Hedge Funds Capitalize on Political Intelligence: Study

July 28th, 2014

According to a recently revised academic study, U.S. hedge fund managers have clearly gained an information advantage from their connection with lobbyists, enabling them to generate excess returns.  However, this advantage may have decreased significantly after the STOCK Act was signed into law in 2012.

Background of the Study

Over the past few years, legislators have been concerned about how hedge funds get access to and trade on nonpublic information from Washington DC that they obtain from lobbyists, boutique research firms, and others dealing in “political intelligence”.

Unfortunately, the opaque nature of the hedge fund industry has made this topic very difficult to study with any rigor – that is until the publication of a recent academic study called “Capitalizing on Capitol Hill: Informed Trading by Hedge Fund Managers”. The most recent draft of this study was published on July 25, 2014 by Jiekun Huang, Assistant Professor of Finance at the University of Illinois at Urbana Champaign and Meng Gao, also from the same institution.

This study examines the thesis that U.S. hedge fund managers obtain an informational advantage through their connections with lobbyists that help them generate excess returns on their trading of stocks that are highly impacted by government policy.   Click below to download a copy of the paper:


Details of the Study

Mr. Huang and Ms. Gao used public lobbying disclosure data to identify which hedge funds had hired lobbyists.  They assumed that hedge funds that hire lobbyists do so primarily to obtain private information about ongoing or impending government actions.  They considered these funds to be “connected hedge funds”.

The authors also used lobby disclosures to determine which stocks might be most impacted by government policies by identifying the public companies that engaged most heavily in corporate lobbying.  This was based on the assumption that companies whose operations and profitability are most impacted by government policies were most likely to try and influence government actions by actively engaging in lobbying.  The authors called these “politically sensitive” stocks.

Leveraging a large dataset of hedge funds’ long-equity holdings, Huang and Gao measured whether connected hedge funds’ trading activity or performance in politically sensitive stocks were statistically different than the activity of non-connected funds when looking at their holdings of similar stocks.

The authors found evidence that, on average, connected funds’ trading volume in politically sensitive stocks account for 8.9% of their total trading volume, compared to 7.3% for non-connected funds.  They also found that connected hedge funds earned abnormal returns of 63 to 86 basis points per month on their political holdings when compared to non-connected funds, suggesting that connected hedge funds possess an informational advantage in trading politically sensitive stocks.

Impact of the STOCK Act

The Stop Trading on Congressional Knowledge (STOCK) Act, signed into law in April 2012, has established a clear duty of trust and confidence for government officials, thus exposing hedge funds that trade on private political information to potential insider trading liability.  Prior to passage of this act it was unclear what liability hedge funds had when trading on private information obtained from U.S. government employees.

Mr. Huang and Ms. Gao analyzed whether the passage of the STOCK Act had any impact on hedge funds’ performance in trading politically sensitive stocks.  Consequently, they ran a test of the performance of connected hedge funds trading in politically sensitive stocks for the twelve months before and the 12 months after the enactment of the STOCK Act.

What the authors discovered was that connected hedge funds earned abnormal returns of between 59 and 96 basis points per month during the twelve months before the STOCK Act was passed.  However, during the 12 months after the enactment of the STOCK Act, connected hedge funds generated statistically insignificant returns in their trading of politically sensitive stocks.

In other words, introducing a potential legal liability associated with trading on nonpublic political information due to passing the STOCK Act all but eliminated the benefits that hedge funds derived from obtaining this type of information from lobbyists.

When asked whether the study proved that Washington had eliminated the profit that hedge funds could generate from private political information, Professor Huang said, “That is an extremely tricky question.  Based on our analysis, we conclude that connected hedge funds’ informational advantages in political stocks decreased significantly after the implementation of the STOCK Act.  However, our tests do not suggest that the Act eliminated the profits from trading on private political information.  The fact that we do not observe significant political outperformance for these funds after the STOCK Act may be because the Act truly eliminated the abnormal profits or because our tests are not powerful enough to detect such profits.  More analysis needs to be done before we can conclude if additional legislative action needs to be taken to eliminate the informational advantage hedge funds gain from their interaction with lobbyists.”

Integrity’s View of This Study

In our view, this study was hampered by a few factors, including data limitations.  Professor Huang was cognizant of this issue when he commented, “Both the political intelligence industry and the hedge fund industry are very opaque, which makes testing our thesis a challenge.  We do not directly observe the information flow from lobbyists to hedge funds, nor do we observe hedge funds’ detailed transactions that are motivated by private political information.  To obtain such detailed data, we would need to wiretap the communication between hedge fund managers and lobbyists like law enforcement does.”

Consequently, Huang and Gao relied on public disclosure of lobbying firms and used disclosed quarterly holdings of hedge funds.  Because of a lack of data, they were not able to examine hedge funds’ use of independent policy research firms or investment banks that provide them with information or analysis on government policy developments.  They also did not have good data on hedge funds short positions during the study period, because hedge funds are not required to disclose such information.

