ITG Acquires Canadian Research Firm to Boost Trading Business

Date: Wednesday, June 8, 2011
Author: Nina Mehta, Bloomberg

Investment Technology Group Inc. (ITG) acquired Ross Smith Energy Group Ltd., its second purchase of an equity research firm, for $38.5 million in cash, the New York- based brokerage said today in an e-mailed statement.

Buying the Calgary-based company gives ITG 60 new equity asset management clients and is expected to add 8 cents to 10 cents per diluted share to earnings in 2012, ITG said. RSEG, which provides research on the oil and gas industry to more than 200 clients including hedge funds in North America and Europe, had $15 million in revenue for the year ending April, ITG said.

“This gives us exposure to a very significant Standard & Poor’s 500 Index industry group,” ITG President and Chief Executive Officer Robert Gasser said in an interview. ITG accounted for 2.6 percent of U.S. equity trading volume in April. The deal follows ITG’s purchase of Majestic Research Corp. for $56 million in October. “It’s time to take the next step, which is to diversify our research offering geographically,” Gasser said.

The purchase comes as agency brokers, which provide execution services and don’t offer investment banking or trade their own money, struggle to maintain commissions from customers. Low U.S. equity volume hurts their ability to trade for clients who use commissions to pay investment banks for research and related services. Daily U.S. volume averaged 7.6 billion shares in the first five months of 2011, down 21 percent from the same period in 2010, according to Bloomberg data.

Retaining Commissions

“Brokers need more hooks to retain commission in a low- volume environment,” said Sanford Bragg, president and chief executive officer of New York-based Integrity Research Associates LLC. “Research is an important component of the commission pool and agency firms are formulating their strategic response to that challenge.”

Agency firms are counting on research and related investment services that help fund managers make money to win order volume that may elude brokers focused solely on how well they execute buy and sell trading requests, Bragg said.

BNY ConvergEx Group LLC, Instinet Inc. and Liquidnet Holdings Inc. of New York have introduced so-called corporate- access programs to help customers meet managers at publicly traded companies, Bragg said. This has traditionally been the domain of investment banks such as Morgan Stanley (MS), Goldman Sachs Group Inc. and Bank of America Corp. Gasser said ITG is considering the introduction of a corporate-access program in the energy industry for institutions.

Paying for Research

Instinet and BNY ConvergEx have also operated programs for years that allow customers to pay for research from independent firms, Bragg said. Asset managers can use those programs to trade through the brokers while setting aside commissions to cover the research they use from other firms. This is part of a shift over the last half-dozen years in the brokerage industry to separate the costs of trading and acquiring research.

Ticonderoga Securities LLC in New York bought Soleil Securities Corp. last month to augment the research services it provides clients. Weeden & Co. LP in Greenwich, Connecticut, and New York-based BTIG LLC have expanded the research they offer institutional clients. Bloomberg Tradebook, owned by Bloomberg LP, the parent of Bloomberg News, also offers research from independent firms.

Commission Payments

For the year ended mid-February, mutual funds, hedge funds and other institutions paid broker-dealers an estimated $11.6 billion in U.S. equity commissions, down 12 percent from the previous year, according to research firm Greenwich Associates. Larger hedge funds accounted for 29 percent of the total, up 5 percentage points from the prior year.

“There’s a shrinking commission wallet out there,” Gasser said. “It’s got to be recognized as a secular shift at this stage of the game,” he said. “There’s a significant demand for a research product that firms can’t find elsewhere.”

ITG has more than 700 customers in the U.S., Gasser said. The firm aims to increase the number of hedge funds among its clients, in part because they’re quick to pay for research they like through trading volume, he said. Traditional mutual funds may assess the research they get only on an annual or quarterly basis, he said.

Access to Executives

Commissions paid for research and advisory services, including access to executives at companies, rose to 59 percent of the total from 53 percent a year earlier, Stamford, Connecticut-based Greenwich said. Larger firms increased the portion paid for those services more than the average, spending 58 percent of their commission dollars for research-related products, up from 48 percent a year earlier.

James Jarrell, president of RSEG, said the acquisition by ITG will enable the firm, founded in 1998, to provide its research to more asset managers and increase its ability to service clients. Customers currently pay for the research on a subscription basis by cutting checks or trading with brokers they select. Those trading fees are then used to cover the cost of the subscription.

RSEG’s research, used by energy specialists and funds with broader mandates, encompasses more than 100 public and private firms in the oil and gas industry, including Houston-based Petrohawk Energy Corp. (HK) and Range Resources Group in Fort Worth, Texas, Jarrell said. RSEG’s products will become part of ITG Investment Research while the company’s staff of about 40, including petroleum engineers and technologists, economists, and financial analysts, will remain in Calgary, Gasser said.

ITG also said today it entered into a four-year $25.5 million term loan to “help preserve its balance sheet flexibility” after the acquisition. Gasser said the company is considering additional acquisitions of research firms as it pursues more hedge fund clients and more trading from firms that consume research.

“We are absolutely in the hunt,” he said.

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net.