New York, NY – Over the past few years, the team at Integrity Research Associates has interviewed and conducted detailed analysis of hundreds of research providers from both the investment bank and alternative research industry. In addition, we have interviewed hundreds of buy-side analysts, portfolio managers and hedge fund managers to determine what types of research they like and what attributes of that research generates the greatest value for investors. Consequently, we have discovered that the value, or the price clients are willing to pay for research is determined primarily by two major characteristics – the Quality / Comprehensiveness of Research and the Distribution / Availability of that Research. We will discuss this in more detail below.
QUALITY / COMPREHENSIVENESS OF RESEARCH It is a little obvious that one of the major determinants of the value of research is the quality and comprehensiveness of that research. However, what is not so obvious is what makes a high quality / comprehensive research service. As we noted earlier, numerous interviews with buy-side analysts, portfolio managers, and hedge fund managers have led us to conclude that research quality is made up of a number of specific variables. The following is a list of some of the most popular of these Research Quality Metrics. Analytical Quality ANALYSTSDeep Industry / Company KnowledgeAnalyst Accessibility / ResponsivenessCommunication SkillsCredibility / IntegrityComprehensive Company / Industry ReportsFinancial ModelsStock RecommendationsEarnings Estimates Industry / Company Knowledge: Countless surveys over the years have revealed that one of the attributes that institutional investors value most in the research they receive is the depth of industry and company knowledge of the analyst. Consequently, many buy-side participants have bemoaned the drop in analytical experience of many sell-side research departments in recent years as these firms have been forced to cut back on their research budgets to make the economics of their research businesses work. Analyst Accessibility: The flood of research providers and the countless reports they generate has made it increasingly difficult for buy-side money managers and analysts to be able to keep up with the most valuable research. As a result, these clients have come to value analyst access more and more as a means to get direct answers to their most relevant and pressing questions. In addition, the buy-side has traditionally valued the ability to “brainstorm” with experienced and insightful analysts as a means of testing personal investment theses and generating unique investment ideas. This has made an analysts’ communication skills quite important to clients.
Credibility / Integrity: As a result of the slew of research scandals that have taken place in recent years, most buy-side investors rank the credibility and integrity of the analyst as one of the most important determinants of how much they rely on that analyst’s research. This includes the reliability and trustworthiness of the analyst, as well as the unbiased and independent approach that analyst takes to his/her research.
Comprehensive Company / Industry Reports: Although research reports are one of the most visible sign of an analyst’s productivity, the value of these reports has fallen sharply in recent years as clients’ e-mail boxes have been flooded with research. As we have said many times in the past, research reports have merely become advertising for a research firm’s real asset – the expertise of their analysts. However, research reports are also valuable as they are proof that the analysts have done their homework, including having developed thorough financial models of the companies under coverage.
Stock Recommendations / Earnings Estimates: According to many buy-side analysts and PMs, one of the least valuable parts of the external research product are the stock recommendations and earnings estimates produced by most analysts. And while this view is supported by countless interviews we have had with the buy-side, it is always interesting to us that various efforts to remove BUY / SELL / HOLD recommendations from sell-side research has often met with tremendous resistance by clients. Other Value-Added Services Many clients we have spoken with have indicated that the analytical quality of the research they receive is significantly less valuable to them than other, non-analytical services that their brokers or research providers can offer. This includes a variety of services, including: SALESUseful & Timely Calls & VisitsInformation Flow / Market ColorRelevant Trading Ideas OTHER SERVICESManagement AccessConferencesCustom Research Useful & Timely Sales Calls: Most PMs, hedge fund managers, and buy-side analysts have a real problem in that they are trying to cover a large number of stocks with limited resources. As a result, most buy-side professionals find it almost impossible to keep abreast of all of the important developments that take place for the companies of the stocks they own. This is one reason the buy-side relies so heavily on good sales coverage.
Information Flow / Market Color: In addition, the buy-side values information flow and market color from well-informed salespeople. Some argue that much of this information could be privileged insight into what other investors might be buying and selling. However, our experience shows that this “color” is often focused on the news developments and demand drivers that influencing the markets.
