Can investment research be crowd-sourced? Or, perhaps more germane, how useful is crowd-sourced investment research? New platforms such as SumZero, Estimize and Value Investors Club share investment ideas and earnings estimates. Academic studies suggest that, unlike traditional social media, value for networked investment research decreases as networks become more broad-based.
In a recent blog, Brian Egger of Breaking Call asks whether stock research should be crowd-sourced at all. Quoting Nicco Mele’s The End of Big: How the Internet Makes David the New Goliath he notes that crowd-sourcing circumvents institutions that have helped to provide accountability and reliability. He concludes “Given the risks attendant to a ‘free for all’ crowd-sourcing investment research process, it seems that there’s an important role for the professional curation of online content.”
The new research platforms do curate their data. Estimize, which is a platform for crowd-sourced earnings estimates, rejects 2.5% of contributors’ input based on the accuracy of projected estimates. 3195 analysts contribute to Estimize, resulting in coverage on over 900 stocks each quarter. Estimize says its consensus estimates have proven more accurate than comparable sell side data sets over 69% of the time.
SumZero is a network of 9000 buy-side investment professionals from hedge funds, mutual funds, and private equity funds which share investment reports over the platform. SumZero’s founder, Divya Narendra, was an ally of the Winklevoss twins in their early struggles with Zuckerberg at Harvard and is now receiving investment from Winklevoss Capital. SumZero subjects its prospective members to qualification standards and vetting. Narendra claims he reviews all applications personally and rejects 75%. However, the community isn’t limited just to the buy side: “A small number of non-buyside candidates may be considered” for access to its buy side services. Further, SumZero sells premium subscriptions to anyone (non-buy side) for access to the buy side research.
Value Investors Club, like SumZero, is a platform for sharing investment ideas. It reportedly accepts only one in fifteen applications. Anyone can have access to the investment ideas with a 90 day delay, and registered users can have access with a 45 day delay. Unlike SumZero, only members get access to the ideas without delays. A similar approach for macro investors is used by Drobny Global Advisors which provides a private network for macro investors to share best ideas. The Distressed Debt Investors Club is an idea sharing platform for vulture investors.
Wesley Gray, an assistant professor at Drexel University, has published a couple of studies of crowd-sourced research. In a paper published with colleagues from Rice University and the University of Missouri, he studied the track record of investment recommendations made on Value Investors Club from January 1, 2000 to December 31, 2011. He found that the buy recommendations earned monthly abnormal returns of 1.31% while short recommendations had abnormal returns of -2.67%.
Gray found evidence that investors gain valuable feedback from sharing ideas in private networks and that the most valuable ideas are shared among smaller groups of agents (collaboration argument). He noted that the other motivation for information sharing is to attract additional capital into a stock, which will drive the stock closer to its fundamental value (talking your book argument).
Gray also conducted an analysis of recommendations on the SumZero web site, which has larger user base than Value Investors Club, and found more limited results. There were no abnormal returns for buy recommendations of mid-cap and large-cap stocks. Buy recommendations for small-cap stocks had abnormal returns of 1.23% in the nine trading days after a recommendation was made. Short recommendations had better results, yielding abnormal returns for all classes of stocks.
Not surprisingly, the paper found evidence of buy-side analysts front-running the reports posted on SumZero. The authors also examined institutional holdings in the quarters before and after buy-side long recommendations were made on SumZero and found that aggregate institutional holdings declined in the quarter when a buy-side recommendation was posted on SumZero. This helps to explain why long recommendations did not perform well.
From the perspective of talking your book, a broader network would in theory be more desirable. However, Gray finds that collaboration is an equally powerful motivator, and that the most valuable ideas are shared among smaller groups. This is a central paradox of investment research: the more limited the distribution of an investment idea the more valuable it is. At same time, the idea generator has incentives to broadcast the idea broadly, whether it is research analysts seeking to get paid for the idea or a buy side analyst talking their book.
The research boutique is faced with a trade-off between a small group of clients that highly-value the research and diluting value with a broader client base. The same dilemma seems to apply to social networking investment research: the broader the community the less value the research.