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MiFID II will require managers to construct monetary research budgets at the fund level, potentially allowing European asset managers to increase returns and create greater alignment with client (asset owner) investment objectives. US managers who choose not to adopt this global best practice risk reducing client returns through inflated and inefficient research spending that is not specifically aligned to different investment mandates.
The regulatory objective was to cut the link between trading turnover and research spending. Spikes in market volatility and turnover have resulted in unintentionally inflated research payments. This excess spending was then deducted from the client’s return.
MiFID II will require European managers to decide, at the beginning of the year, how much (in dollar terms) to pay research providers for specific services. Once those limits are reached (with a broker), trading commissions move to ex-only rates, capping the research payments regardless of equity market volatility.
Policy decisions by senior management can have a material effect on both asset manager and client outcomes. The key is motivating busy investment teams with an aversion to change and administration. Most investment teams are extremely interested (if not obsessed) by their returns; they are very keen to grow AUM and are frequently passionate about promoting their specific investment processes. If fund-level monetary research budgeting is presented as an opportunity for investment teams to generate alpha, grow AUM, identify and retain the research that is critical to their process, and achieve greater alignment with their clients, rather than as the latest in an endless procession of regulatory requirements, adoption will be enhanced.
The “contract” between the asset manager and the asset owner goes far beyond the fee structure. To invest, the asset owner must be comfortable with the manager’s investment process, fund strategy, risk framework, securities universe and expected return targets. Fund-level research budgets can uniquely reflect both investment process and portfolio construction, completely aligning the research spending with the investment objectives that have been mutually agreed by the asset manager and the asset owner.
For European asset managers, this is a 360-degree “win-win” situation. Returns improve. Investment teams are happy. Clients are happy. Compliance is happy – and marketing is delighted, as targeted fund-level research budgeting is integrated with the investment process, allowing the manager to demonstrate how it maximizes ROI on research spending, while simultaneously supporting mutually agreed investment objectives – thereby transforming unavoidable regulation into competitive advantage.
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