In addition, Huang and Gao relied on lobby disclosures to identify hedge funds that were obtaining private political information from lobbyists.  However, lobbyists are only required to register an engagement under the LDA if they are specifically hired to try and influence government decisions on behalf of their clients.  If a lobbyist concludes that their engagement with a hedge fund client does not qualify as lobbying (they are not trying to influence government decisions), then they may choose not to disclose this under the LDA.  As a result, current LDA disclosures could significantly under estimate the instances when hedge funds hire lobbyists to provide them with private political information.

Lastly, Huang and Gao analyzed the impact of the STOCK Act over the first 12 months after it was passed.  Could this impact have declined over time as hedge funds became more confident that regulators would not use it as a basis to try and charge hedge funds for insider trading?  Of course, this issue could now be moot as the SEC is now in the midst of investigating up to 44 hedge funds for trading on nonpublic government information provided by independent research firm Height Securities.

Despite these issues, the team at Integrity Research felt that the recent study produced by Mr. Huang and Ms. Gao is an extremely unique and insightful one as it is the first time that anyone has attempted to rigorously analyze the benefits hedge funds obtain from hiring lobbyists to provide private information about potential government policy decisions.  This study is also important in helping the public better understand how a piece of government legislation like the STOCK Act might have actually impacted the benefits that hedge funds derive from their relationship with lobbyists.

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Proposed Ban on Research Commissions Generates Backlash

July 23rd, 2014

The aggressive UK Financial Conduct Authority (FCA) call for a ban on research commissions has generated heated reactions, even in the insular US market.  There is skepticism that other European regulators support the FCA’s position, and the regulatory battle lines are now moving to the continent.  Independents are wary of the fallout from a ban.

Two weeks ago, the FCA stunned industry observers by releasing a discussion paper supporting an elimination of asset managers’ license to pay for research with client commissions.   The FCA’s extreme position was precipitated by a review it conducted of current market practices and also by its view that the European Markets in Financial Instruments Directive (MiFID) reform was headed in the same direction.  The FCA concluded that MiFID II would effectively ban research commissions and that this would be a net positive.

Not so fast

However, many are taking exception to the FCA’s interpretation of MiFID II.  First, there is a view that the inducements provision in MiFID II was originally intended to address inducements given to retail financial advisors as incentives to recommend specific securities or funds.  The argument is that extending the inducements language to reform the institutional market was not contemplated in the original regulation.

Further, the market regulators in France and Germany are rumored to be uncomfortable with the extensive reform embodied in the FCA’s position.  We spoke with sources in Paris who attended a conference sponsored by FinFees, a French consulting firm, AlphaValue, an independent research firm, and ITG on June 24th, during which the French regulators presented their perspective.

At the conference, the Autorité des Marchés Financiers (AMF) indicated that it favored more commission transparency, and has been a strong supporter of commission sharing arrangements (CSAs).  However, the AMF seemed hesitant to adopt changes that would reduce the volume of research.  It would be concerned with the impact of a ban on French asset manager profit margins, which remain depressed after the financial crisis.  The AMF was also worried that smaller asset managers would be less able to afford research than larger managers, putting them at a competitive disadvantage.

It appears that the FCA has some lobbying to do with their regulatory colleagues, but then again, the arguments assembled in its discussion paper suggest that it was aware of continental concerns and has sought to address them.

US reactions

We have been surprised by reactions from US asset managers.  A meeting we had last week with a mid-sized US asset manager opened with a thirty-minute discourse on the shortfalls of the FCA position.  We were told that the head of US sales for a major bank fielded a dozen calls from US managers in the first few days after the FCA announcement.  US asset managers are paying attention, and not liking what they are seeing.

Not that we expected any movement from the US Securities and Exchange Commission (SEC) on this issue anyway.  The likelihood of US reform is so negligible as to be non-existent.  A repeal of Section 28(e) of the Exchange Act would take an act of Congress.  This would require a groundswell of negative sentiment to overcome the political influence wielded by the banks and asset managers.

Independent worries

Independent research providers are tantalized by the land of milk and honey envisioned by the FCA, where all research is explicitly priced and there is a more level playing field with the investment banks.  However, independents worry they will expire in the wilderness between here and the Promised Land.  We have already seen independents lose market share to banks when commissions fell 40% after the financial crisis, as asset managers shifted commissions to protect their largest relationships.

Banks are able to cross-subsidize research with their corporate finance business, giving them more staying power than independents during the financial dislocations following a ban.  Independents are concerned that the exemption of broadly distributed research from the inducements language will translate into a free pass for bank research.

Next steps

The deadline for comments on the MiFID II draft language is August 1st and there is expected to be a deluge of responses.  Reportedly the volume of responses is a factor in determining any revisions to the language.  A subsequent consultation paper is expected to be published between December 2014 and March 2015, which will contain the next version of inducements rules.  EU Member States are required to adopt MiFID II provisions by June 2016 and the rules would take effect January 2017.

In the meantime, banks are said to be aggressively lobbying European regulators to water down the inducements provision, and to oppose the FCA position.

Our take

We had assumed that the draft MiFID II language reflected a consensus among European regulators, but that does not appear to be the case.  We’ve also been surprised by the depth of US reaction.  It appears there will be a large and highly mobilized global backlash to the FCA position.

