Hammered by the large scale US insider trading investigation and investor concerns, expert networks have found conditions outside the US to be much more favorable for their services, enabling these firms to thrive in regions like Asia where corporate transparency is much less developed.
Trouble for Expert Networks in the US
US insider trading cases against the likes of Raj Rajaratnam of Galleon, Chip Skowron of FrontPoint Partners, Anthony Chiasson of Level Global, Todd Newman of DiamondBack Capital, and now Mathew Martoma of SAC Capital have put the media’s and regulators’ focus squarely on investors’ use of expert networks.
In response, many US investors have reduced or even outright banned the use of expert networks over the past few years as buy-side compliance officials have tried to mitigate the risk that their firms obtain material nonpublic or confidential information. And despite bolstering their compliance programs, most expert networks have found it difficult to expand their businesses with US hedge funds, mutual funds or pension funds.
Asia – Land of Opportunity?
Fortunately for expert networks, Asia has provided a fertile market for their services. The reason for this is three-fold. First, the number of Asian-based institutional investors has grown in the past decade. For example, in 2000 there were approximately 200 hedge funds in Asia managing less than $25 billlion in AUM. This has grown to over 1,200 hedge funds by the end of 2011 managing over $130 bln in AUM. And while this is well below the 2007 peak, the mere fact that Asian hedge funds accounts for less than 10% of the assets invested in hedge funds globally has made this region a focus for the growth strategies of many multi-strategy US and UK fund managers.
The second reason Asia has become a focus of expert network’s growth plans is the lack of transparency that currently exists in this region for corporate information. Many experts explain that corporate disclosure in Asia tends to be less robust because family-run enterprises are common and companies have little experience complying with relatively new disclosure rules. Family-run corporations often have little incentive to share information, analysts say. In addition, investor-relations departments in Asian companies tend to report to legal departments. Consequently, many Asian firms choose to provide less disclosure to minimize legal risk.
The third reason expert networks are thriving in Asia is due to lack of attention. Asian regulators have not really paid attention to the issue of investors paying to obtain information from company supply chains, regulatory developments, or corporate management changes in advance of the general public. Additionally, Asian companies have not really considered the risk that employees could be receiving compensation to pass on company secrets to investors. These three trends have made Asia a ripe growth opportunity for both global and local expert networks.
Expert Networks Experience Rapid Growth
According to a recent Reuters article, both global and local expert network firms have seen significant growth in Asia over the past few years.
GLG, the largest expert network in the world, has tripled its Asia revenue in the past three years. GLG now has approximately 400 institutional investor clients across Asia, as well as clients at strategy consulting firms, banks, and public or private companies.
David Legg, managing director of Asia and Europe for GLG explains that a relative lack of transparency in Asian markets means investors are much less willing to rely solely on research from investment banks and brokerages. “In London and New York, you get a lot of people who say: ‘Look, I can rely on some banking analyst on the sell-side to help me figure out something’; In Asia, nobody believes that.”
Capvision, the largest local expert network firm in China, said it had tripled in size over the past 3 to 4 years, and now employs close to 200 people.
Kai Hong, a former Bain & Co consultant who co-founded Capvision in 2006 agrees that his firms’ recent growth is due to the lack of transparency in Asia. “We have been fortunate enough to be in one of the fastest growing markets in the world and were able to capitalize on the fact that information flow in China has always been fairly un-transparent,” he says.
GLG’s Response to Reuters’ Article
GLG, however, was less than enthusiastic about the recent Reuters’ article (“Expert networks: thriving in Asia, away from U.S. Scrutiny”, Sept. 2, 2013 5:27pm EDT). David Legg, Head of International Markets at Gerson Lehrman Group (GLG), made the following statement about the article.
“The Reuters article discussing expert networks, which refers extensively to GLG, is inaccurate, incomplete and misleading.
“GLG is the most transparent and auditable platform for primary research – and is widely used for valuable and appropriate research by hundreds of the world’s leading mutual funds, hedge funds, strategic consultancies, law firms, pharmaceutical companies, corporations and non-profits. The article’s description of expert networks as services that connect “hedge funds with company insiders” does not accurately describe our firm, our overall client base and most of our industry.
“While hedge funds are a minority of our clients, they, like our other clients, need to conduct research before making important decisions, or investing someone else’s money. GLG helps professionals engage other professionals for short consulting projects and educational seminars – helping them learn and understand complex issues and marketplaces. While we understand some investment firms may choose to do their research themselves and informally, our platform for consulting and education, with audit trails and compliance protocols built-in, has become a vital tool in a highly-regulated, complex, technical and global economy.
“The article also fails to accurately describe our expert population and the way we do business. The vast majority of our experts are academics, consultants and executives who run their own businesses – not company insiders. Moreover every expert completes interactive compliance training (in one of 20 languages) and prescreening questions before they can engage in projects. In contrast to the ‘informal’ research that occurs outside GLG, each call is logged with compliance and supervisory tools provided to every client firm.
“Contrary to the article’s conclusions, one of the main reasons GLG has been successful is because of government regulation and the compliance requirements of our clients. GLG has seen great growth in Asia, as the article points out, but lack of regulatory supervision is not the reason. The markets and information needs in Asia are especially complex and expert platforms are a relatively new tool in the region. GLG has adopted global compliance standards which apply to projects in Asia just as they do to projects in the U.S. and U.K.
“It is precisely because of our global compliance policies and systems, our respect for laws in each jurisdiction in which we operate and our unwillingness to waiver on our compliance standards, that many investment firms in Asia have turned to GLG. Our clients in Asia find our compliance systems and rules are a great differentiator as they too are subject to regulatory supervision and are concerned about how they conduct their business.”
Expert Networks Not For Everyone
Despite the growth of expert network use seen in Asia, some Asian investors are not comfortable using expert networks for a variety of reasons. Some argue that as expert networks become more popular, any edge they receive from them is diluted as countless other investors speak to the same experts and ask the same questions.
Others, however, are concerned about the compliance risk of using expert networks and speaking to company employees who might divulge confidential or material nonpublic information. They question why investors would spend between $300 to $3000 for an hour of a senior executive’s time if the edge they obtained from that call wasn’t inappropriate.
Better Than “Solo Research”
However, some compliance experts acknowledge that the use of formal research platforms like expert networks, is a much safer way for buy-side analysts to conduct their research than by finding and speaking with experts on their own. This is because most of the top expert networks log all expert calls, who spoke, what topic they spoke about, and what was paid for each consultation.
Unfortunately, most firms that don’t use expert networks don’t prohibit their analysts from conducting their own research, including finding, vetting and speaking with their own experts. Given the proliferation of on-line tools like social media or job hunting databases, this has become extremely easy to do. However, these calls are rarely logged or tracked by the analyst who made them or the asset management firm he or she works for.
In fact, the development and use of a “private network” of experts outside of an existing expert network was clearly how Raj Rajaratnam collected the inside information that he eventually was convicted of trading on.
Clearly, a growing number of Asian analysts, traders and portfolio managers are using expert networks to conduct research in otherwise opaque financial markets. The real question we have is whether Asian regulators plan to crack down on their use, or at least bring their own insider trading cases anytime soon which could effectively slow the use of these research services. If they don’t we would not be surprised to see the use of expert networks (and other independent research firms) continue to grow throughout Asia in the coming years.