Market Insights Alert: MiFID II: Another Well-Intentioned Regulation That Could Undermine Investment Boutiques

Boutique and smaller investment managers will bear the brunt of regulatory costs

PHILADELPHIA, PA, November 21, 2017 – FIS Group, a manager of U.S. and global developed, emerging and frontier markets equity portfolio strategies, today issued its latest Market Insights Alert which looks at the amended Markets in Financial Instruments Directive (MiFID II), due to go into effect in January 2018. “MiFID II: Another Well Intentioned Regulation that Could Undermine Investment Boutiques,” outlines the impacts of the MiFID II regulation on boutique or smaller, entrepreneurial investment managers.

MiFID II is a European Union directive which aims to create more transparency for clients and to transfer the cost of research from the client to the manager. While MiFID II only applies to European firms, a significant number of large brokerages and asset managers appear to be adopting the principles of the regulation on a global scale. FIS Group believes this will transform clients’ expectations on how investment managers should allocate and report on their research expenses.

“At FIS Group, we globally source, evaluate and retain smaller, entrepreneurial managers because of their greater flexibility to identify alpha opportunities and be nimble, particularly in less liquid markets,” says Tina Byles Williams, CEO and CIO, FIS Group. “While MiFID II creates much needed transparency in manager expense reporting, it could present yet another headwind to these boutique managers.”

According to the Alert, the costs of MiFID II will be disproportionately borne by smaller, fundamentally-driven investment boutiques, whose third-party stock research is an integral part to their portfolio management. These rising expenses will further exacerbate the increasing concentration of investment assets towards large firms. FIS Group believes that the future holds a decline in new firm formation, closures and consolidations among smaller firms, and a pooling of resources between entrepreneurial boutiques to leverage their operational synergies.

According to recent research by McKinsey & Company, MiFID II will cause further asset migration toward passive funds as investors demand greater transparency on research expenses during periods of challenged active manager performance, resulting in a decline in commission revenues by as much as 50 percent. Furthermore, greater transparency on “hard dollar” research could drive up the cost of compliance, as research will need to be properly vetted, disclosed and retained.

Floyd Simpson, CFA, Manager Research Analyst, FIS Group adds: “Boutique and smaller, entrepreneurial investment management firms’ operating margins are already being squeezed by higher cost structures from both regulation and distribution, coupled with slowing revenues because of competition and downward fee pressures. MiFID II may be the final straw for firms struggling to survive. However, this could also create an industry shakeout, allowing managers with competitive performances and strong balance sheets the opportunity to stand out.”

The Alert highlights FIS Group’s key takeaways on the impacts of MiFID II, such as:

• If brokerages charge “hard dollars” for research as a result of MiFID II, this will enhance the competitive advantage of large firms whose balance sheets can better weather higher expenses.
• The need to pay “hard dollars” will raise the bar for the quality of investment research, and may increase demand for more niche research firms.
• MiFID II will hasten the adoption of technology-based research services, including artificial intelligence and sensing, which will drive down the cost of research.
• The impact of MiFID II on driving down commissions could further challenge boutique and small, entrepreneurial managers.

In addition to its Market Insights Alerts, which examine global economic themes and are published throughout the year, Byles Williams contributes to FIS Group’s Market Outlook series on a quarterly basis, based on research that examines market conditions over a three-to-six-month period. The last Market Outlook was published in November 2017.

About FIS Group

FIS Group is an investment management firm that provides customized manager of managers investment solutions for institutional investors. For 20 years, we have delivered risk-adjusted returns by conquering the complexity of identifying high skill, high active share entrepreneurial managers that have gone largely undiscovered by the institutional investor community. Unique among our peers, FIS Group enhances risk-adjusted returns by using macro strategy insights to allocate capital among the managers and/or through a global macro tactical completion strategy. Our culture is a fusion of relentless curiosity and a scientific, disciplined process.

For more information please visit us at xponance.com.