Has the Rise in Independents Come to an End?

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New York, NY – According to a new report published this month by Greenwich Associates, the buy-side’s shift from using sell-side research to regional brokers, sector specialists, and independent research providers has come to an end.  However, data collected by the team at Integrity Research Associates reveals that this conclusion is misleading at best.

The Greenwich Perspective

Greenwich concluded that from 2007 to 2008 U.S. institutional investors paid $5.7 billion in trading commissions to providers of research and advisory services (out of a total commission pool of $12.2 billion).  And while the buy-side continues to spend the bulk of their research commissions on sell-side research, Greenwich also highlighted a trend where institutional investors have reduced using regional brokers, specialists, and independent research providers.

“In 2004, the 14 major brokers as a group controlled nearly 79% of research share among U.S. institutions; regional and sector specialist firms controlled almost 18% and independents captured approximately 2.5%. By 2006-2007, the majors’ share had dropped to 74-75%, while specialist firms had grown to more than 21% and independents had increased to just about 4.0%. But from 2007 to 2008, the majors’ share increased to 76% from about 75%, while specialists slipped below 20% and independents essentially held at just about 4%.”

Our View

Unfortunately, the Greenwich data could be misconstrued.  In fact, we have received a number of phone calls from journalists asking our opinion of this survey.  Many assume that the Greenwich report concludes buy-side investors are spending a mere 4% of the total research commission pool on independent research – or $234 million. 

However, our research shows that U.S. institutional investors spent close to $1.9 billion on independent and alternative research in 2007.  Of this total, we estimate that $1.4 billion was spent by the buy-side (the rest was spent by retail investors or corporations), with $1.05 billion coming in the form of soft dollars, CSAs / CCAs, or bundled commissions.  Consequently, we believe that institutional investors spent close to 18% of the total $5.85 billion in research commissions on alternative or independent research, while the remaining $4.8 billion was spent on research produced by investment banks.

In addition, based on close to 100 interviews in the past few months, it is clear that buy-side firms are spending considerably more on alternative and independent research today than they did three or four years ago.  Of course, we have seen a drop in buy-side interest in fundamental company research provided by independent research firms.  However, this is more than offset by increased buy-side use of primary research (channel checks, expert networks, quantitative market research); investment strategy research; and specialized research (patent analysis, forensic accounting / short ideas, ESG research, etc.),    

Why the difference?

Of course, we suspect that much of the difference between the Greenwich survey results and the data we have collected is definitional (just what makes up “independent research”?).  We also think that the research approach taken by Greenwich Associates is inherently biased against boutique independent firms. 

Clearly, buy-side analysts and portfolio managers are not likely to mention most independent or alternative research providers when they are asked who their five to ten most important research sources are across a slew of distinct industry sectors (though a few huge firms like Bernstein or Gerson Lehrman are likely to show up).  This cannot capture the amount spent by the buy-side on the “long tail” of research.

In addition, this approach measures “share of mind” or brand name, not share of wallet.  We have also noticed that many buy-side firms (particularly hedge funds) have a tendency to try and hide high value alternative research providers from their competitors.  As a result, basing your estimate of research spending on a limited “vote” is likely to give inaccurate estimates.

Summary

Based on our own bottom up analysis, we have seen an increased not decreased use of independent or alternative research in the US in recent years.  In addition, we estimate that the amount being spent on independent research is considerably higher than what Greenwich estimates.  However, we do agree with one conclusion reached by Greenwich Associates in its recent report, and that is that “independent research is still a very tough business”.  

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