Courage (and $) of Conviction


New York – Investors use external research for two key investment activities – idea generation and developing convictions. Research is valuable to the extent it contributes to one activity or the other. Once an investment has been made, there is a role for maintenance research, but this is far less valuable than research that contributes to the initial investment.

Idea-generating Research

Integrity Research works with clients to source research supporting idea generation and developing convictions. Of the two, idea generation is the more difficult. Many investors use quantitative screens to generate ideas. Usually, these screens are driven by financial data and will be performed using platforms like Bloomberg or FactSet. Hedge funds often have idea dinners and other gatherings where participants swap investment ideas. A research firm which has successfully leveraged this concept is Drobny Global Advisors, which hosts a moderated online forum for macro hedge funds to share investment ideas.

Another source of ideas is the investment themes developed by investment strategy firms. Our recent ResearchFocus report on investment strategy showed that investment themes are highly valued by investors, and one of the key reasons that they rely on investment strategy research. Some investment strategy firms also provide screens tied to investment themes which identify securities that meet the criteria outlined in the theme.

Fundamental research can be a source of investment ideas. Some brokers publish lists of their high conviction stock ideas. Some investors are leery of broadly disseminated ideas, however, and prefer other sources.

Forensic research and earnings quality analysis are used by long/short investors to develop short ideas. Similarly, there are short ideas specialists that provide fully researched ideas to investors. We will cover all these providers in our ResearchFocus report which will be released later this month.

Another type of specialized research that is good for idea generation is firms that analyze M&A transactions and spinoffs. Data mining firms also pride themselves in coming up with investable ideas derived from the analysis of large datasets.

Buy-side analysts who specialize in specific sectors sometimes get ideas from industry level research, particularly industry consulting firms which typically sell their research to the firms in the industry they follow. This research is particularly useful for identifying new industry trends, product developments or changing industry dynamics.

Conviction Research

Many, if not most, ideas are not investible so successful investors are careful to winnow the ideas to those where they have the highest conviction. External research often plays a critical role in this process. Many investors value access to company management as an important ingredient in developing conviction. Given its broad usage, fundamental research is also a common reference point.

Almost by definition, primary research in all its forms is a critical tool for determining how investible an idea truly is. The most popular primary research tool is the expert network, which specializes in one-on-one consultations with industry experts. Many expert networks also provide survey capabilities, helping investors conduct surveys of experts available through their networks. We will analyze these capabilities in greater detail in our ResearchFocus report on expert networks, due out in July.

Other primary research capabilities include custom survey firms, channel checkers, web scrapers and other forms of search-based research. Investors value primary research because it allows them to test investment ideas and discard those which don’t prove out or for which the timing is off. Primary research also has the advantage of having customized characteristics, making it potentially less broadly recognized in the market.

We also find that industry consulting firms are also a growing source of idea-testing. The industry consulting firms offer deep analytic expertise, and they often have off-the-shelf studies which can shed light on the investment theme.

Generating Value

Once the investment has been made, surveillance of the investment is important. Here maintenance research can play a role, helping to monitor any changes that may invalidate the investment theme. However, maintenance research is significantly less valuable than research that contributes to the investment decision because it is prevalent and relatively easy to produce.

Fundamental research, which is one of the few forms of research which contributes to all phases of the investment process, should be expected to be the most valuable. In aggregate this is true when you look at the volume of research spent on fundamental research. However, in the case of brokerage research, this value is somewhat diluted by broad dissemination. Wide usage diminishes the value of idea generation–the best ideas are those that are not widely held, yet. This helps explain the ongoing appeal of boutique research.

The customized nature of primary research is an important part of its appeal, but it also tends to be limited to one phase of the investment process, idea-testing. Primary research is valuable and growing, but its ultimate value will be constrained unless it can address a broader spectrum of the investment process.

Ultimately, the most successful research is that which focuses on adding value to investors in all phases of their investment process.


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