The outcome will now be a function of European politicking.  The FCA decided that its best course would be to lay its cards on the table with a thorough 59-page paper outlining its views.  The fact that it went public suggests that it may not have a strong hand to play in negotiations with its European counterparts.  Perhaps the FCA hoped for a groundswell of public support.  Whatever the goal, the FCA’s paper has had the perverse effect of galvanizing industry opposition.

The FCA bombshell might at first seem a political miscalculation, serving to frighten both friends and foes to reform.  In reality, the FCA is in a no-lose position.  The firestorm has ignited deep industry debate, even on this side of the pond.  Even if MiFID II does not ultimately ban research commissions, it will have sensitized the industry and the FCA’s regulatory colleagues to the issues surrounding research commissions.  At a minimum, the net result will be a far tighter regulatory regime than existed a year ago.

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Washington Insider Trading Probe Could Become Biggest Ever

July 21st, 2014

The SEC’s current investigation into potential illegal tipping on Capitol Hill has ballooned into one of the largest insider trading cases in history as regulators are now probing whether as many as 44 hedge funds engaged in insider trading based on the information, according to recently released court documents.

Possible Illegal Government Tipping

Initially, regulators were focused on whether a congressional staffer, Brian Sutter, illegally passed on material nonpublic information about an upcoming Medicare rate change which led to a huge spike in the share prices of several healthcare stocks, including Aetna, Humana, UnitedHealth Group, and WellCare Health Plans.

According to court documents, at around 3 p.m. on April 1st 2013, Sutter called a lobbyist from Greenberg Traurig, where he allegedly discussed the upcoming Medicare rate changes.

The lobbyist then purportedly passed on this information to an analyst at Height Analytics, an independent policy oriented research firm based in Washington DC.  The analyst then sent a note to his buy-side clients ahead of the official government announcement that Medicare would increase its reimbursements to some companies.

Thus far Sutter, and the House Ways and Means Committee, have fought the SEC’s subpoenaed for information regarding this investigation, arguing that congressional staff members are “absolutely immune” from having to comply with subpoenas from a federal regulator in an insider-trading probe.

The SEC, on the other hand, argues that Sutter’s action directly violates the 2012 STOCK Act passed by Congress that bars lawmakers and their staff from disclosing confidential nonpublic information about government matters that could move stock prices.

Investigation Turns To Hedge Funds

However, now the SEC has turned its attention to Height Analytics’ hedge fund clients who allegedly traded on the early notice of the Medicare reimbursement change.

In a July 16 declaration letter to the court, the SEC’s senior associate regional director for the New York region, Sanjay Wadhwa said that the investigation is now focused on “some of the largest hedge funds and asset management advisers in the nation.”  Of the 44 hedge funds that are now under investigation in this matter, 25 are based in New York, one in Washington, and the others in California, Connecticut, Illinois and Massachusetts, among other states.

Although the SEC did not identify the specific hedge funds under investigation in court documents, the Wall Street Journal previously reported that Viking Global Investors and Point72 Asset Management (formerly known as SAC Capital Advisors) were two funds which traded ahead of the official government announcement on the Medicare reimbursement change on the hope that health insurance company stock prices would rise.

If government regulators were to pursue all of Height Analytics’ 44 hedge fund clients who are accused of trading on this inside information, the scope of the case would easily become the largest insider trading case in history.

Difficulties for the Regulators

While this insider trading case is an extremely high profile one, many market participants say that it is fraught with difficulties for the SEC and will not be an easy one to win on a number of grounds.

The first issue that regulators need to address is whether they can prevail in their suit against Brian Sutter and Congress, forcing them to provide the information requested by the SEC in its subpoena.  This is the first time that regulators have used the 2012 STOCK Act to bring a suit directly against Congress.

However, maybe even more problematic for the SEC is whether they can successfully win an insider-trading case where investors traded on information which they did not clearly know where that information originated.

Legal experts claim that in order to violate insider-trading rules an investor must either know they are trading on material nonpublic information, or it must be proven that the investor acted recklessly in assuming that the information they based their trades on was obtained legally.

Ultimately the SEC’s case will hinge on whether the hedge funds should have known that the information in Height Analytics’ research note was an illegal stock tip rather than the result of on the ground research and a solid analytical conclusion.

In our minds, this case will clearly establish a number of important legal precedents for policy-oriented research, and we will have to wait and see how it progresses.

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Equity Revenues Down in Second Quarter

July 17th, 2014

Financial reporting from major investment banks is reflecting the worsened equities market conditions in the second quarter.  US equity market volumes were down 12.9% in the second quarter, and bulge bracket banks are reporting declines in equity market revenues for the quarter.  For the five bulge banks reporting to date, equity revenues were down 5% in the second quarter.

Bank of America cited low volatility which depressed secondary market volumes and reduced client activity.  Goldman said that lower volumes were particularly pronounced in the U.S. and Asia.  JP Morgan blamed lower equity derivatives revenue.

Equities revenues for Bank of America (-12%), Citi (-15%) and JP Morgan (-10%) declined in line with US equity volumes.  Morgan Stanley (+4%) and Goldman Sachs (+1%) bucked the trend with offsetting increases in their prime brokerage businesses.  Morgan Stanley said that “ongoing strength in prime brokerage [was] offset by lower revenues in derivatives due to declines in client volumes and volatility.”

