McLean’s quantitative methodology analyzes a company’s free cash flow and cost of capital in order to generate actionable recommendations. Companies with strong and steady free cash flow are rated as “buys” while those with poor cash flow profiles are rated as “sells”. A low cost of capital classifies a company as a “conservative” risk while those with high cost of capital are rated as “speculative” bets.

What is most unique about the McLean database, we feel, is the rigor and detail of the algorithms it uses to arrive at estimates of a company’s free cash flow and cost of capital - eschewing shortcuts to come to the most accurate figures possible. The database keeps track of cash flow anomalies at all of the approximately 13,000 non-financial companies that report their financials to the SEC. The firm’s algorithms adjust a company’s accounting metrics to reflect its underlying economic reality so as to accurately measure how the core operations of the business are actually performing.

Furthermore, McLean Capital Research significantly reduces the amount of time it takes to go from filing to cash flow analysis to actionable recommendation. The firm typically issues an “upside filing alert” to clients within only hours of a favorable and relevant change to a company’s reported cash flow. In addition, McLean Capital is able to carry out a custom portfolio evaluation that applies its quantitative cash flow discipline to a client’s existing portfolio or watchlist.

The research database regularly turns up intriguing recommendations - in particular, it does a good job of highlighting smaller companies with favorable cash-flow characteristics and valuation that may otherwise have slipped under the radar screen of most analysts. Richard McLean, the CEO of the firm, is an experienced money manager, and uses this methodology to make many of his own portfolio decisions.

Some recent performance data are available along with backtested results. While clients typically discount backtested data, the actual performance statistics (measured over a mediocre two years for the stock market as a whole) suggest that the McLean methodology has the potential to outperform in both small-cap and large-cap arenas. The significant outperformance of the McLean small cap portfolio makes intuitive sense, as one would assume that small cap companies are most likely to be inefficiently valued by the market. However, the outperformance in the large cap portfolio is presumably harder to achieve, and more impressive as a result.

Philosophically, the McLean approach is very much in line with the traditional value principles of Graham & Dodd; however, their quant system allows them to screen a larger number of stocks, react more quickly to emerging opportunities, and recommend trades much more frequently than typical fundamentals-driven value analysis. While this generates relatively high portfolio turnover, we feel that the currently low cost of execution allows this to be a viable strategy. Hence, the McLean Research tool may be of interest to any value-oriented investor.

Contact information for McLean Capital Research is available here.

The cause to the issue is the $30 billion emergency loan that the Fed gave to Bear Stearns in order to avert the investment bank from going into bankruptcy. This loan is outside of the jurisdiction of the Fed, since the Fed’s discount window is for commercial banks and not Investment banks or securities dealers.

Paulson is a proponent of widening the Fed’s powers to include monitoring investment banks, but this would clearly require congressional consent .  A new structure would allow the Fed to monitor reserves, capital, liquidity and leverage of the commercial and investment banking communities.

Congress feels that having the Fed as a backstop for the investment banks might encourage a moral hazard. We wonder what happens to the Fed funds market and the Repo markets. Will they become one?  There are collateral issues related to this, specifically who is holding the collateral. But in any case the spread between repos and fed funds would at least converge.

New York—The parent of GaveKal Research, a prominent Asia-based provider of macro research, has partnered with UK hedge fund manager Marshall Wace to create a new asset management venture,  Marshall Wace GaveKal Asia.  For GaveKal, the new venture expands their asset management capabilities by partnering with one of the largest hedge fund management groups.  For Marshall Wace, the venture represents a diversification into more actively managed strategies.

Putting Money Where Your Mouth Is

GaveKal was already in the asset management game, having launched its first fund in 2003.  First and foremost, this move will help GaveKal scale the asset management portion of its business more quickly, as well as give it professional support in moving away from its previous long only orientation.

