Reports of the demise of soft dollars are greatly exaggerated, suggests Greenwich Associates in a new report.

“After several years in which institutions cut back on their use of soft dollars under the spotlight of regulatory scrutiny, the soft-dollar business appears to have stabilized in terms of both the proportion of U.S. institutions involved and total dollar volume,” Greenwich reports.

Greenwich Associates says that its latest research reveals the total amount of soft-dollar commissions used to purchase third-party equity research and services held steady between 2005 and 2006 at estimated US$970 million, and U.S. institutions expect that level to hold for the coming 12 months. Also, the proportion of U.S. institutions using soft dollars was flat at 73% over the 12-month period.

“Currently, long-only asset managers and banks are the most active users of soft dollars, with between 83% and 87% of these institutions reporting that they employ soft-dollar arrangements. Hedge funds are the least likely to use soft dollars (only 57% do so) and the share of mutual funds reporting soft dollar usage fell from three-quarters in 2005 to 65% in 2006,” it reported.

Overall, soft-dollar commissions made up 9% of total U.S. equity commissions in both 2005 and 2006, and soft-dollar budgets are expected to remain unchanged next year, the firm said. It noted that mutual funds have decreased their soft-dollar expenditures to 6% of their total commission spend. Meanwhile, banks made significant cuts from 2005 to 2006, slashing soft dollars from 28% to 11%, but they expect to increase soft-dollar allocations to 17% in the coming year.

“Mutual funds have been the target of especially close regulatory scrutiny, so it is not surprising that they would adopt a more cautious approach to what is still considered a somewhat ambiguous practice in regulatory terms,” says Greenwich Associates consultant Jay Bennett.

Long-only investment managers continue to devote a higher-than-average proportion of their commissions to soft dollars at 12% to 13%, it reported. Pension funds’ soft-dollar allocations rose to 12% over the 12-month period ending February 2006 and are predicted to increase to 15% next year.

The services most commonly purchased with soft dollars are financial market quote services, financial databases and third-party research, Greenwich found. By contrast, institutions are more likely to pay hard dollars for news subscriptions and publications, security master records databases, order management systems and portfolio analysis and models.

“Almost 70% of institutions use soft dollars to pay for third-party research produced by independent brokers, and of the 9% of soft-dollar commissions currently directed to third-party research and services, almost 35% went to independent providers and non-broker dealers,” says Greenwich Associates consultant John Feng. “Mutual funds had the highest soft-dollar allocations to independent research providers at 59%, compared to 29% among long-only managers and 39% for hedge funds.”

U.S. institutions spent an estimated US$325 million in hard dollars on broker or independent research from 2005-2006, a 65% increase over the prior year, it added. “The proportion of institutions using hard dollars to pay for broker equity research increased from less than 30% in 2005 to 35% in 2006, and 43% of U.S. institutions expect their hard-dollar research spend to increase in the next year,” it said. “Among the largest participating U.S. institutions, the average hard-dollar spend on research increased from US$4.5 million in 2004 to US$10.6 million last year. Overall, the typical U.S institution increased its hard-dollar spend on research from US$2.9 million in 2004 to US$4.3 million in 2005.”

“Hard dollars now represent 7% of the total amount spent by institutions on broker equity research, up from just 4% last year,” says Jay Bennett. “But the typical institution predicts that it would cut its overall research expenditures by 27% if required to pay hard dollars for all equity research.”