Goldman Sachs, which reports more detail on its equity business, showed that its prime brokerage business was up 6% and market making was up 16%, cancelling out a 9% decline in its cash equities commission revenues.

Bulge firms still to report: Barclays, Credit Suisse, Deutsche Bank and UBS.

Separately, U.S. regional broker FBR & Co. said its cash equities revenue increased 2.7% quarter-over-quarter, marking the third consecutive quarterly increase in equities revenue.

Our Take

An upbeat first quarter fanned hopes that last year’s improved environment would continue for 2014.  The second quarter damped optimism, especially since all else being equal seasonality tends to suppress activity in the third and fourth quarters.  Nevertheless, current levels remain higher than the lows of 2011-2 supporting the view that the overall trend has stabilized.

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UK Regulator Supports Ban on Research Commissions

July 14th, 2014

In a dramatic move, the UK Financial Conduct Authority (FCA) has called for sweeping reform of research commissions, eliminating the ability of asset managers to pay for research with client commissions.  The aggressiveness of the UK regulator caught the industry off guard even though the FCA has strongly signaled its concerns since last October.  The FCA’s position increases the likelihood that major reforms will be implemented in Europe through MiFID II.

The FCA released a 59-page discussion paper detailing the results of its recent thematic review of client commissions, which in large part has led to a hardening of its position.  The paper, which is a must-read for anyone involved in the research industry irrespective of their domicile, articulates the regulator’s reasons for advocating major reform and its assessment of the impacts of reform.  We will review the paper in this and subsequent articles.

Supervisory review

From November 2013 to February 2014, the FCA conducted a thematic supervisory review of 30 firms including 17 investment managers and 13 brokers.  The results were not positive.  The FCA acknowledged that many of the investment firms had made improvements in their procurement of research since the FCA wrote a ‘Dear CEO’ letter to asset managers in November 2012 calling attention to shortcomings.  However, the FCA found only two firms operating at the level the FCA expected, and these were the same two firms that the FCA had originally held out as models in 2012.

The FCA found that for 11 of the investment management firms, the amount paid for research remained linked to trading volumes because the firms did not have research budgets or caps on research spend. Even more blatantly, one large firm was using dealing commission to pay for market data services in full, contrary to guidelines established in 2006 and updated this past May.

The review also increased the FCA’s understanding of the current commission regime, and it did not like what it found.  Because the majority of asset managers link research payments to trading volumes, the FCA was troubled by the fact that research payments fluctuated with the level of trading irrespective of the value of research.  Worse, asset managers were often paying for research they did not want or use.

Many asset managers were not using Commission Sharing Agreements (CSAs) which help to separate execution from research.  And while the FCA considers CSAs as current best practice, it recognized that CSAs have limitations in providing transparency and a competitive market.

The FCA also took a dim view of most broker vote practices since most broker votes do not directly assess the monetary value of the research received.

Call for reform

Both the UK Investment Management Association and the CFA Society UK suggested additional disclosure as a solution to the conflicts inherent in the current regime.  The FCA dismisses disclosure as an effective remedy, in part because disclosure was the main impetus around the regime imposed by the FCA’s predecessor in 2006, and yet it was clear that the intended recipients of the disclosure, the clients of the asset managers, were not paying much attention to the disclosures.

Ultimately, the supervisory review has led the FCA to discount the value of incremental reform, preferring deeper structural change:

“Overall, we conclude that unbundling research from dealing commissions would be the most effective option to address the continued impact of the conflicts of interest created for investment managers by the use of a transaction cost to fund external research. We believe it would drive more efficient price formation and competition in the supply of research, removing the current opacity in the market.”

The FCA’s stance on reform is not just the result of its recent supervisory review, but also reflects the parallel progress of European reform through the Markets in Financial Instruments Directive (MiFID).


While the FCA has been focusing on commissions, the second generation of MiFID has been grinding slowly through Brussels.  MiFID II will prevent portfolio managers from receiving any third party inducements, with a limited exception for ‘minor non-monetary benefits.’  Inducements include receiving research in return for client commissions, effectively banning research commissions.  The proposed language is sufficiently strict to lead the FCA to conclude that an investment manager’s ability to receive research from brokers or other third parties in return for dealing commissions will be significantly restricted.

The FCA views MiFID II as a window of opportunity for European-wide reform of commissions.  This has two benefits for the FCA.  First, it would make UK reform less of an outlier if all of Europe were under the same regime.  Second, it takes some of the industry heat off the FCA since reform would be coming from the EU not the UK.

The reality is that the FCA remains a bellwether for financial regulation in Europe, despite the UK’s diminished status within the EU.  The FCA’s strong stance on reform increases the likelihood that MiFID II will institute commission reform.

Further, the FCA outlines in its discussion paper more thorough reform than is currently implied in the draft MiFID II language, and we suspect it will be lobbying its European regulatory colleagues for the most stringent interpretation.

Why the hard line?