The new venture, which launches today, will begin with $300 million in assets under management from GaveKal’s existing funds:

• The GaveKal Asian Absolute Return Fund is a US$ denominated, Caymans domiciled, long-only, absolute return oriented fund investing in Asian bonds, equities and currencies. This fund was launched in July 2003.
• The GaveKal Asian Absolute Return UCITS Fund is a Euro denominated, Irish domiciled fund. This fund follows the same strategy as the GaveKal Asian Absolute Return Fund and the main difference is the currency exposure (Euros against US$). This fund was launched in January 2006.
• The GaveKal Platform Company UCITS Fund is a US$ denominated, Irish domiciled, long-only equity fund which aims to outperform the World MSCI by investing in companies evolving away from the vertically integrated business model to the “platform company” business model. This fund was launched in September 2006.
• The GaveKal New World Fund is a US$ denominated, Irish domiciled, long-only equity UCITS fund which invests in companies in Asia, the Middle East and the former Soviet Union. This fund was launched in October 2007.

GaveKal is also advisor to the following funds, which are outside the new joint venture:

• The European Divergence Fund. GaveKal Capital is a co-advisor to this hedge fund whose purpose is to profit from the unfolding European credit crunch.
• The Trophy Property Fund. GaveKal Capital is an economic advisor to this Chinese real estate private equity fund managed by Winnington Capital.
• The Asia Prosperity Fund. GaveKal Capital is an advisor to the Asia Prosperity Fund. The Asia Prosperity Fund is an Asian Long-Short equity hedge fund managed by Mattias Lamotte (a former GaveKal partner) and Richard Wu.

The firms said the joint venture will develop a number of new Asian dedicated long/short hedge funds, starting with a Japan-focused vehicle scheduled to be launched in the third quarter.

Diversification from TOPs

For Marshall Wace, the venture provides diversification from its $14 billion TOPS (trade optimised portfolio system) platform, which analyses broker research to produce trade ideas.  Returns from TOPs have started to flag as new competition from other managers such as Two Sigma has become established.   

Chief executive and co-founder Ian Wace, said in a statement the agreement was part of a larger expansion plan.  “This joint-venture also marks the first step in a major build-out of our ‘manager-led’ strategies,” the statement said.  “My co-founding partner, Paul Marshall, has recently taken global executive responsibility within Marshall Wace to build our manager-led activities to a level compatible with our unique process-led applications.”

The venture will exclude Marshall Wace’s existing $1 billion in Asian funds managed using its TOPS (trade optimised portfolio system) platform, which analyses broker research to produce trade ideas. It will also exclude GaveKal’s research business.

GaveKal Chief Executive Louis-Vincent Gave will be CEO of the joint venture, and GaveKal chief investment officer Alfred Ho will take on the same role for the long-only business within the venture.

Prior to joining RiskMetrics in August of 2007, Mr. Leggett was President and Chief Executive Officer of the Center for Financial Research and Analysis (CFRA), which was acquired by RiskMetrics. Mr. Leggett was also a Managing Director at Goldman Sachs in New York and London in both the technology equity research and investment banking divisions, where he held leadership roles. “Investorside is very fortunate to have a person like Rich who is taking over as Chairman,” Mr. Green said. “He is a thoughtful, intelligent person with a real understanding of the research industry and an appreciation for the issues facing it. From his days at Goldman through CFRA and now RiskMetrics, Rich has demonstrated an intelligence and ethical standard which is core to Investorside values.”

Mr. Leggett praised Mr. Green’s tenure as Chairman. “Stanton’s contributions to Investorside have been invaluable; he spearheaded the largest membership growth in recent years, implemented several innovative outreach programs such as Members Day and organized the highly successful 2008 annual Independents Day Conference, which reached a new milestone in attendance. In addition, Stanton oversaw the 2007 legislative initiative in Washington, D.C., created educational programs to keep pace with the rapidly changing investment landscape, and supervised the transition of a new executive director.”

Investorside is also pleased to announce the appointment of three new board members: Penny Herscher, President and CEO of FirstRain; Paul Henneman, President of ValueEngine, Inc. and Anne Maffei, President of Vista Research, Inc. “Given the influx of new members this year and the changing landscape of investment research from traditional methods to recently adopted alternative methodologies, it makes sense to diversify our leadership to match the dynamics of the market,” said Mr. Green. “We are fortunate to represent the leading independent research providers who continue to innovate the way research is gathered and disseminated.”

About Investorside

The Investorside Research Association is a non-profit trade association of investment research providers that do not engage in investment banking, company consulting or research-for-hire. Our members constitute the leading investment research firms in the world, providing research that works purely for investors.

