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Change to Thrive: How Structural Changes in Fixed Income Markets are Compelling Asset Managers to Rethink their Research Strategy

Published on November 12, 2014 by Adarsh Gupta

In today’s fixed income markets, where decent yields are hard to find, volatility is negligible, and volumes are thin, asset managers are struggling to identify opportunities to generate respectable levels of returns. The good old days, when the broad rally in the fixed income market helped investors generate decent returns without much deep dive research, are long gone. However, in today’s highly competitive market, access to tailor-made cutting-edge research is prerequisite to identifying “hard-to-find” opportunities.

It is therefore not surprising that a recent survey by Greenwich Associates found that demand for fixed-income research from buy-side clients has increased significantly. This is particularly more relevant in the less-liquid securities space e.g. high-yield. According to the survey, 54% of institutional investors now reward their dealers for high-impact and intuitive research compared to just 28% in 2012. For illiquid products such as high-yielding bonds, this proportion is even greater at 68%.

At such a crucial time, when asset managers need cutting-edge fundamental research, sell-side firms are struggling with numerous structural changes in their own troubled fixed-income business. Declining trading volumes, guidelines concerning higher capital requirements, and increasing cost of complying with complex regulations have all put significant pressure on sell-side revenues and profitability. Moreover, the emergence of electronic trading in corporate bonds is expected to further dampen the core over-the-counter fixed-income trading business. In what is clearly a challenging environment with profitability near historical lows, sell-side firms may find it hard to invest in ramping up their research offerings.

To make the situation even worse, proposals currently being floated in Europe, aimed at unbundling research costs from commissions to dealers, if implemented, will severely impact asset managers’ ability to pay for sell-side research (although currently relevant only for equities, this is likely to cover all asset classes including fixed income). Today, research costs are clubbed with trading commissions and consequentially borne by investors, albeit unknowingly. Post this change, sell-side research costs will either have to be borne by asset management companies themselves or by investors as part of the fund’s management expense ratio. This is expected to make it an area of concern for investors.

Such structural changes in the fixed income market will likely require asset managers to strengthen their own in-house research capabilities. Needless to say, such a move would have to be made without putting any upward pressure on a fund’s already tight expense ratios. The situation is far more complex for mid-sized asset management firms who, given their small scale, run the risk of becoming uncompetitive due to higher research costs.

What is needed is an effective low-cost model of expanding research capabilities while, at the same time, keeping costs under control. One proven and effective way of achieving this is leveraging the highly advanced research capabilities of offshore destinations, particularly India. Over the last decade, credit research outsourcing in India has evolved significantly with strong existing domain expertise across asset classes including investment grade, high-yield and distressed. Outsourced research teams in India are both experienced and proficient in supporting credit funds across the investment research value chain be it with idea generation, investment evaluation or monitoring.

We at Acuity Knowledge Partners have been providing fixed income research support to clients for well over a decade and know the industry well. We not only count some of the world’s largest credit funds amongst our long-standing clients, but also provide customized solutions to numerous mid- to small-sized funds. Our domain expertise spans across asset classes including investment grade, high-yield, distressed debt, leveraged finance, convertibles, structured products and sovereign and public finance. Our research teams not only take complete ownership of time consuming and routine tasks such as financial modeling, capital structure analysis, relative value screens, covenant analysis, stress testing, and writing investment notes, but also provide asset managers support in high-value activities, such as generating trade ideas, identifying investment themes and providing deep industry insights. Over the years, some of the industry’s leading asset managers have begun to view our research teams as an indispensable part of their credit research function helping them create differentiated and monetizable research content, and investible ideas, in a high-quality, customized, cost-effective and flexible manner.

To know more about our Fixed Income Services for sell-side and buy-side firms, please visit https://www.acuitykp.com/fixed-income-credit-research/


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About the Author

Senior Vice President

At Acuity Knowledge Partners, Adarsh leads the fixed income research practice for buy-side clients. He has over 9 years of experience in managing teams, clients and setting up and managing efficient research delivery processes across multiple strategies and geographies. Previously, he worked with a leading audit firm, where he was responsible for internal and tax audits.

Adarsh is a Chartered Accountant and holds a Bachelor of Commerce degree from Delhi University.

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