Though gloved in velvet, we now know that the FCA has an iron fist on this issue.  Like many in the industry, we were startled when FCA Chief Martin Wheatley passionately attacked research commissions last October.  However, we reasoned—wrongly—that concerns for UK industry competitiveness would ultimately dissuade the regulator.  After the FCA published the final rules in May of this year, the industry assumed that compliance with the new guidelines would forestall any more drastic measures.

What changed?   Two factors hardened the FCA’s position.  First was the thematic review, which convinced the FCA that no amount of regulatory reform could counteract the economic disincentives inherent in the current commission regime.  Second is MiFID II, which is heading in a hardline direction.  The FCA decided that rather than trying to steer the MiFID II toward a more moderate outcome, it would throw its weight behind making MiFID II the death knell for research commissions.


Because the FCA is linking reform to MiFID II, it is not proposing at this point to unilaterally implement a research commission ban in the UK.  Its discussion paper is meant to elicit feedback which will inform its participation in the MiFID II process.  The FCA requests comments on its position by October 10, 2014, and suggests that interested parties also submit comments to the regulatory bodies involved with the implementation of MiFID II.

The FCA expects the final MiFID II language to be finalized in late 2014 or early 2015.  Any reform implemented under MiFID II would be implemented by 2017.

Our take

The FCA’s passionate commitment to commission reform will have major implications not only in Europe, but in the U.S. and Asia.  The FCA will not only be lobbying its European regulatory counterparts as part of the MiFID II process, but also its other regulatory counterparts outside of Europe.

We deeply doubt that the U.S. Securities and Exchange Commission (SEC) will muster enthusiasm for the level of reform the FCA is advocating.  In part this reflects the fact that U.S. reform would require an act of Congress.

Nevertheless, as the FCA points out, globally active investment managers may voluntarily move to adopt European standards which would have a knock on effect for international suppliers of execution and research services.  At the very least, global managers would need the ability to implement European standards as they apply to European funds managed.

No one seeing the FCA’s recent success in banning commission payments for corporate access will dismiss the seriousness of its purpose, nor its potentially far-reaching impacts.

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A Victory for Short-Oriented Research

July 9th, 2014

Seeking Alpha, a web-based research platform, recently won a decision in the NY Supreme Court protecting the anonymity of a short-oriented contributor from the legal wrath of the targeted company.  The decision is positive for Seeking Alpha and for short-financed research providers, but does little to dampen the risks associated with the short-and-shout business model.

In February, Seeking Alpha published an article by pseudonymous contributor using the name Pump Terminator which savaged a small biotech firm, NanoViricides (NNVC).  Among other things, the article said that NNVC was “offensively similar to the China RTO frauds”, claimed that the company’s two principals had “stolen all potential value in NNVC from public US shareholders” and that NNVC was a “worthless shell where shareholders own virtually nothing.”

NNVC sued to compel Seeking Alpha to reveal the identity of Pump Terminator so that it could bring a libel claim against the author.  The NY Supreme Court dismissed NNVC’s petition on the grounds that the article was the author’s opinion and therefore protected as free speech.

For its part, Pump Terminator disclosed in its Seeking Alpha profile that it was a hedge fund manager and likely had a short position in NNVC: “Please assume PT currently has a short position in any common stock mentioned.”  However, because the action involved libel, disclosure was not at issue.

Libel is one of the vehicles available to vindictive companies spurned by short-oriented researchers.  In 2005, Overstock.com sued Gradient Analytics, a forensic research firm, for libel.  Gradient was not as successful as Seeking Alpha in getting the suit dismissed and ultimately had to settle. Andrew Left, the principal behind Citron Research, has been sued multiple times for libel and defamation.

Securities fraud and stock manipulation are the other legal weapons.  Gradient Analytics had the misfortune of being sued for stock manipulation by Biovail and both parties ultimately settled.  Canadian regulators have accused Muddy Waters contributor Jon Carnes of producing a fraudulent report on Silvercorp Metals Inc. (SVM), an action which is still pending.

After the negative report on NNVC was released, NNVC’s share price dropped from $4.60 to around $3.  Presumably, the short seller authoring the report was able to cover its short position at a profit.  NNVC’s share price has recovered to around $4.

As we have noted previously, the short-and-shout business model can be lucrative, albeit fraught with legal risks.  Seeking Alpha won a victory in this case, but it is a sure bet there will be more cases to come for short-oriented research.

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Wall Street Layoffs Slow in June, But Second Half Picture Not Rosy

July 7th, 2014

Layoffs at many Wall Street firms slowed in June as often happens during the summer.  However, the employment outlook for the financial services industry doesn’t look so bright as we look to the second half the year as many banks continue to struggle with declining profits brought on by low volatility, weak volumes, and underperformance in their fixed income trading units.

June Challenger, Gray & Christmas Report

According to Challenger, Gray & Christmas’ monthly Job Cuts Report released last week, the financial services industry announced a 22% decline in planned layoffs during June of 897 jobs from 1,151 in the previous month.  The drop in the number of planned job cuts last month was also 46% lower than the number of layoffs announced in June of 2013.

Supporting the improvement seen in June, Wall Street firms have announced 42% fewer layoffs on a year-to-date basis — 21,478 layoffs so far this year – compared to 36,762 job reductions announced during the same period in 2013.