Contact: Patrick Shea, Investorside Research 877-834-4777

The goal of this disclosure initiative is to come up with a blueprint “for overhauling the SEC’s current form-based structure with one that truly meets users’ needs.” The study will look at how information is collected, how the data is stored, and more generally how to maximize the usefulness of information collected by the commission for investors.

“On the 75th anniversary of the SEC, with so much new technology available to improve the quality of information for investors as well as the way investors acquire it, we’re initiating a broad, introspective look at our business model,” said SEC Chairman Christopher Cox. “What hasn’t changed in 75 years is the importance of full disclosure - sunlight remains the best disinfectant for problems in our capital markets. We’ll be examining how to improve the way disclosure works, including tapping the full potential of today’s technology and integrating it seamlessly into our regulatory approach. That could mean fewer confusing forms, and more useful information at investors’ fingertips in a form they can really use.”

According to the Commission, this study will include a review of all existing SEC forms and reporting requirements, as well as the manner in which information is provided to the Commission, with a special focus on needless redundancy. It will also include consideration of various alternative strategic approaches to acquiring and publishing disclosure information. In addition, the study will consider ways that regulatory requirements for the collection of information might be tailored to get the best real-time distribution of financial and narrative disclosure to investors. Finally, the study will examine how best to integrate public disclosure with the SEC’s proposed new post-EDGAR architecture for investor search, assembly, and comparison of data.

Chairman Cox noted that the first phase of this study is expected to be delivered to the commission by the end of this year, after which a follow-on advisory committee will be appointed in 2009 to consider questions in more detail through a public and consultative process.  The initial study will be led by Dr. William D. Lutz of Rutgers University.

Dr. Lutz’s background includes expertise as both a securities lawyer and a plain-English expert focused on transparency. Dr. Lutz has significant experience in working with the SEC on disclosure issues, having participated in several SEC roundtables, and having frequently provided advice on SEC rulemaking.

From 1995 to 1999, Dr. Lutz played an important role in advancing the SEC’s Plain English initiative by preparing the SEC’s Plain English Handbook, a manual to help mutual funds and public companies write clear and understandable SEC filings. He is Emeritus Professor of English at Rutgers University, and the author of numerous books and articles on the importance of plain-language disclosure.

The Consequences of this Study

While we are supportive of the SEC’s interest in overhauling its rather outdated approach to information collection and disclosure, we fear that the announcement of the “21st Century Disclosure Initiative” is likely to further delay (if not outright derail) any move by the SEC on commission disclosure.  This means that many asset managers will continue to spend investors’ assets (commissions) on research provided by broker-dealers and investment banks, without telling them what they are paying for this research, and what they are getting for the money they are spending. 

We suspect this continued delay is not in the best interests of investors.  Lack of disclosure means that U.S. asset managers will continue spending in excess of $5 billion per year of investors’ assets on sell-side research without having to justify these expenditures to the people whose money is being spent.  And while we are confident that most investment managers are making good faith efforts to spend investors’ commissions wisely, we are also wary of any system where lack of transparency is the norm.  Like SEC Chairman Cox, we also believe that sunlight is the best disinfectant for the problems in our capital markets.

The sale of the two information providers is part of Xinhua’s short-term strategy: to streamline operations and focus on its core business of providing information on China’s financial sector. This strategy, disclosed in the press release by the company’s CEO Jae Lie, might be related to the current economic challenges in the US. Today, the higher growth opportunities are emerging in China, rather than the US. Xinhua’s strategy apparently, and understandably, prioritizes to pursue the Asian growth opportunities while leaving behind the current economic hardships in the US.

Mergent, with headquarters in New York and Charlotte has been providing financial data for over a century. Its database includes more than 35,000 global publicly traded companies from 100 different countries. Kinetic, headquartered in London, delivers software products and consultancy to the financial market.

Xinhua acquired Mergent in 1994 in hopes of gaining an independent tool to develop its own financial market indices. With this acquisition 14 years ago, the Chinese giant also pursued the supply of the indices and the underlying data required by investors to measure their performance. Xinhua’s plans have scaled back since then, and now it will focus on providing information on China’s financial sector. Meanwhile, Carousel Capital, which has specialized in small leveraged buyouts and recapitalization transactions since 1996, will put its expertise into practice attempting to revitalize its two new acquisitions.

