One of the UK’s most eminent economists, John Kay has built a reputation as something of an iconoclast. He was made the first director of Oxford University’s Said Business School in 1997, but walked away from the ivory towers just two years later, frustrated at having failed to reform the university’s outdated management structures.
He has lampooned the ‘bullshit’ spoken by so many business people and characterized the proliferation of corporate social responsibility (CSR) reports as ‘absolute garbage’. So should the big broking houses be concerned now that Kay has sell-side research in his sights?
Establishing independence
From his elegant townhouse in the heart of London’s West End, Kay explains he doesn’t rate the quality of sell-side research very highly. He is speaking as an economist who likes to challenge the received wisdom but also as the chairman of Clear Capital, an independent equity research firm founded in 2003.
New regulations came into force in the UK at the start of the year, requiring the separation of trading and research fees paid by the buy side to brokerage firms. Kay believes this change could hit the sell side hard. ‘I doubt if sell-side research is going to die out but it will diminish quite a lot in quality,’ he says. ‘Some of it will become more genuinely independent and some will become more internally focused and directed toward investment banks’ own investment management and trading activities, rather than being in free circulation to institutional customers.’
Although still in its early stages, recent research by Investit, a fund management consultancy, indicates that unbundling is fueling growth in independent research. Kay agrees there is a new opportunity for independent research. ‘I first thought about independent equity research ten years ago when I was running an economic consultancy,’ he explains. ‘But I decided against it then because I concluded there was no way I was ever going to get paid for the work. I became interested again because conflicts of interest had been so obviously exposed as a result of the dotcom boom and, with some of the regulatory pressures that followed, I though it might now be possible to get paid.’
Regardless of the changes taking place in the market, Kay stresses that independent research must justify itself, not by being independent but by being better. To achieve this quality, Clear Capital has adopted a different kind of research methodology that Kay feels eschews the short-termism so rife on the sell side.
‘It’s about lifting your head above what next quarter’s earnings are going to be and looking at fundamental values in terms of long-term strategy,’ he says. ‘Our starting point is to look at an industry and ask what distinctive capabilities are important to it and then look at a firm, asking what its particular capabilities are. That takes you into questions of which kind of differentiation companies have that is sustainable.’
The future’s bright, but for whom?
Fidelity Investments and Morley Fund Management are already paying to receive Clear Capital’s research, and the company hopes it will pick up more business as institutions finalize the restructuring of their commission payments. Kay thinks the strategy-led approach represents the future for equity research and believes this could significantly alter the nature of relationships between companies and investors.
‘What’s intellectually interesting about independent research is that you can look at basic medium to long-term questions about company strategy without being dependent on good relations with management or having to listen to what management tells you,’ Kay observes. Ultimately, if Clear Capital’s approach becomes a larger part of the market, he thinks IR practitioners are ‘going to have to learn some different skills’ or even ‘be different kinds of people’.
But, perhaps rarely for an economist, Kay is keenly aware of the limitations of crystal ball gazing. ‘Even ten years ago, it seemed inevitable that almost all large business would be organized in big, quoted public companies – that no longer seems to be true,’ he points out. ‘And it’s a reversal people haven’t really noticed. They used to think the continental European corporate organization, which typically had very concentrated ownership, was yesterday’s model and obviously on the way out in favor of an Anglo-American structure. But, actually, the direction of change is now the opposite.’
