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- Investment-research firms are scrambling to comply with new European regulations known as MiFID II.
- We sat down with the head of a quickly rising Wall Street research firm to discuss what's hot in markets today and how RBC Capital Markets is preparing for the new rules.
When Marc Harris joined RBC Capital Markets' team research in 2004, it was a small player on Wall Street with only a few of its analysts being recognized as stars.
This year, with Harris in charge of research for RBC, and his team cracked the top 10 of Institutional Investor magazine's annual analyst rankings. Sixteen of its analysts made the list, with the firm in the top five across 13 different sectors.
Business Insider recently caught up with Harris at RBC's Wall Street headquarters to discuss how he's built the research team, the sweeping changes about to affect equity research around the world, and how he views markets today. This interview has been lightly edited for clarity and length.
Graham Rapier: How did you manage to grow RBC's research division into what it is today?
Marc Harris: Over the course of the past decade, we've transitioned from a boutique, middle-market-oriented product that had a lot of fans — a lot of good, individual analysts, into a true top-10 platform. The way we did that was not by going out as a mercenary and saying we're going to be the highest bidder in the market for the No. 1-, 2-, 3-ranked analysts and just basically add them year after year.
More than half our analysts in the top-ranked categories are organically grown people, people who we brought up inside the organization. That was intentional. There are also sectors where we need to be there yesterday, so sometimes I have to make a choice.
Rapier: Can you give an example?
Harris: One is biotechnology. It's an incredibly important area, and we have a major franchise there. We had someone I had grown from an associate into a senior analyst [Mike Yee]. He had gone, over the course of a six-year period, from being an unranked analyst to literally being the No. 1 guy in the space. He was at the firm for over a dozen years, but he recently left. He ended up getting bid away and went over to another firm — a loss for us.
While I would love to start that over again from scratch, it's too important a space with too much going on. We have three dedicated analysts in this space. We can't be there without a substantive, known quantity, so I went out and hired people to backfill there.
There are other spots where I'm willing to do the three- or four-year view of taking one of our great up-and-coming associates, or an analyst who's covering part of a sector and promote them into a lead role. A good example of that is media, where I took Steve Cahill — who was an associate on the aerospace and defense team — and when our media analyst ended up leaving, I said this is a space where I know I have A-plus talent with the time to develop that over a few years, so we made that investment and put him in there.
In his first full year this year, he's already broken into the top 10 of II, and my bet is he will continue to go higher from there. We do much more of the latter than the former because we've tried to build this thoughtfully, gradually, and sustainably.
I won't name specific competitors, but I could show you companies where every third year they go through a massive hiring streak, pay peak of market for all of their talent on one- or two-year contracts, then drop like a stone, and they have to start all over again. I knew when we were building this that the only way to make it sustainable was to build from the bottom, make a culture where people want to be here and not just for the salary.
Rapier: Are there any other sectors you're expanding into now?
Harris: There's no industry that's not going to be affected by big data, and all the derivatives of that.
There's no industry that's not going to be affected by big data, and all the derivatives of that.
Frankly, if you were looking for something that ties all this together, believe it or not, the backdrop of all of this — one of the defining factors of success or failure — is going to be the ability of every business we analyze, and in our own business, to take big data in all of its various forms and create true information out of it. That's literally everyone.
For consumer companies, it's how do we micro-target consumers and which companies are well prepared to do that. If you're talking about healthcare IT, it's going to be understanding the massive amount of information coming out of the healthcare industry, analyzing it person by person, doing population health analysis, and things like that.
For biotechnology, it's going to be, "Can we use artificial intelligence to start to create jobs?" Google recently launched an effort to basically run through protein folding and use big data to analyze the conclusions out of that, and in essence make themselves into a biotechnology company. That means new competition for biotechnology that they never expected.
This is like the merger of every industry into a tech-led, big-data industry. The way I think about our investments, where we need to be, where the opportunity is, a lot of it comes from thinking about where technology and the acceleration of that technology going to a variety of industries.
