Independent analysts take a bite out of investment banks in Asia

After 27 years working for investment banks and hedge funds, Hong Kong-based equity research analyst Paul Schulte decided it was time to fly solo.

Carrying a resume littered with big names like Nomura Holdings Inc <8604.T> and CCB International, the overseas investment banking arm of China Construction Bank <0939.HK> <601939.SS>, and several others, some of whom no longer exist, Schulte wished he had gone independent sooner.

The independent research industry has started to gain a foothold in Asia. It is already relatively mature in the West thanks to regulations enacted last decade in the United States to end the conflicts of interest between banks and analysts.

Now, a growing number of analysts are trying their luck as independents, selling knowledge and expertise picking stocks, as investment banks have cut back on research departments in the wake of the global financial crisis.

"We are in a very different world," Schulte, a 48-year-old American, told Reuters in a Hong Kong office space that he shares with other companies.

"In the last four years, if you don't see that the research game in investment banks is over, then you are just a fool," said the ex-Lehman executive.

Banks were and continue to be under pressure because of shrinking trading volumes, thinning client lists and regulatory changes restricting their proprietary trading activities.

As a result, there were less jobs and pay in research units, and less chance of career advancement. It became a recipe for disillusion, raising questions over professional values and quality of life for Schulte.

"When you are inside an institution, there are fundamental conflicts of interest. Let's not pretend there is any independence going on whatsoever," said Schulte, who has sovereign wealth fund CIC and hedge fund Fortress among his clients.

"Some people just don't feel comfortable anymore working for financial institutions."

These days he is unafraid to make a lot more sell recommendations than he ever did working for banks. Nearly half of his calls are "sells" right now as compared to less than a tenth that the teams he led at banks regularly issued.

Schulte, who also teaches at the University of Science and Technology in Hong Kong, is among a growing number of independent analysts challenging the overly optimistic ratings that the sell side analysts often give to the companies they cover.

Critics have long said that research analysts working for banks were too soft on companies, while independent analysts can be more cold-eyed and ready to issue sell calls, helping clients to short or stay away from struggling companies.

Top analysts, who just a few years ago took home $1 million-plus, have become increasingly unaffordable and left banks to set up on their own.

The inroads made in Asia by independents are modest and few are profitable, but the growth is evident.

Commissions paid to the independent research industry in Asia has risen by 40 percent to $200 million since 2009, according to Integrity Research Associates, a consultant.

By comparison, global equity commissions, which are mainly paid to investment banks, fell 21 percent $27.7 billion.

GROWTH INDUSTRY

In April, Schulte joined the platform of IND-X Securities (Asia) Ltd, a marketing and support firm for independent analysts, and founded his own research service.

Hong Kong-based IND-X has marketing and support relationships with over 30 quality independent research providers, focusing mainly on Asia and emerging markets. It estimates there are roughly 40 such independent firms operational in Asia.

A number of analysts in the region have built up more than a decade of experience, command a following among fund managers and are ready to take the risk of striking out on their own.

The funds industry itself is maturing. As the rank of experienced analysts shrink at banks due to cost pressures, senior portfolio managers are likely to consider subscribing to independent research firms started by top analysts.

"These are sort of grizzled analysts, who are disillusioned, highly sceptical, do not want to work for big investment banks and they have seen a number of cycles and that's what people pay for," said Gillem Tulloch, founder of Forensic Asia.

Independent research firms charge anywhere between $10,000 to $100,000 per year subscription fees in Asia.

To keep cost down they share resources, often hosting meetings at Starbucks rather than the boardroom. They face other challenges such as persuading Asian fund managers, who are used to getting support from the sell side, to pay for research.

Louis Vincent Gave, the chief executive of a 60-man team at Gavekal, said one of the main challenges is also from the rise of passive funds and exchange traded funds that require no research to invest and are getting more popular globally.

"I don't think we are going to see a wholesale migration of the research function from banks to the independent research space," said Tim Condon, managing director and head of Asian research at ING Groep NV in Singapore.

"There is definitely room for them but they will be at the fringes. Research is free at the banks and comes packaged with other benefits for the buy side."

Banks help funds execute trade and arrange corporate access. While technology is making execution less of an advantage, banks continue to rule when it comes to connecting fund managers with companies using their investment banking relationships.

It's tough for the independent analysts to match that, but they say clients do not expect corporate access from them but value and pay for research and opinion.

"As the funds industry move towards unbundling of services such as corporate access, research or investment banking deals, independent research firms are likely to gain," Tulloch said.

They are already benefitting from the cuts at research units of banks, hiring talent at lower cost. The long-term lure also includes M&A opportunities as investment banks may buy some of the independent firms to bring back talent.

Staying put in shrinking world of investment banks research units would carry its own risks.

"As an analyst, whether you like it or not, you are tied to the bottom-line and if you are not perceived to be contributing to the bottom-line, you are a suspect," Schulte said.

(Editing by Simon Cameron-Moore)