However, planned hiring at financial services firms has remained tepid as no new hiring was announced in June following no new hires announced in May.  This weakness is borne out by the fact that year-to-date hiring plans at Wall Street firms remains sluggish as 54% fewer new jobs have been announced so far in 2014 when compared to the same period in 2013.

Major Industry Moves

While the employment picture looks improved in June, we are not so sure that the rest of the year will continue in this manner as weak Wall Street 1st Qtr earnings announcements could prompt a new round of layoffs in the second half of the year at a number of investment banks.

One firm that is said to be mulling over a new round of layoffs is Goldman Sachs.  Goldman is said to be weighing a formal announcement about the size and scope of potential cuts in their ranks of fixed income traders unless conditions improve.  Some experts say these cuts could exceed the 10% in staff reductions that often takes place at large investment banks.

Last month, JP Morgan CFO Marianne Lake said that the firm might be forced to implement staff cuts and/or compensation reductions in its investment banking division due to a slowdown in trading conditions.  Ms. Lake did not give any time frame for such a move.

As we have mentioned in the past few months, Barclays has been planning a major right sizing effort in its investment bank.  Barclays started its planned staff reductions by eliminating 100 jobs across its investment banking and markets business in early June – a cut which represents approximately 5% of the firm’s Asian-based investment banking workforce.

Impact for the Research Industry

It appears that the real weakness at Wall Street firms has been in their fixed-income trading units and not in their cash equities or M&A businesses.  All of this should enable most firms to retain their existing research staffs – at least for the time being.

However, Wall Street management is likely to be a little nervous about their trading divisions as the first quarter typically represents the strongest period for trading.  Consequently, we suspect that many on Wall Street will be watching their trading activity closely to see if a rebound takes place as the year progresses.

If sell-side firms continue to experience weakness in their trading businesses into the second half of the year, we would not be surprised to see Wall Street firms scale back staff in other areas of their banks, including their research divisions.


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MSCI Nabs GMI Ratings Bargain

July 2nd, 2014

MSCI Inc. is acquiring GMI Ratings, an ESG research provider, for $15 million in cash, representing a bargain price of about 1.5x revenues.  The transaction price signals we are still in a buyer’s market for acquisitions despite recent improvements in the market environment.

GMI Ratings was formed in 2010 through the merger of three ESG research firms:  The Corporate Library, GovernanceMetrics International and Audit Integrity.  One of the objectives of the merger was to obtain critical mass for a sale.  However, the merger presented both technical and cultural challenges as the three firms integrated products and staff.   The firm has had three different CEO’s in the three and a half years since the merger.

MSCI’s ESG unit, which operates as a wholly owned subsidiary MSCI ESG Research Inc, is itself a collection of smaller ESG firms:  KLD and Innovest, which were acquired by Riskmetrics, and IRRC (Investor Responsibility Research Center) which was acquired by ISS prior to its purchase by Riskmetrics.

Meanwhile, MSCI has spun off two related properties: ISS and CFRA, a forensic research firm.  ISS was sold for $367 million, representing about 3x revenues.  Terms for the CFRA sale were not disclosed.

It is likely MSCI has entertained thoughts of spinning off its ESG unit, and may ultimately do so.  However, unlike with ISS and CFRA, MSCI maintains indices tied the intellectual property in the ESG unit.

We estimate GMI’s revenues as being between $9 and $10 million, and profit between $1 and $2 million.   This suggests a revenue multiple between 1.5x and 1.7x and an EBITDA multiple around 10x.

The low multiples suggest that the sellers of GMI were more motivated than the buyer.  For MSCI, the acquisition adds critical mass to its already significant ESG unit, making it the largest independent source of ESG research.  However, the business has lower margins than MSCI’s core index business and its ultimate place in MSCI’s portfolio remains in question.

ESG research has been the coming thing for many years now.  It has been especially hard for ESG research firms to get traction in the US, where asset owners less concerned about sustainability issues than their European counterparts.  Demographics and climate change support the case for future growth in the demand for ESG research and perhaps MSCI will have the patience to wait for it.  Getting a bargain price should help steady its nerves for the duration.

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Buy Side Investors Unlocking the Value of the Web

June 30th, 2014

While the amount of data available on the internet has been exploding at an exponential rate in the past few years, many on Wall Street have been hesitant to adopt web-based information in their research or investment processes primarily because of the amount of noise surrounding this data, as well as valid compliance concerns.

The following blog is an excerpt from a recently released white paper by a “big data” based research and data provider called Eagle Alpha called Discovering the Web’s Hidden Alpha addressing how the buy-side is currently using the web to find unique and profitable investment ideas.

White Paper Excerpt

While Wall Street may be lagging behind other industries in making the most of online information, research by Gnip (a Twitter subsidiary) suggests that the adoption of social data analysis in the financial industry is at the beginning of an inflection point and is set to accelerate rapidly in the near future: “In the past 12 months, we’ve seen both an escalation in the number of new firms embracing and innovating, as well as early adoption by some of the larger somewhat risk-averse players in the industry”.