One way to estimate an enterprise value is to assess, not only the worth to the shareholders, but also the value to other stakeholders in the business: debt holders, employees and the local or global community.    Let’s take a look at the constituent parts one letter at a time.

Environmental

The assessment of the environmental impact on the “community” relates to the measurement of global greenhouse gases and other pollutants that are a bi-product of the production process. In welfare economics, these are called negative externalities. Environmental factors, such as carbon emissions and other greenhouse gases are one factor that can be measured, though it is very detailed and extensive work. One research provider out of London, called Trucost, appears to have the most robust dataset on carbon emissions we are aware of. In addition, the firm uses microeconomic techniques to assess the impact of these negative externalities.

Social

Social factors are somewhat more difficult to corral. An area called SRI (Socially Responsible Investment) tends to dwell in this camp, though it also covers the environmental area as well. The social analysis has tended to deal with how employees are treated relative to the management of a corporation, labor law violations—including bans on products that are produced outside of the US which do not adhere to US labor laws. Additionally, this area has grown to include harmful products, such as tobacco, alcohol and drugs. Some investor groups have internal rules about investment in companies that produce these products. In this area, a prime example of a market leader is KLD Research and Analytics. KLD creates indexes, manages lists of banned companies for money mangers that do not adhere to the investors’ requirements, assess the compensation disparities between management and employees for its clients, and general factors that promote productivity and ownership among employees.

Governance

Governance analysis deals with the powers and controls available to shareholders, the board and management in the governance of the company. As such, the topic is also quite broad: dealing with board accountability; financial disclosures; internal controls; shareholder rights; executive compensation; and ownership base. An example of a research provider that covers this space is GoveranceMetrics International.  GMI rating reports include a summary of the company’s overall governance profile and commentary on each of six research categories employed by GMI: 1) Board Accountability; 2) Financial Disclosure and Internal Controls; 3)Shareholder Rights; 4) Executive Compensation; 5) Market for Control and Ownership Base; 6) Corporate Behavior and CSR Issues.

Another company that covers this space from a different angle is Glass Lewis. Glass Lewis provides investment research, class action settlement solutions, and proxy services to its clients.

It is safe to say that it is difficult to directly compare one ESG firm to another. The analysis and data utilized in ESG analysis covers everything but the kitchen sink. Then again, the kitchen sink is a source of grey water, which may hit the radar as an environmental risk soon enough.

New York—The growth of the Special Purpose Acquisition Company (SPAC, also known as ‘blank checks,’) market illustrates the symbiotic relationship between research and new markets.  SPACs, which are companies that go public in order to raise capital to make acquisitions, have begun to attract alternative research coverage, which has helped the market gain traction with hedge funds, but still lacks the depth of coverage to get broad acceptance from long only managers.

Background

Special Purpose Acquisition Companies (SPACs) are a growing financial vehicle used for raising capital for private companies.  SPACs raise blind pool money (most of which goes into a trust) from the public for an unspecified merger, sometimes in a targeted industry.  In the typical structure, each SPAC is typically sold at $6 per unit for one share of common stock (to be publicly-traded in the future) and two warrants for the purchase of additional shares. If an acquisition is not made in two years, the money is returned to the original investors.

In the United States, approximately US$500M was raised in 2004, over $2B in 2005, over $3B in 2006 and over $12B raised in 2007.   SPACs thrived in 2007 and in the first quarter of 2008, as investors turned to them as an alternative to private equity deals, which were disrupted by the credit crisis.  A record 65 SPACs went public in 2007, raising $11.7 billion in proceeds, according to Renaissance Capital’s IPOHome.com.  Prior to 2007 a total of  75 SPACs were issued from 2003 through 2006, raising $5.8 billion.  Volumes are down in 2008, but issuance is continuing despite the current market conditions.

SPAC investing appeals to event driven investors, who view the investment in SPAC warrants as a form of risk arbitrage investment.  Hedge funds make a profit by buying as SPAC when the stock price is down post-IPO and then redeeming their shares at a higher price after the SPAC has made an acquisition and liquidated.       

