A report today from Greenwich Associates shows that U.S. institutional investors are diverting equity commission dollars from Wall Street’s traditional research offerings in favor of face-to-face meetings with company management and research from independent and specialized providers.

Stock picks and company analysis appear to be falling out of favor as institutions direct more of their equity commission dollars to securing access to analysts and face-to-face meetings with company management teams, the report says. “Institutions once viewed sell-side analysts as providers of ideas,” says Greenwich Associates consultant Jay Bennett, “but increasingly, they see them as providers of access.”

Between the first quarter of 2004 and Q1 2005, U.S. institutions paid their brokers approximately US$1.4 billion in commission dollars for the facilitation of meetings with company management, Greenwich reports. That amount represents 36% of all U.S. equity commission dollars allocated by institutions for sell-side research. As recently as 2003, institutions devoted only about a quarter of their research commissions to management access. Over the same period (Q1 2003 to Q1 2005), institutions cut the annual amount they pay brokers for in-depth company or industry studies by $800 million, it says.

These findings are gleaned from the results of Greenwich Associates’ 2005 U.S. equity analyst research study, based on interviews with 1,138 analysts at large U.S. investment institutions.

“In 2005, institutional investors are directing the same share of their equity commissions to research as they did in 2004 — nearly US$5 billion — but what they value has changed dramatically over the past several years,” says Greenwich Associates consultant John Webster. “In particular, they are less willing to pay for Wall Street’s stock picks and studies of individual companies or industries, and much more interested in direct meetings and interaction with company management and sell-side analysts. When they do seek out more traditional forms of research, institutions are more apt to turn to research from independent providers and regional or sector specialists.”

Greenwich Associates says institutions report that they rank access to a corporation’s senior management as the single most important factor in assessing the effectiveness of company investor relations efforts. Buy-side analysts also rate the quality of in-person meetings with company officials as infinitely more important than the quality of press releases and conference calls.

Firms are willing to pay brokers to arrange access because of the sheer number of companies being covered, Greenwich suggests. Its research shows that the typical buy-side analyst covers between four and five industries, each containing a dozen or more companies. In contrast, the typical sell-side analyst covers just one industry and 12 to 15 companies — a much more manageable load in terms of scheduling.

Institutions’ commission dollars are also buying them access to private companies. “Since private companies are not constrained by restrictions associated with Reg FD [an SEC rule against selective disclosure], buy-side analysts can glean a great deal of otherwise unobtainable information from them about their industries and their competitors,” says Bennett.

It also finds that when institutions do look to the sell side for traditional forms of research, they are turning more often to specialized and independent research firms. As recently as 2003, the 15 or so so-called ‘bulge bracket’ firms earned more than 82% of the equity commissions paid out by U.S. institutions. In 2005, the proportion claimed by this group fell to about 75%.

Over the same period, the 30-odd firms generally regarded as the leading independent research brokers increased their share of the commission pool from 1.8% to 4.4%, Greenwich adds. And the share of total annual research commissions allocated to 40-odd regional, sector-specialist, and broad-based research-driven brokers that mainly distribute but don’t underwrite deals, has risen from 15.9% to 19.8%.

“Thanks in part to the fallout from the Spitzer settlements, institutions are making greater use of independent research,” says Greenwich Associates consultant John Colon. “Looking ahead, a full 45% of institutions tell us they intend to increase their commission payments to independents, as opposed to just 1% expecting their payments to decrease.” Currently, U.S. institutions pay 15% of their total commissions to independent research boutiques.

However, Greenwich suggests that the independents could soon begin bumping up against a limit to their growth. The increase in commission flows to independent research providers has cost bulge-bracket firms some $25 million over the past two years, it notes. “Institutions that reduce their commission allocations to full-service brokers in order to finance the purchase of independent research will very quickly discover the connection between commission flows and research, sales coverage, and other services,” says Webster. “Many investment managers are already beginning to understand the need to concentrate their commissions with their important brokers in order to preserve critical relationships and services. Indeed, some managers may be more inclined to reduce the number of brokers with whom they do business, as opposed to adding new relationships with independents.”

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