Over a year ago, Burgundy did a complete reassessment of our research costs based on new financial rules from Europe called MiFID II.
Historically, brokerage firms have incurred expenses on research activities like analyst reports and industry conferences. Rather than charging money management firms directly for this research, they have bundled this expense into the price of their trading services. Under this approach, when Burgundy pays a broker to carry out a trade on behalf of clients, we are paying for both the cost of executing the trade and the brokers’ research. We pay the same price regardless of whether we have used their research or not.
Under MiFID II, equity research costs and trading execution costs must be unbundled. The theory is that while trading costs should be borne by clients since they are directly related to the execution of a trade in their portfolio, research costs are far more difficult to directly allocate to specific clients and mandates.
The European regulations gave money managers a choice: either they could break out the research portion of trading commissions into a separate account and report it to their clients, or they could charge for execution only and pay for research costs themselves. The first option was complicated, especially if you tried to only apply it to European clients; the second was a hit to the money managers’ bottom lines since they were now assuming the costs of research. Most money managers unhesitatingly chose complication over adding to their expenses.
At Burgundy, we have a superb list of European clients, largely based in the U.K. We have an abiding dislike of unnecessary complexity. And we have a fundamental principle that all our clients should be treated equally.
We therefore chose to go to execution-only trading for all our clients in every geography, including Canada (where no similar regulations seem to be contemplated), and the U.S. (where money managers won a specific exemption from these rules). Absorbing all the brokerage research costs into our own income statement rather than paying for them through trading commissions was the only way to avoid the conflict of interest of using clients’ money for something that may not benefit them.
As far as we can tell, we are the only money manager in Canada that has gone this way. Some others are experimenting with individual products, and if they have European clients they have to report to clients how much of their money they are appropriating. Still, nobody else has decided to pay full investment research costs.
Admittedly Burgundy had certain advantages in going fully unbundled. Brokers are only one of our three research sources. The most important source is our own investment department, which engages directly with our investee companies. The second source is expert networks, who provide us with access to experienced thought leaders in various industries. Burgundy has always paid for these services directly. And the third is the brokerage channel, which can be very helpful to our internal research efforts with conferences, company meetings and analyst input. As of January 2018, brokerage research costs are paid for by Burgundy’s shareholders (our employees), just like the other two sources.
Another advantage we have is that we trade sparingly for a company our size, so we never developed the kind of mutual dependency that money managers and brokers often do. As a result, our implementation of MiFID II did not result in a massive reduction of our brokerage research costs. It did make us carefully examine just what we were buying, and why. We have been able to maintain respectful and productive relationships with our brokerage partners. For the most part, that has allowed our access to conferences and company meetings to remain intact.
As an aside, Burgundy CEO Rob Sankey hopes our MiFID II move demonstrates our firm’s commitment to remaining independent. After all, if a company were looking to sell, it would not voluntarily reduce its profits by several million dollars.
In our business, the assets belong to the clients; the investment research is the responsibility of the investment manager. Shouldn’t the responsible party pay the bills?
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