By Trevor Hunnicutt
NEW YORK (Reuters) - As new rules spur Wall Street banks to further shrink their research budgets, U.S. asset management firms are shoring up in-house research, and reinventing the stockpicking business in the process.
Fund managers are eschewing the traditional model of teams built to cover a broad range of industries, instead picking areas of expertise and hiring analysts with very specialized knowledge and often non-Wall Street backgrounds.
The European Union's MiFID II regulations that target conflicts of interest and took effect in January require asset managers to separately report trading commissions and investment-research payments. In the past, banks bundled research with trading fees covered by investors rather than fund management firms.
While the rules apply only to those operating in the EU, the transparency is making fund managers globally re-think what research they are willing to pay for.
Interviews with more than a dozen senior executives, research analysts and other staff show fund managers are already weaning themselves off routine analysis of major sectors where it is difficult for any investor to gain a lasting advantage.
Instead, fund companies would rather go it alone and focus on narrow slices of the market they can dominate, from breakout technologies like cryptocurrencies, niche international markets and environmental, social and corporate governance.
That means fund managers are hiring, but not necessarily those who have spent their careers with brokers or banks.
For example, ARK Investment Management LLC recruited James Wang to cover artificial intelligence (AI) and "the next wave of the internet." Wang was previously a product manager at Nvidia Corp in California and helped the semiconductor company launch GeForce Experience, a gaming application.
"I never thought I would work in finance, much less on the East Coast," said Wang, who turned 34 in October.
ARK is now hiring a specialist focused on cryptocurrencies and another researching genomics.
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BlackRock Inc (NYSE:BLK) Chief Executive Larry Fink, who runs the world's largest asset manager, told Reuters he is spending more on research done at his own firm.
In recent weeks, BlackRock, which has $6 trillion in assets under management, asked several providers to stop sending research they were not paying for so the company could make sure it complied with the new rules, according to a person familiar with the matter.
Fink said in October that BlackRock would consider paying out-of-pocket for the research the asset manager consumes from banks globally.
Other managers are going further.
Richard Bernstein went "cold turkey," stopping paying for external research and cutting all of his fund company's subscriptions to investment-bank research about a year ago. What he found was that he could live without most of it.
"That was the way we could decide who we need and who do we miss," said Bernstein, who was an analyst at Bank of America (NYSE:BAC) Corp's Merrill Lynch unit before he started his current company, Richard Bernstein Advisors LLC.
"A handful - a dozen, whatever - analysts we really wanted back. However, a lot of them we didn't."
He says the company does 95 percent of its research in-house.
Across Wall Street, asset managers are also betting that some research can be automated.
Even before the new MiFID II regulations, which stands for Markets in Financial Instruments Directive II, banks were scaling back equity research as algorithmic trading, regulation and the growing popularity of index-tracking funds, which tend to trade less, weighed on their income.
Major global investment banks slashed their equity research budgets from a peak of $8.2 billion in 2008 to $3.4 billion in 2017, according to Frost Consulting. McKinsey projects the top 10 banks will cut those budgets by another 30 percent in the near term, due largely to MiFID II.
Fund managers can ill afford giving up on research altogether because that is what sets them apart and allows to compete for investors' money with index funds set up to merely match market benchmarks.
Applying artificial intelligence and machine learning to stockpicking requires a new breed of tech-savvy specialists, and managers think some of the best opportunities are there.
Morgan Stanley (NYSE:MS) polled fund managers and other clients at a recent conference on the subject and found that nearly half hired "quant" researchers in the past year.
More traditional expertise is also in demand. Ariel Investments LLC, which manages $13.1 billion, hired research analysts who had lived in Russia, China and Greece to bolster its efforts combing through international markets for ideas, company vice-chairman Charlie Bobrinskoy said.
The company added six analysts to its global research team over the past year. Three previously worked for traditional brokerages, two came from asset managers and another moved from elsewhere in finance, Ariel said.
As banks cut research expenses and thin their ranks, fund managers might be offering fewer, but potentially more lucrative opportunities.
The average asset manager's equity research analyst with five to eight years' experience range made $419,000 in 2016, compared to $385,000 at a bank, according to a survey by financial services recruiting company Options Group.
Reuters found the gap widens for those with more experience and special expertise with asset-management firms paying millions for high-caliber researchers.