New York-Earlier this week we mentioned we now refer to third party research as Alternative Research, preferring this term to Independent Research. Today we wanted to give you some additional background on why we’ve switched our nomenclature.
Rise of Independent Research
The term “independent research” became popular in 2003 with the Global Research Settlement, which mandated that the investment banks participating in the settlement purchase third party research to distribute to retail clients along with their proprietary research (to be administered by an Independent Consultant, of course.) The settlement provided a definition of independent research which is still very much in use, but most importantly the term ‘independent research’ gave a great PR boost to third party research.
One of the intents behind the settlement was to provide an economic catalyst to third party research by requiring the participating investment banks to set aside nearly a half billion dollars for the purchase of third party research over five years. While this prompted a mini-gold rush of new third party research firms when the settlement was announced, the real beneficiaries were a small number of research firms, including Standard & Poor’s, Morningstar, Argus, Renaissance Capital, theStreet.com (formerly Weiss Ratings) and a few others.
The regulators had a bias toward fundamental research, reasoning that fundamental research would be most competitive with the Street firms’ own proprietary research. If Merrill said that something was a buy because of improving earnings, third party fundamental research firms would provide a counterpoint with their own earnings forecasts. This is very logical, but ultimately totally wrong from a markets perspective. What the research market wants is differentiated research, not more of the same.
Rise of Alternative Research
What is driving the growth of third party research is not regulatory stimulus, but the growth of hedge funds, aka, alternative investing. It is no accident that the fastest growing segments of the research industry-primary research, specialized research and economic research-are those favored by hedge funds.
- Primary research techniques, whether expert networks, channel checks, data mining, or management access, are designed to help investors did deeper and get insights more quickly than fundamental research can deliver.
- Specialized research–whether its forensic accounting, earnings quality, SRI, insider trading, patent analysis, analysis of regulatory filings, weather analysis, or any of other techniques we track-help generate short ideas or give fresh unique insights which can often be translated into trading opportunities.
- Economic research, including policy analysis, sector analysis, legislative and regulatory analysis, asset allocation, appeals not only to macro hedge funds, but long/short hedge funds and hedge funds investing in international and emerging markets and various asset classes.
Taken together, primary, specialized and economic research represents 44% of the alternative research market today. This in itself is pretty amazing and speaks to the diversity of the alternative research marketplace. We’re forecasting the these three segments will grow to represent 60% of the research market over our forecast horizon.
Our primary reason for switching nomenclature is that we believe the term ‘alternative research’ better reflects the reality of the third party research marketplace. There is another reason for the change: ‘independent research’ is a slight misnomer in that the term implies that third party research is not conflicted. By definition, independent research does not have the conflict with investment banking that was so prevalent in Street research during the go-go 1990’s. However, third party research can have other conflicts which need to be managed, including insider/non-public information, money management affiliates, analyst trading, issuer-paid research. These potential conflicts are for the most part managed well by firms, but users of the research should not be lulled into a false sense of security.
One downside to our switch is that we were used to referring to third party research as IRPs (Independent Research Providers). ARPs doesn’t quite have the same ring to it. Maybe we’ll have to just shorten it to RPs.
So Alternative Research it is. At least until it stops being alternative and becomes mainstream, and then we’ll have to come up with a new term…
Comment by Michelle Applebaum:
I think the term alternative research is a fabulous way to describe the work that many of us in the primary research side are doing. I find that “independent” research seems to connote a retail-oriented product, and our firm specializes in fundamental work exclusively for institutional buy-side and private equity firms. It’s a good thing our language is evolving in line with our business. Thanks!
Comment by Dave Frankel:
Great thread — as an “alternative” source of research, we are definitely seeing a residual uptick from the buyside as they do more research in house and search for new sources of impactful information.
Thankfully you didn’t name it Research 2.0……..
Comment by Rob Wilson:
Great idea. I like it much more than indy research.
Comment by Bill George:
Sandy: Well done, this article really gets to the source of many of the positive reasons for “alternative” research, and I think your discussion about potential sources of conflict in alternative research is also very important.
One subtlety that this article mentions peripherally, but doesn’t explore in detail, is something I’ve questioned and discussed with a few industry professionals recently. That is, in 2003, when the Global Research Analyst Settlement was implemented, regulators obviously thought it was necessary to have an independent trustee monitor the payment for, and distribution of, the independent research which was mandated in the settlement. In that context, it seems inconsistent, almost paradoxical, that in 2007* regulators redefined commission sharing arrangements as client commission arrangements and at the same time defined a new operating model that will require a regulatory and audit process different from the process in place since 1975. Suddenly full-service brokers and institutional advisors are totally trustworthy again? In my opinion shifting the responsibility for qualifying and paying for independent research from the broker to the advisor will create several problems, some of which may be short term adjustments, but many of which will have longer term, more serious negative consequences.
* See link>
Also, see >
Request for rulemaking filed with the SEC on February 10, 2007 – file # 4-531