Smallest Hedge Funds Will Be Quick to Drop Research Under MiFID

(Bloomberg Markets) –

When hedge-fund manager Dario Sacchetti gets into work each morning, he’s met with an inbox filled with sell-side research reports.
“We receive a lot -- definitely more than 20 a day,” said the co-founder of London-based Anavio Capital Partners. “It’s helpful but we’re very selective about what we read and what we don’t.”

Come January, money managers like Sacchetti will have to pay thousands of dollars to read basic research reports and potentially several hundred thousand to access services such as private discussions with a bank’s most sought-after analysts. The ban on sending clients free analysis is one of the most talked-about aspects of Europe’s upcoming MiFID II rules, and means Sacchetti will “drop research not deemed necessary.”

The sweeping rule changes threaten to upend the business model of smaller hedge funds, which are already bearing the brunt of an investor exodus and declining fee income. Almost 7,000 hedge funds have closed since 2009 and more than 80 percent of those oversaw $100 million or less, Eurekahedge data show.

“The numbers I’ve heard in terms of what’s going to be paid looks completely impossible for smaller managers,” said Samuel Gruen, who started Lightfield Capital last year and whose his firm manages $20 million from London. The rules will force people to “rethink the investment process when launching a hedge fund.”

Theron de Ris, who oversees less than $10 million at Eschler Asset Management, said he plans to stop getting outside research altogether because of the new rules.

“I’m not going to consume sell-side research for the foreseeable future,” said de Ris, Eschler’s London-based managing partner. “It’s not going to change my world if they stop coming, but” the reports “are quite useful.”

Banks and specialist research companies publish thousands of pieces of analysis and investment recommendations each year, covering everything from palm-oil producers in Malaysia to Las Vegas casinos. They’re particularly useful for smaller money managers, which may lack the resources to generate their own in-depth research and use the reports for intelligence-gathering, tracking companies and cross-checking investment ideas.

For their part, banks have been happy to give them access to their research in exchange for routing some of their trades through their systems -- and in the hope that small firms will become bigger clients.

The European Union’s revised Markets in Financial Instruments Directive, and its requirement that research is paid for separately from trading commissions, will change this arrangement forever.

Prices Vary

Prices quoted vary widely, and range from JPMorgan Chase & Co. planning to charge as little as $10,000 a year for basic equity research to the $455,000 Barclays Plc has proposed to some of its small- and medium-sized clients for its top stocks package, according to pricing documents and people familiar with the matter.

At a time when even larger firms are having to cut costs, these prices are too much for some small hedge funds -- estimated by Eurekahedge to make up almost three quarters of the industry by number.

Tony Chedraoui, founder of Tyrus Capital, said his $2.3 billion hedge-fund firm is evaluating what research is essential and what it can safely “scrap.” Gruen of the far smaller Lightfield Capital has gone a step further and stopped using outside research.

With banks prioritizing what companies they cover, there may be opportunities for smaller funds to take up the slack and do their own research, said Cutler Cook, who helps hedge-fund investor Pacific Alternative Asset Management Co. pick money managers.

Yet overall, MiFID II’s research rules are only likely to reinforce the advantages that larger and wealthier asset managers have always had over smaller players, said Andrew Dickson, whose own London-based investment firm, Albert Bridge Capital, launched last year with $125 million under management.

“We have direct relationships with companies ourselves,” Dickson said. “But for those that don’t, this could be game-changing.”

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