Seth Mc Guire, director of business development at Gnip said that they provide “over a dozen” large quantitative hedge funds (with minimum $1bn AUM each) with the entire Twitter firehose. Rob Bailey, CEO of Datasift (the only other authorized reseller of all of Twitter’s data), said that even before launching in 2011 they received a number of calls from hedge funds and investment banks who wanted access to social media feeds8.

Brunswick, the financial communications firm, conducted a 2014 survey; “Investor use of Digital and Social Media”. From a sample of 472 buy-side investors and sell-side analysts across the US, Europe and Asia they found that 70% of investors believe that digital media will play an increasing role in future investment strategy. Just over a quarter of respondents had based an investment decision on information sourced from a blog, and about 15% from micro-blogging sites like Twitter or its Asian equivalent, Sina Weibo9.

Clearly certain buyside firms are already making use of online sources of information to create competitive advantage but who are they and how are they doing so?

Only a few notable exceptions have broadcasted publicly how they have incorporated social media analytics or curated web content into their investment process, including Bridgewater Associates, Artemis, AKO Capital and Mediolanum Asset Management.

Bridgewater have publicly disclosed that they leverage web information for real-time economic modelling. This macro hedge fund uses all tools at their disposal to “track the economy on a day-to-day basis” and “to be really on the pulse of what’s going on”. This includes social media data, real-time internet price data and search engine data.

Analyzing web data they search for equivalents of traditional macro indicators. Greg Jensen, Bridgewater’s co-chief executive and co-chief investment officer has said that they use sites like Amazon India to track inflation “during a balance of payment crisis on a moment-to-moment basis” and thus can tell if any sharp currency moves have filtered down to end prices. Another application mentioned by Jensen is monitoring auto sales by listening for every time someone says that they buy a new car on Facebook or Twitter and comparing this to official statistics released periodically10.

Hedge funds are not the only economic agents using online data to gain a relevant and timely understanding of economies. Central banks are using Google search data in a similar way. A study published in 2009 by two MIT professors, Erik Brynjolfsson and Lynn Wu, found that it is possible to predict US house prices and sales with search volume data11. Brynjolfsson recognized the significance of this for policy makers: “When central bankers were looking at traditional data, they were essentially looking out the rear-view mirror.” Since their study, many central banks around the world have done their own studies and used web data to assess their national economies 12.

The Bank of England monitors online search data as part of the range of different indicators it considers in forming its view about the outlook for the economy of the United Kingdom, in particular for the housing and labour markets. They find that searches for “job seekers allowance” can help predict unemployment data.

The Bank of Israel was one of the first central banks to use search data for policy making. It analyses keyword counts to gauge consumer demand before official statistics are released. The bank computes a monthly index that reflects the health of the economy which is considered before setting Israel’s benchmark interest rate.

The Federal Reserve have researched how internet search data can forecast financial market data, finding it useful to “now-cast”, or forecast the trajectory of refinancing applications filed by homeowners through searches for “mortgage refinance”.

The Bank of Japan investigated using search data and point-of-sale records to create a new index of economic indicators that would be updated daily or weekly, instead of monthly.

The Banca d’Italia’s working paper deals with the predictive power of Google searches in forecasting unemployment.

The Banco de Espana used search data from the UK to predict tourism towards Spain by analysing travel-related queries.

Economists from the Central Bank of Chile found that an increase in people browsing for cars predicted an increase in auto-sales.

The applications of web data and information are in the early stages of discovery, but are set to be crucial to real-time understanding of economies.

Other hedge funds and asset managers are sourcing information from the web to gain a competitive advantage. Artemis, a UK-based fund manager with £18.6 billion in AUM, differentiates itself by its use of social media data when raising assets under management for the Artemis UK Growth Fund and the Pan Euro Hedge Fund. As we see in the slide below, to their traditional four pillars of portfolio and security selection they have added social media. They seek specific company colour insights from the web.

Tim Steer, Equity Fund manager at Artemis, remarked:

“Social media is an increasingly important part of understanding companies, particularly as traditional sources of information on companies have become quieter: Closer regulatory scrutiny means that companies are more cautious with information disclosure, and investment analysts are providing ever less insight. Adding this new element to my investment process has helped raise AUM”.

AKO Capital LLP ($9.4 billion AUM) broadcast on their website that social media research is incorporated into their investment strategy. In fact they specifically hired a “social media analyst” who performs in-depth equity analysis based on information from the web. Eagle Alpha currently employs 11 research analysts who can complement the work of an internal social media analyst.

Mediolanum Asset Management have similarly integrated social media into the investment process. This graphic shows how they leverage information from Google Trends, Twitter and investment blogs as an important step in the process of identifying opportunities.

A Senior Portfolio Manager of Mediolanum Asset Management explained further:

“Med3® utilizes a combination of fundamental and technical analysis combined with an appreciation of investor sentiment and positioning to determine where an asset is in its investment cycle. For the latter we invest with the momentum until the sentiment becomes extreme and this is where we take a contrarian position. We have a number of sources for determining investor positioning and sentiment including fund flows, institutional and retail surveys. We also leverage the web to determine sentiment in the markets through Twitter. We also utilize Google trends to analyses whether the frequency of news stories on a topic has become so extreme as to indicate a potential inflection point”.