Research Coverage

Despite the increasing number of SPACs, sell side research coverage of SPACs has been limited by restrictions on covering IPOs.  Also, it is difficult to allocate scarce analytic resources to companies that may unwind in two years.   

As is often the case, alternative research firms have moved in to fill the void.  There are currently two firms specializing in covering SPACs:  SPAC Research Partners LLC and SPAC Investments Ltd.  SPAC Research Partners was founded by former employees of an Indian technology outsourcing company, Global Infozone, who teamed up with a boutique, Sand Hill Research Partners.  SPAC Research Partners offers a few research products, including weekly valuation analysis of warrants and ‘Red Flag’ reports on pending acquisitions which analyze the risks to the transaction, similar to merger arbitrage analysis. 

SPAC Investments Ltd. was founded by Neil Danics a former portfolio manager of a risk arbitrage hedge fund at Deutsche Suisse Asset Management.  The service is offered through www.spacanalytics.com, and includes analysis of a pending SPAC transaction and the probability of the deal being approved by the SPAC shareholders.

Recent Events

 Liberty Lane Acquisition Corp, a SPAC IPO sponsored by Goldman Sachs, withdrew from the market in early May in a closely watched transaction.  Liberty Lane was targeted to long-term institutional investors — pension and mutual funds, rather than the traditional group of hedge funds.  It had fewer warrants and other characteristics to appeal to long-only investors and discourage hedge funds.  Unfortunately, it failed to attract enough interest from traditional investors and was pulled. 

Since Goldman dropped Liberty Lane, the SPAC market has revived with more traditionally structured deals, including Navios Maritime Acquisition Corp, a $220 million SPAC listed on the NYSE issued by a Greek shipping firm, and $49 million Symphony Acquisition.  The market was also boosted by the proposed $688 million purchase of Hughes Telematics from Apollo Management by an existing SPAC, Polaris.

Conclusion

Which comes first, market liquidity or research coverage?  Alternative research has helped the SPAC market grow from its early stages, but as the failure of Goldman’s Liberty Lane structure shows, the appeal to traditional investors is still lacking—at least in the current market environment.   Research coverage plays a role in attracting investors.  The current research, which is focused on hedge funds specializing in merger arbitrage, does not yet resonate with traditional investors, who have been generally slower to embrace alternative research than hedge funds.  The maturation of the SPAC market is one example where has not yet alternative research bridged the gap.

While Ms. Warner’s comment is true, it is clear that the problem doesn’t lie solely with investment banks, but instead with the bundled business model which has enabled both the buyers and sellers of sell-side research to avoid adopting the market discipline which would naturally produce a “price” for investment research.

The Research Model of the Past

In most markets, the ultimate price of a good or service is established once producers and consumers communicate their willingness to supply and demand these products / services at different price points.  Unfortunately, this market mechanism has not existed in the sell-side research business.  

Sell-side research has traditionally been bundled with execution, thereby obfuscating the price of it to research consumers.  Consequently, research buyers have not known how much they are being charged for the research.  As a result, they haven’t had to worry too much about how much they value this research.  Of course, it must be noted that in most cases, most research buyers have not really cared how much they were being charged for sell-side research as they were not paying for it with their own money, instead, they were using client commissions to pay for this research.

Research producers, on the other hand, have not had to worry too much about what they should charge for the research they produce – particularly in a world where no one knew how much revenue was directly attributed to their research.   In many instances, this led sell-side firms to disregard the cost structure of their research departments.  In addition, the sell-side has not really understood what research clients really valued.  As a result, they have historically “turned on the fire hose” hoping that each client would value some part of the research they produced.

The Evolving Marketplace

However, the research industry has undergone considerable changes in recent years.  First, the sell-side (research producers) have suffered from sharply falling commission rates  – dropping from 75 cents per share in 1975 to less than one cent per share on an electronic trading system in 2006.  In addition, the Global Research Analyst settlement forced investment banks to decouple analyst compensations from the revenues associated with any banking mandates won by a firm.  Consequently, most sell-side firms have started to pay considerable attention about how much clients pay and how much research resources they consume. 

