Greenwich Associates New Report Say That In Crisis, Asian Equity Investors Seek Support From Sell Side

As Asia's institutional equity investors contend with plunging portfolio values and pressures to reduce their own internal costs, they are relying increasingly on sell side firms for essential research and advisory services. At the same time, the results of the

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As Asia’s institutional equity investors contend with plunging portfolio values and pressures to reduce their own internal costs, they are relying increasingly on sell-side firms for essential research and advisory services. At the same time, the results of the most recent Greenwich Associates Asian Equity Investors Study reveal that the typical Asian institution is cutting back on the number of equity brokers with which it trades.

Sharp declines in stock prices and the ongoing de-leveraging of buy-side portfolios have shrunk the pool of institutions’ equity brokerage commission payments. Within that diminished pool, however, the share of total commission payments used by Asian institutions to compensate equity brokers for research, sales coverage and for the facilitation of meetings with company management teams jumped to 66% in 2008 from just 55% in 2007. Most of the commissions shifted to research and advisory services came from allocations for trading coverage and agency execution, which declined to 26% of total commissions from one-third a year ago.

It is an open question as to whether this new emphasis on sell-side research and advisory services will prove purely a function of the current crisis, or if recent changes to the market have resulted in a more secular shift in buy-side priorities. In particular, the drop in the value of institutional equity portfolios and the broader reduction in the amount of resources available to institutions for investment, analysis and administration functions could leave the buy-side increasingly dependent on brokers for data, insights and access to company management.

As the global financial crisis deepened last year, Asian institutions reported a reduction in their number of sell-side trading relationships. In 2007, Asian institutions executed trades through an average of nearly 20 brokers; that average fell to just shy of 19 in 2008. Among the largest institutions in Asia, the average number of sell-side trading relationships declined to 20.5 in 2008 from 24.5 in 2007. Three trends were driving these declines:

1. The growing use of commission sharing arrangements (CSAs). In 2008, about 40% of institutions reported using CSAs and more than two-thirds said they expected to be using a CSA within the next 12 months.

2. Counterparty risk concerns in selected cases, which reached a new high after the demise of Bear Stearns.

3. A new caution on the part of investors. During the boom years, institutions steadily added new broker relationships as they expanded their investment operations into new markets such as China, Vietnam and Pakistan. With the collapse in global markets, some institutions have retreated to more familiar territory.

The competitive landscape of Asian equity markets is clearly divided between a top tier of brokers that have made the substantial investments required to cover most major countries in depth and a lower tier of firms that tend to focus on more narrowly defined markets or niches. The fact that there are no brokers in the middle of these two extremes reflects the structural challenges associated with doing business in a region spanning a diverse geographic expanse and numerous individual country markets, each with its own set of companies, rules and market fundamentals.

CLSA ranks as Asia’s equity broker, topping the market in terms of both market share and quality in equity research and advisory, and essentially tying Morgan Stanley with the largest market share in equity trading. Behind CLSA in research and advisory share are Goldman Sachs and J.P. Morgan, both of which have well-rounded Asian equity franchises and both of which gained share from 2007 to 2008. On the trading front, UBS and Credit Suisse are statistically tied at 3rd in market share, with Credit Suisse also dominating the fast-growing electronic trading business.

In Asian flow equity derivatives, spanning futures, swaps, options and other volatility products, Goldman Sachs is the leading broker based on its broad relationship penetration among institutions, narrowly besting Deutsche Bank and Morgan Stanley, with all three firms boasting a strong profile across a diverse range of products. In contrast, qualitative feedback by investors puts Deutsche Bank in the lead on overall trading and sales capability and ahead of the competition by a considerable margin.

D.C.

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