Some Updated Thoughts on Sell-Side Research
Based upon the current sell-side research model, prospects for these legacy research providers (and the commissions that have largely supported these efforts) are increasingly poor. Hedge funds - accounting for approximately 70% of equity-based commissions - demand value for their research spend, and are finding less and less of this value emanating from the bulge bracket sell-side firms. So how are these fund spending their research budgets?:
- Building in-house research capabilities. While not every firm has the budget and the scale to undertake such an effort, those that can are doing so and keeping idea generation inside the firm. By doing this, these firms are fully bifurcating the research decision from the execution decision, maximizing quality control while minimizing costs.
- Leveraging alternative research tools. A new type of tool vendor has emerged over the past few years, one that is designed to aggregate, parse and analyze information from a wide range of disparate sources, with an eye towards mitigating the signal/noise problem that plagues the research analyst, portfolio manager and trader. Monitor110 is one of these new-age financial intelligence vendors. This helps institutional investors cast a wide information net without having the devoting the internal resources necessary to staff such an effort.
- Engaging expert networks. Rather than relying on sell-side research analysts to do general legwork, which is then broadly disseminated across hundreds or thousands of clients, an increasing number of institutional investors are using targeted expert networks to mine for the data they really need. And their findings aren’t published and widely distributed. This, like the alternative research tools, is a vehicle for maximizing return on human capital and making the analyst’s job more efficient.
- Buying selective independent research. There are certain boutique research shops that are very good at what they do, so good that an array of investors are willing to pay for their work. However, like classic sell-side research, this suffers from the “diminishing value of information” conundrum: as the company becomes more successful, the value of its research declines as its insights are more widely known, causing the information’s value to decay rapidly.
- Buying selective sell-side research. Make no mistake; there is some good stuff being put out by the bulge bracket firms. Problem is, it is few and far between and not sufficiently pervasive such that it should be purchased on anything but an a la carte basis by the buy-side firms.
So in light of these mega-changes, what is a Wall Street firm to do?
- Sharply scale back the sell-side research operation, only focusing on those areas where the product delivers true value-added. The research should be of such quality that a hedge fund would be willing to pay hard dollars for it. This will take huge costs out of a firm’s equity and banking divisions. This is the good news. The bad news is that it doesn’t solve the declining commissions problem.
- Cannibalize the existing research operation by doing deals with alternative information providers, independent research shops and expert networks. This is sort of what Goldman’s Hudson Street appears to be doing. By offering institutions these leading-edge tools as part of its service offerings, it is delivering real value to clients that they are willing to pay for. Might this hurt the commissions flowing from sell-side research as clients do more of their own homework? Yes. But might this protect the overall commission pie that the sell-side is currently capturing? Yes. And if the big sell-side firms don’t do this themselves, the market will invariably do it for them.
- Bring the sell-side research business into the 21st century. Sell-side research analysts should be using the same kinds of tools and technologies as their sophisticated hedge fund clients. Problem is, many analysts are caught in the last century’s mind-set and ways of doing business. It just makes no sense. If they want to be valued, then they need to go where all sources of value are found. And in today’s world, a large source of that value is either on the Internet or can be discovered using the Internet. Until the sell-side research complexes realize this and get with it, they will encounter a slow, grinding decline with absolutely no hope of recovery.
As I’ve written about previously, I see huge opportunities in the realm of next-generation expert networks and strategies for monetizing alternative data. All of this disruption can bring new life - a smaller, smarter, more nimble life - to the sells-side research business, if only they can embrace the creative destruction that is already afoot. Deny it if you will, Wall Street, but it will be at your peril.
——-
——-
COMMENT:
AUTHOR: Greg Battle
EMAIL: gbattle@gmail.com
URL:
DATE: 03/11/2008 11:45:39 AM
Roger, though I agree with much of what you’ve said, I do believe you aren’t extending your well constructed sell-side research insights to these new 21st century “tools”.
As you and I have discussed previously, the speed at which information becomes a commodity is accelerating quickly, especially with these 21st century tools. Automated tools that troll the internet are leveraging the democratization of information - the theory that what can be out there and freely available will be out there eventually. With all this free information, the value now lies in connecting intent with results via search, but what happens when search becomes a commodity? People then create tools that leverage the commodity of intent-driven search to usher in discovery tools based upon statistics or behaviors which stumble upon new insights and ideas (“if you like A, you might also like B”). Sure, it increases the signal to noise ratio, but what happens when discovery becomes a commodity?
Let’s look at the general internet for answers. From a search perspective, who is to say that Google, MSFT, Yahoo! or Amazon has the “best” search engine? It’s highly subjective and debatable, but it’s nearly immaterial as search is a commodity. For search companies, the question is who is better able to monetize the commodity.
We can say the same for discovery tools. The classic example being music discovery tools Pandora vs. Last.fm, the former scaling expert opinion and the latter using behavioral consumption patterns. Which is “better” is again completely subjective, but there’s been a clear winner in terms of who better monetizes the commodity of discovery. We could say the same argument for Techmeme vs. Digg or Google News vs. Yahoo Buzz or Rotten Tomatoes vs. Netflix or Del.icio.us vs StumbleUpon.
I submit that every algorithmic/automated strategy for search or discovery on freely available information will eventually eat itself and become a commodity monetized by advertising or some other differentiated value-added service. Any information advantage/edge that can be bought, be it sell side research, private research, outsourced skilled financial labor to India (which you skipped), 21st century tools or flux capacitor (haha) will be bought and rendered moot.
The question lies not in what can, but what cannot be commoditized. In terms of information, the definition of insider trading perfectly sums up the answer: material non-public information ie. information that is pertinent to your intent and its privacy renders it indiscoverable. Culture, personal relationships, family, trust networks, exclusivity, and sworn secrets are all barriers to free information. There’s a reason why Bloomberg’s most popular function by a long shot isn’t the news or the price quotes or whiz-a-bang tools (all freely available elsewhere), but the private-messaging function. Yup, people pay $2K/month for instant messaging with their inner circle (a brilliant $4B/year business model, I might add).
I’ll leave you with a timely quote from sanctimonious politician du-jour Elliot Spitzer circa 2004 during his most high-and-mighty point: “Don’t say in email what is better said on the phone, and don’t say on the phone what is better said in person.” We can extend this to forums, blogs, instant messaging, twittering, texting, Skyping, Facebook Walling, ad infinitum. If only Mr. Spitzer were wise enough to follow his sage advice.
The better mouse trap can only catch tangible mice.
——-
COMMENT:
AUTHOR: Jason M.
EMAIL: jason.meshwork@rbccm.com
URL:
DATE: 03/12/2008 01:33:11 AM
Roger
A key issue facing the sell side on the technology front is the actual ability to be nimble. Your suggestion that the sell side should be using similar tools and technologies to hedge funds is idealistic given that many SSR shops are trapped behind extensive IT beurocracy, therefore leaving little room to be “progressive”. I don’t think its just an old mindset, but rather a legacy of old technology, bulge bracket IT policy and restrictions and budgetary constraints not impacting newer to market HFs that basically neuter the SSR business.
I think you are also under-valuing access to corporate management which HFs definitely pay for and cannot be provided by expert networks or independents.
SSR will always be around - but agree with your premise that change is required - in fact most in the business would argue its been going on for quite a while now.
——-
COMMENT:
AUTHOR: Yaser Anwar
EMAIL: yaser@yaseranwar.com
URL: http://www.yaseranwar.com
DATE: 03/14/2008 11:01:07 PM
Greg,
Thank you for the excellent post.
Yaser
——-
————
2 years ago
| view comments
| Wall Street