Research consumers (the buy-side), have also been faced with a rapidly changing business.  Unbundling and commission transparency in the UK, and the impact of CSAs and CCAs in the US, have forced institutional investors to think about what they should pay for the sell-side research they consume.  This has led many buy-side firms to implement broker voting systems to establish a repeatable process to help them decide how much to pay their research providers.  Unfortunately, the way most buy-side firms use the broker vote makes one big (and flawed) assumption – and this is that the value of research should be related to the amount of commissions generated by an institutional investor.

Establishing a Research Market

In order to create a better market mechanism to establish a price for research, research consumers need to come to terms with what / how much sell-side research they are willing to purchase at various prices (a demand function).  This means buyers need to first decide how much they want to spend on research, and what makes this research valuable.

Simultaneously, sell-side firms need to decide how much research they are willing to supply at various price points (a supply function).  This determination will take into consideration what sell-side firms feel is a fair price to be paid for the research they produce, based on the cost of production, a desired profit margin, and the value they believe they are delivering. 

It is interesting to note that a few buy-side firms and a few sell-side firms we have spoken with in recent months have started developing their own rudimentary demand and supply functions.  This has enabled them to better negotiate a clearing price for the research they consume or produce.  However, a majority of the sell-side and buy-side firms we have spoken with have not yet progressed this far.  As a result, these firms remain unable to value the research they produce or use.

Africa’s Appeal

Historically regarded as corrupt and politically unstable, Africa’s frontier markets have gained newfound interest among money managers in recent years. Some of this interest is attributable to promising political developments. According to Freedom House, a non-governmental organization that tracks democratic processes around the world, the number of free democracies in Africa has increased from four to eleven over the past decade, and more than half of the remaining countries in the region are in the transition process toward full and free democracy. In a panel on “Sourcing and Structuring Opportunities in Africa” at the Hedge Funds World Global Opportunities Conference in New York (hosted by Terrapinn), sentiment on Africa’s political situation was cautiously optimistic.

Because of these developments (and other global macro factors), economic performance in Africa has been strong in recent years. According to Exotix, a brokerage firm that has extensive operations in the African markets, real GDP growth in Sub-Saharan Africa (ex South Africa) was 6.7% in 2007, up from 5.4% in 2006. With significant resource and mineral reserves, and a relatively cheap labor, there is cause to believe that Africa’s frontier markets could benefit substantially from increasing global demand for commodities (especially oil & gas) in the coming years. Already, many of the world’s leading powers—notably China and the EU—have developed trade deals with these countries.

In spite of strong growth and an improving political landscape, challenges to Africa’s political and economic development remain. Corruption and economic mismanagement are still problems in many of Africa’s frontier economies. In Rising Powers, Shrinking Planets, a new book on global energy issues, energy expert Michael Klare points out that revenues derived from resource development projects “typically line the pockets of well-connected government officials—often with no ‘trickle down’ effect whatsoever.” Even so, the macro picture for Africa has some promising qualities, which can explain the recent uptick in fund flows and investor interest in the region.

Financial Information in Africa’s Frontier Markets

As fund flows and investor interest have increased in recent years, Africa’s financial information infrastructure has improved considerably. “Global investment is driving higher standards in African corporate governance and disclosure,” said Clifford Quinsberry of Investment Frontiers Research, a consultancy that advises on investing in the frontier markets. Ashley Bendell, Associate Director of African Equities at Exotix, points out that many companies now adhere to GAAP accounting standards and submit to audits from international agencies.“Even so, corporate reporting and disclosure standards still lag many countries outside of Africa.” Bendell notes.

Another challenge for investors is the lack of standard research coverage on the Sub-Saharan economies (ex South Africa). Exotix, which provides fundamental and thematic research on approximately 250 companies in this region, is one of the few players with a comprehensive eye towards the frontier markets. “Some investment banks are writing research on the bigger names in the frontier markets,” said Bendell, “but none are looking across the market cap spectrum in the emerging African economies.”

There are signs, however, that coverage is improving. More and more, local brokers in the African frontier markets are providing structured research and information products, while some primary research firms are expanding their capabilities in the region. Coverage is still better on the more developed markets—i.e. South Africa, Egypt and Morocco—but in a few years, the frontier markets might not be so far behind.