Information Arbitrage muses on the state of sell-side research...

Information Arbitrage has an excellent post today on the transition sell-side research has made post the Bubble, and the continuing need for further rationalization of what's essentially a dying breed. The post hits on a lot of great points, but I wanted to draw particular attention to his conclusion:

I am convinced that we are entering "the a la carte world," where kind of like SaaS you can pay for only what you need. This will lead, as properly referred to in the Booz report, in a barbelling of the research industry (just like the phenomenon going on in the hedge fund industry). Further, you will see greater use of alternative research methods (expert networks, alternative information providers, financial intelligence tools) as a vehicle for supporting the idea generation that is already taking place on the buy side, continuing to marginalize the value of idea-driven sell side research. It is a train that just cannot be stopped. Just like free markets, efficiency will eventually find its way into the nooks and crannies of the business. "Eventually" just happens to be today.

As a former sell-sider and constant buy-sider, I'm fascinated by this trend; which I saw as an inevitability many years ago (hence the move to the buy-side). What's not understood by many people is just how much of a bubble research analysts became in their own right. Dan Reingold gives a very clear account of the rise & fall of sellside analysts in his book: Confessions of a Wall Street Analyst: A True Story of Inside Information and Corruption in the Stock Market; but the gist of things is that analysts went from brainy afterthoughts to integral cogs in the ever-increasing quest for investment banks to differentiate themselves in the uber-hot bubble IPO and M&A market. Top analysts started making millions of dollars, and that made the job an attractive one for a broader swatch of folks. But even in its heyday, it was a cost center; albeit a vital one. Once new regulations were put in place disintermediating banking and research, it was just a matter of time before a rationalization had to occur.

Adding to that was the proliferation of the Internet and Regulation FD "Full Disclosure." Reg FD requires public companies to make any material information available to everyone simultaneously. Without Reg FD, we wouldn't have the webcasts on all important company announcement that we do today.

In today's world, Apple announces a slew of new products to the world at large. It's webcast, podcasted, and widely available in multiple channels. The investors and research analysts have neither the advantage of time or detail on their sides. Contrast that with how it would've been even a few years ago. Back then, a select group of sell-side research analysts and their biggest buy-side clients would've heard the news at a lunch or dinner before the rest of the world. The same rules applies for every company in every industry.

Increased transparency is a good, no, a great thing. It levels the playing field for both professional and individual investors. But it also took much of the power out of the sell-side research analyst. Today, a majority of published research essentially parrots what the company is doing and saying; yet anyone interested can get at that information at virtually the same time.

To be clear, there are exceptions on the Street. There remain people with a true passion for analysis with differentiated bodies of work that let them excel despite more challenging circumstances. Long-time stalwarts in the tech industry like Goldman Sach's Rick Sherlund and Citigroup's Brent Thill continue to do quality primary research that adds value. But unfortunately they are now the exceptions that prove the rule (note: please don't be insulted if you weren't named here, there are dozens of analysts on the sell-side I still respect; so don't accuse me of overgeneralizing).

As to the notion of independent research; I think we're in the first inning of that model. I recently attended the Investorside Conference devoted to promoting third party equity research. I was blown away by the depth and breadth of the available research product. There is still work to be done; the buy-side needs an easier road to pay these independent thinkers. But we're getting there. And on a personal note, my funds utilize several independent research analysts who do great work. For example, Mark Gomes (a friend and vendor) of Pipeline Data, is one of the sharpest minds in software research today, in my opinion.

The good news regarding research is that hedge funds have money to spend and are eager to spend it. People with a passion for a given industry and a sharp analytical mind still have avenues to pursue; whether it's as an independent researcher, working for a buy-side firm directly, or venturing off into an industry analyst position.

Note: At the time of this writing I, and/or funds I maintain discretionary control over, did not maintain a position (long or short) in AAPL.

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Comments

[Dennis Howlett]

Is this brave new world driving the cost of analysis down or up Jason? Are you getting an improved qquality of assessment from those that advise your firms?

[Wood]

Den,

It's been the best of both worlds. Total costs are (or can be) reduced dramatically while the quality of the research increases. It's the pick and choose model to perfection.

In the past, you had to direct business to the big sell-side shops on a holistic level, just ot get "coverage." Now, it's much easier to pay for the analysts you value directly without fear of reprisal that you're going to be shut out of the party.

Personally I think the blogosphere is going to be a major factor in the next wave of independent research. The barriers to publication that are in place for us obviously also benefit people who are trying to publish investment research. I look forward to the evolution.

Call it the long tail of research if you will... :)

[Roger]

I think you hit the nail on the head. Research, as a product, has the ability to get better and better by simply admitting that the old model was broken and will inevitably be replaced by: (1) industry experts with unique perspectives, relationships and experience that have laser-focus on a particular set of companies, an industry or a niche; (2) financial intelligence firms with the technology platforms to aggregate, filter, display and analyze millions of data points, in real time, to harvest value from the long tail of the internet; and (3) truly value-added macro thinkers have had and will continue to have value in any and every investment environment. The prospects for research are awesome - and well-endowed buy side participants have the propensity and willingness to pay for it - but you'd better bring value to the table. Research-for-commissions quid pro quo just won't cut it any more. The hard dollar/soft dollar issue for the firms controlling the largest pool of research spend simply doesn't matter. The product does. Thanks for adding valuable perspective to my original post. I loved the Reingold book as well. As a long time Wall Streeter I laughed, cringed and covered my eyes while reading it. Too painful (yet too true) for words.