Rapier: Let's talk about the new MiFID [markets in financial instruments directive] regulations. How will those affect RBC's business?
Harris: The sustainability I mentioned earlier will be incredibly important as we go into this new and uncharted environment of content unbundled from the execution at varying degrees. When you take a product that's never been priced in the market before, and you all of a sudden decide to start pricing it, the only way to be in there is to know you have top-tier talent to start with, and then work backward.
When you take a product that's never been priced in the market before, and you all of a sudden decide to start pricing it, the only way to be in there is to know you have top-tier talent to start with.
The largest asset managers will most likely make the choice to start paying in cash [for research] and will basically try to force the sell-side to accept the payment in cash. What that means is that we will all have to figure out a structure that works.
Everybody is going to reorganize their research departments under something that is a registered investment adviser structure. In essence, it means analysts will be dually registered doing half what they have been doing, and the other half doing the advisership thing.
It's a major change, with substantial reorganization to be done for any firm that wants to accept these cash payments. It's really just a question of will enough asset managers start paying in cash, forcing everybody to make the choice.
A lot of our competitors have already made the decision to reorganize as an RIA, and almost everybody is considering it right now. [Editor's note: So far, only Bank of America Merrill Lynch has publicly applied to register as such.] It's the hot topic of discussion in every major sell-side investment bank right now.
Rapier: You sound optimistic.
Harris: I am.
There are a couple of things that are clear. One is that mediocrity in research simply will not have any value. You cannot just be a sort of down in the middle, 15- to 20-ranked firm, producing OK research with OK analysts doing OK work. There was a long period of time where that kind of firm, with enough other peripheral business around them, could survive. Today, that simply will not get paid for in any geography, period. If you're one of those firms, you've got a problem.
There may be consolidation in the research industry, but if you've got the scale and size, with the right people providing that content, you end up in a pretty good position. You'll have to ride through the volatility of a storm, but if you can, you'll end up in a pretty good spot that serves a lot of different consumers.
There are two things driving this. This new set of regulations have sparked this fire, but the reason its spread as rapidly as it has is pretty simple: performance. Quite frankly, performance is also what's going to solve it at the tail end. If active managers are able to outperform passive alternatives, then we won't be having a discussion about the death of sell-side research. The reason this is topic du jour is, for several years, active managers have not been able to outperform passive alternatives.
The reason this is topic du jour is, for several years, active managers have not been able to outperform passive alternatives.
With the added pressure of regulation, what are you going to do? You're going to cut costs.
Rapier: Where are we in the business cycle? Is there still room for the bull market to run?
Harris: Anybody who thinks that volatility in equity markets is dead has not lived long enough. Volatility will return. Nobody can ever define exactly when it's going to come back, but it will. Whether that's going to be caused by some external event — a war, another type of black swan that causes panic — really hard to say. People have been focused lately on the Black Monday crash and there have been lots of musings about what caused it.
The reality is, nobody can define why the Dow dropped 22% that day. In all the books that have been written, with all the historical analyses, there's nobody who can look at that and say, "The reason why that happened was 'blank.'" It's always a group of factors coming together.
I do think volatility will be there, but I also think that those crashes are always good refresh opportunities for the market and particular companies. We need those. It's healthy for the market to have those resets. If we don't have any fear in the market, obviously we've got a problem, especially in equities, which are driven by fear or the lack thereof.
One of the things that could begin to hit the reset on that is when we start to enter a more full-blown Fed cycle. That will begin to sort of pull this back. When people don't have alternatives for returns, equity markets will tend to get a little bit over-inflated perhaps. That's more of a reset to the norm than something where you look and say the earnings today can't justify the current levels.
The reality is, earnings today are in many ways justifying where we are in this process. It's a healthy economy. It's a healthy market. Don't discount the fact that we will get some form of tax reform through. It may not be exactly what's on paper right now, but any incremental amount — I won't opine on whether it will actually help the true economy — but I do know that when earnings go up, companies are considered to be more valuable and more flows down to the bottom line.
There are more positive things putting the wind at our backs still right now than there are negatives.