High frequency traders leverage information from the web. As mentioned previously, the Associated Press “hash crash” revealed that, as well as scanning news sources, HFTs are scanning social media, like Twitter. In just two minutes the tweet drove 140 points off the Dow Jones Industrial Average.

Download Eagle Alpha’s complete white paper here  http://eaglealpha.com/whitepaper_pdf.

About Eagle Alpha

Eagle Alpha (www.eaglealpha.com) was founded in 2012 by a former Morgan Stanley investment banker, Emmett Kilduff.  Since 2012 Kilduff has built a world-class team of employees, investors and advisory panel members that brings together experience from companies including Barclays, Cairn Capital, Cantor, CQS, Credit Suisse, HSBC Asset Management, Jefferies, JP Morgan, Knight Capital, Macquarie, Markit, MergerMarket, Morgan Stanley, Oaktree and Schroders.

A key differentiator of Eagle Alpha is that they curate the entire web. While Twitter provides breaking news and insights from analysis of the 15 billion tweets each month, there are also great opportunities to find actionable insights elsewhere on the web. For example, Eagle Alpha sources intelligence from hundreds of forums, thousands of blogs, millions of websites, LinkedIn, Facebook, Sina Weibo and Tencent Weibo.


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Fed Scrutiny of Capitol Hill Leaks Hampers Political Intelligence Biz

June 25th, 2014

In the past few weeks, news stories have highlighted that regulators are continuing to scrutinize the leaking of valuable information regarding health care policy on Capitol Hill – a development that could have had a bearish impact on the political intelligence business.

House Staff Under Investigation

Recently the SEC and federal law-enforcement officials have been reportedly trying to obtain records from the House Ways and Means Committee and a top congressional health-care aide about whether congressional staff tipped off hedge funds about an April 2013 change in healthcare policy.

Separately, the Justice Department issued a subpoena to Brian Sutter, staff director of the committee’s health-care subpanel, to compel him to testify before a federal grand jury at the U.S. District Court for the Southern District of New York related to criminal and civil investigations into this matter.

Late last week, the SEC took the unusual step of going to federal court in an effort to enforce the subpoenas it issued to the House Ways and Means Committee and Mr. Sutter to turn over documents and information in the case.  In its court filing, the SEC said the healthcare aide “may have been” the source for the information at the heart of its long-running insider-trading investigation.

So far the house has refused to comply with the subpoenas, arguing that they “run seriously afoul of the Constitution’s Speech or Debate Clause”, and that they were vague and overly broad.  The SEC disagreed with the House’s objections. U.S. District Judge Paul Gardephe ordered representatives of the House committee and Mr. Sutter to explain why they refused to comply with the subpoenas by June 26th and to appear at hearing on July 1st on the matter.

While federal agencies have occasionally subpoenaed Congress in the past, it is highly unusual for an agency to actually sue Congress to comply with their subpoenas.

Hedge Funds Scale Back Washington Info Gathering

The most recent tussle between the SEC, DOJ and Congress is reflective of broader regulatory scrutiny into how hedge funds obtain nonpublic information about Washington policy moves to enhance their trading profits.

The most recent case has taken place in response to the passage of the 2012 STOCK Act, which clarified that employees of the government are barred from providing nonpublic information obtained as a result of their jobs to others who can benefit by trading on this information.

Rob Walker, an ethics lawyer and former congressional-ethics attorney, explained the reason why many asset managers have become nervous by these developments, “The SEC is trying to make a test case, and you don’t want to be it.”

In response, many hedge funds and other asset managers have either eliminated or dramatically reduced their use of Washington policy research, lobbying firms, or other sources of potentially risky “political intelligence” information.

As a result, many lobbying firms or traditional research providers that have historically provided this type of information and analysis have found that demand for their services have decline sharply in the last few years – prompting some of them to scale back or shutter their operations altogether.

Some Research Firms Transform

However, a few research firms have responded to these market pressures by changing the way they collect information in Washington.  One such firm is VogelHood Research which has developed a data-driven quantitative approach to analyze how potential legislative and regulatory actions might impact investment decisions.

Alex Vogel, one of the founders of the new research firm, was formerly a lobbyist who had built a successful business providing investors with insight about Washington policy developments which could have a significant market impact.

Vogel explained the reason for making the shift, “The market has been demanding the change.  The combination of dramatically increased access to data via growth in transparency, and the increased compliance burden on the old access model made the change obvious to us.”

Instead of collecting information from conversations with congressional aides, agency officials, or other lobbyists, VogelHood Research has developed quantitative models which produce policy predictions based on the growing availability of public data, such as campaign donations, lobbying expenditures, congressional voting records, and polling data.


We expect that the fight between regulators and Congress will continue in the months to come as the SEC continues its investigation into government leaks of a change in healthcare policy which led to significant investment gains by a number of well-heeled investors.

In addition, we suspect that many hedge funds will limit their use of lobbyists and policy research firms to collect information on potential market moving policy changes for fear that they could get caught up in a “test case” brought by federal law enforcement officials.

Consequently, we would not be surprised if some lobbying firms or research providers that collect traditional political intelligence information either scale back their businesses, or like VogelResearch, change the way they collect information and produce their research insights.


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