks tend to receive less research coverage, he believes his company can better attract research payments by focusing on stocks overlooked at other equity research firms. While Moore is confident in the strategy, he acknowledged that it might not pay immediate dividends.
"How and when it translates to revenue is a bet," he said.
Crockett, whose coverage has included media, internet and leisure companies, is betting that offering quality reports will capture research payment market share. He has no plans to set up a trading desk.
Crockett said some institutional investors have always made separate research payments from trade commissions, and as the practice becomes more commonplace, that creates a greater opportunity for independent providers to attract some of those fees. He also envisions a platform that can connect with retail investors.
"My No. 1 clients are institutional investors, but I think there are opportunities to speak to the broader world," he said in an interview.
Crockett said consumers see little solidly grounded research that attempts to show how much a stock is actually worth, and he wants to present investment principles long followed by the buy side to retail investors. Distributing research on the internet puts a large potential audience on the table, he said.
"I think there is a lot of regulatory constraints on traditional broker/dealers that make it difficult for them to communicate in the ways that people want to communicate now," he said.