Dark Pools of Investment Research

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New York, NY – In recent years, many financial market participants have discussed how accessing “dark pools” of liquidity have become increasingly important for buy-side clients looking to achieve “best execution”. However, a small but growing number of institutional investors have come to realize that “dark pools” of research also exists. Consequently, finding ways to access these sources of unique and exclusive research has become an important part of helping these buy-side investors locate identify and leverage sources of alpha.

Definition of Dark Pools

According to Investopedia, “dark pool” is a slang term that refers to the trading volume created from institutional orders which are unavailable to the public. The bulk of dark pool liquidity is represented by block trades facilitated away from the central exchanges. The dark pool gets its name because details of these trades are concealed from the public, clouding the transactions like murky water.

While this term has traditionally been used to describe “hidden liquidity” when speaking of private execution venues, it could also be used to discuss restricted or hidden industry expertise or sources of investment research.

Pareto’s Law

Interestingly, some institutional investors believe they know of all the best sources of industry expertise and investment research. After all, these money managers argue, don’t the largest investment banks and most well-known alternative research firms actively market their best research to the buy-side?

And while this is true, what these managers don’t know is that they are seeing only the top 80% of all investment research and industry sources. Unfortunately, 20% of the best providers rarely if ever provide their research and expertise to a large universe of mutual and hedge fund managers. The following is a partial list of some of these “undiscovered” sources of research and insight.

Industry Experts / Consultants

The first obvious source of expertise that has become a “hot button” topic for many investors has been sources of “industry experts”. As we have discussed in past blogs, the team at Integrity Research Associates has identified 26 Expert Network providers (though we also know of at least half a dozen firms that are working on new offerings in this space). And while it is true that the top seven firms generate 90% of all industry revenue, investors remain interested in finding high quality sources of unique industry experts.

It is also interesting to note that many industry consultants we have spoken with over the past year rarely if ever sell their advice and expertise to the buy-side. Instead, these experts sell their advice back to the industries they cover. Of course, these consultants would be extremely interested in providing their expertise and industry research to this marketplace. Unfortunately, most of them don’t understand the needs of institutional investors and they don’t know how to translate their deep domain expertise into insight that might be relevant to a sophisticated investor.

Restricted Investment Research

In the past few years, a number of research providers have decided to build business models around the client demand for “proprietary” content. As a result, these firms have decided to limit the number of buy-side clients who can purchase their expertise. And while none of these firms have moved to an “auction model” to value this research, most have charged their clients a significant premium to gain access to this restricted content.

It is important to note that most of these providers of “restricted research” typically are not interested in becoming well known. Consequently, they don’t market themselves aggressively and they try to stay “fly below the radar”. In fact, many of these firms have specifically asked the team at Integrity Research Associates not to put them into our commercial database, and to recommend to a limited number of clients who fit a specific profile. And while we have complied with these requests, we do keep records of these firms so we can recommend them to specific clients who might make sense to the research provider.

Custom Research

Another source of “dark pool” expertise is custom research produced for a small number of investors. And while this type of research can take a variety of forms, one of the most popular forms of custom research is based on data gathered from primary interviews (channel checks, industry market research, and other custom survey work).

Work we are currently conducting for a new ResearchFocus report on channel checks reveals that slightly below half (49.6%) of all buy-side investors surveyed indicated that they conduct regular channel checks. Of this group, 31.7% use an external channel checking service to augment their internal primary research capabilities.

The buy side cited a wide range of reasons for valuing channel checking. Many indicated that channel checking is a great way to get in-depth insights on industry trends, which can help with supply and demand forecasting. Many others indicated that channel checking provides company-specific insights from company insiders or industry participants close to the company in question, which can help with forecasting earnings or understanding company issues. Some cited the independence of channel participants as an incentive for contacting them – often, channel participants provide opinions that are out of consensus with the opinions of company managers and Wall Street analysts. A small number of respondents specifically said that channel checking was a primary mechanism by which they generated new investment ideas.

New and Innovative Sources

Another source of “dark pool” research and insight can be found in new and innovative providers. Integrity has had the unique opportunity to discover dozens of new research providers before they have commercially released their products to the buy-side as they have contacted our team of analysts to discuss current demand trends in the industry. In addition, we have helped many firms that produce research, consulting, databases, and other analytical tools for other markets understand how they might serve long only asset managers and hedge funds.

Of course, part of Integrity’s business lies in helping clients who come up with new and innovative ideas to find relevant suppliers of data, industry insight, software, etc. In many instances the clients have defined a new type of content they want to evaluate, and we have found them a variety of suppliers to meet their needs. Often, the kind of content clients are seeking out are completely new sources of “insight”.

So What?

The ultimate consequence of this trend is that buy-side investors have more and more sources of high quality expertise, insight, research, data, and analytic tools to include as part of their investment management process. The problem is that many of these sources are not easy to find as they don’t promote themselves to mutual and hedge funds. However, therein lies the beauty of these “dark pool” sources, as the value of this content is typically not discounted into the current market.

This topic, and many others will be discussed at the upcoming AQ Research conference called Reinventing Research that is slated to be held at Dexter House, Royal Mint Court, Tower Hill in London, this Tuesday and Wednesday, April 1st and 2nd. More information about this conference can be found here.

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