New York – In a luncheon meeting last week several research firms and other market participants got together to discuss the research industry. While the discussion was wide ranging and off the record, there were several salient points that reflect the issues facing alternative research today.
One issue was the use of equity research performance measures systems as a report card on the value of research. Some of the comments were about the difficulty in finding an appropriate way to measure and rate research providers. We all know the issues here. And while the general consensus was that performance was a useful way to assess at least part of the value proposition of research providers, there was also a consensus that this was only part of the overall value of research.
First, a large proportion of the research industry does not produce BUY/SELL/HOLD recommendations. Examples of this are the Forensics. Second, other research companies recommendations are forced into the BUY/SELL/HOLD construct in order to assess them along side those firms that do make recommendations.
Quant shops are an example of this, in that most quant systems sort stocks according to their desirability (or not). This creates a ranking that indicates which stocks are thought to be the best and the worst in the market, but it does not indicate whether the worst stocks should be shorted. In a strong up market, it would be foolish to short stocks that in the least preferred category of a quantitative model.
Next performance does not assess the holding period of the potential investor. Also, since they typically do not charge the stocks a penalty for churning, some performance can be generated by numerous trades all generating less in return than could be reasonably thought to be trading costs. An asset manager with fiduciary responsibility is looking for research with calls that last some period of time 3 to 6 months typically, while a hedge fund is looking for more rapid turnover (albeit still outperforming transactions costs).
At the end of this thoughtful and wide-ranging discussion, we arrived back at the beginning, realizing that in the research industry “beauty in the eye of the beholder”.