The Changing Landscape of Stocks Research and Trading
November 27, 2017
Stock brokerage house operations have been the same since the 1990s in the Philippines, but there are winds of change coming from the horizon. A stock brokerage house has traders, a research team and backroom operations.
There are currently 132 active stock brokerage houses. The top 20 in volume have research, while most of the rest rely on their traders for their individual research. Enumerated below are some developments abroad that may soon reach and affect local stock brokerage operations.
Flashboys – Flashboys operate High Frequency Trading (HFT) wherein computers generate multiple gains out of small increments of trades. The nearer the system is to the exchange, the faster these small increments of trades are made and the more gains the house makes.
With short-selling to be allowed again by the PSE soon, this may set up flashboys to emerge locally as they can operate and gain in both a bull and a bear market. The PSE, however, is a small exchange with just over 200 listed companies and an average volume of just around USD120 mn as seen today.
70% of trades in Japan come from HFT, and flashboys are emerging in Hong Kong and Singapore. If HFT were to surface locally, it would result to computers replacing traders. People in IT specializing in financial engineering will be the top professionals local stock brokerages will be after rather than traders.
On-line trading has somehow started displacing traders already especially in the Philippines wherein clients prefer to be the traders, fund-managers and analysts themselves. This is from our observation and experience in dealing with potential retail clients. Flashboys will be the new rock stars in finance.
Robo-Advisors – They are computer programs that determine the best stock portfolio for investors. Some houses abroad promote this new service claiming they generate the best yields for investors. Our opinion of this is that robo-advisors or robo-advising is just a catchy marketing term and tactic to attract more clients for the house.
There is a close semblance of robo-advising in our current operations wherein we derive the best stocks in terms of performance and price through computer programs. This is through our own financial, sector and market models with our own formulas and methodology. Still, the best advisor is still an analyst, and that robo-advising is just a step prior to the final decision-making in a recommended stock portfolio.
The late great value-investor Irving Khan once said that value-investing is both an art and a science. Computer programs, for example, may gauge or rank but cannot ultimately evaluate the quality of a company’s management through a set of variables. Still, a robo-advisor is an essential tool for analysts especially those practicing value-investing. Combined, they are the ultimate advisors for investors.
MIFID 2 – Markets in Financial Instruments Directive (MIFID) 2 is a regulation in the EU to promote transparency in financial advisory services. One of its aspects directly affects stock analysts as it requires stock brokerage houses to separate and show fees from stock transactions and research.
The effect is that the sell-side analysts of houses may decrease as competition rises when research fees are exposed and not lodged in commission fees from stock transactions. Research will now be required to be bought by fund managers and not obtained free through stock transactions from a house.
MIFID 2 may take effect as far as the US and eventually into Asia since EU-based banks have a global presence. Fund managers will be opting for less-expensive high-quality research that can be found outside of the stock brokerage houses. Meanwhile, houses will be cutting down or pricing their research.
We’ve noticed many analysts from foreign houses that have changed their careers to investor relations, sales, trade execution and fund management. Most of them are bright and promising analysts as we think they are, but they changed careers because of MIFID 2 which takes effect on January 3, 2018.
A regulation similar to MIFID 2 may come about locally as around 102 houses do not have research at all but yet charge the same commission fee as with houses with research to their clients. This does not bode well to gaining public trust especially in the Philippines where only 1% invests in stocks.
The CMIC, PSE and the SEC may notice this glaring discrepancy especially when MIFID 2 takes effect and be felt in local finance. What we see is houses without research being required to establish their own research capabilities at a bar similar to houses with research in the top 20.
This is pure analysis, research not parroted from the papers and valuations not obtained from consensus sources. This evens the playing field, reduces the huge number of houses, establishes public trust and in effect, higher volumes for the Philippine stock market.
We’ve been wanting to write about this topic for the longest time but have to gather our thoughts and vision meticulously on this industry to which we belong to. This, especially MIFID 2, was brought to our attention by a foreign research provider and a former analyst now in investor relations.
It seems we are in an advantage being an independent research firm in the changing landscape. However, it does not feel so. The fund managers will soon be sourcing research from research providers and independents such as us. The Philippine market, however, is just a minute part of their portfolio.
We have also been approached by providers with the intent of procuring our research for a minimal fee and bundling it with other ASEAN or Asian markets research. It is not enticing to be a circus monkey to be part of a package for just a few dimes. We have been firm our service is for subscription even to them.
Still, we view these changes as developments and a firm ground to which we can continue our operations. We hope to service the best clients in our mission of Seeking Value and Minimizing Risks in the Philippine Stock Market.
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