Relevant Trading Ideas: Another reason the buy-side values high quality sales support is that good salespeople often generate relevant trading ideas for clients. Many investment banks and brokerage firms produce research on hundreds, or even thousands of stocks every year. However, most clients are only interested in learning about a limited number of “high conviction” ideas that meet their specific investment criteria. Consequently, the salesperson fulfills a valuable filtering function – identifying the few of the best ideas that might be appropriate for any given client.
Management Access: One component of the traditional fundamental research product that many buy-side analysts and PMs value very highly is access to company management. And while management access has recently become less important in some circles, many analysts and PMs still rate this is the single most important part of an external research provider’s offering.
Conferences: Another value-added component of a research provider’s service are the various conferences they sponsor every year. Conferences are important to the buy-side for three reasons. They provide clients an opportunity to brainstorm with analysts, speak one-on-one with company management, and interact with their peers. Custom Research: Some buy-side clients also value a research providers ability to help them test their investment theses by conducting custom research. This might include conducting channel checks, market research on industry trends, or writing other “out of the box” research.
DISTRIBUTION OF RESEARCH The second major determinant of research value is the level of distribution of that research. Conversations with buy-side investors make it clear that the more broadly available the research, the less valuable it is to them. Thus, the most valuable research is the research which is exclusive to only themselves. This is one reason that asset managers and hedge funds have staffed up their own research staffs – to create exclusive research. This is also a reason why expert networks and custom research have become so valuable, as these services provide expertise or research which are available only to one investor. This is one reason that some investment banks have followed the lead of Lehman Brothers and moved some “publishing analysts” to become highly compensated institutional salespeople where they can communicate their best research ideas to clients in a more limited and restricted fashion. Broad-based research, on the other hand, has less value to investors as this analysis, recommendations, or conclusions are available to a large number of potential investors simultaneously. In fact, most sell-side investment banks and broker-dealers have suffered from this problem in recent years as the broad availability of their research reports has depressed the value of their research. In fact, the Merrill Lynch’s Director of Research, Candace Browning argued that many sell-side firms like Merrill have experienced a “Napsterization” as they have lost control of the distribution of their intellectual property. A number of other sell-side firms have silently agreed with Ms. Browning and have taken a more serious look at how they can limit the distribution of their research only to their best paying clients.
RESEARCH VALUE QUADRANT
The discovery of these two primary value drivers has led us to develop a Research Value Quadrant to describe how customers value investment research. This includes:
High Quality / Comprehensiveness – Low DistributionHigh Quality / Comprehensiveness – High DistributionLow Quality / Comprehensiveness – Low DistributionLow Quality / Comprehensiveness – High Distribution The quadrant that includes High
Quality / Comprehensiveness – Low Distribution research represents research that is either exclusive or semi exclusive, including buy-side research itself, custom research, expert networks, and the research offered via other “limited distribution” models. We have discovered that if this research is of high quality, then institutional investors value this type of research the most. Consequently, clients are willing to pay the most for research that exists in this quadrant. It must be noted that “High Quality” represents research that provides both Analytical Quality and the Other Value Added Services that institutional investors require. It also must be noted that firms that exist in this quadrant may not have extremely large research businesses as they constantly fight with the issue of how to scale their businesses when they produce “exclusive content”. The quadrant that includes High Quality / Comprehensiveness – High Distribution research represents the type of High Quality research that is broadly distributed. This type of research, while valuable, cannot support the same price level over the long run that low distribution research can support. This, however, does not mean that firms cannot develop and sustain an extremely viable research business in this quadrant. To do so, firms that exist in this quadrant, must be able to generate sufficient revenues from a large volume of customers. Of course, the bottom two quadrants are — Low Quality / Comprehensiveness – Low Distribution and Low Quality / Comprehensiveness – High Distribution are where less successful research firms reside. Again, we need to be clear that firms in either of these two quadrants could produce extremely good and / or insightful research. However, these firms might not provide the value-added services that buy-side clients value – including institutional sales support, trading ideas, management access, conferences, custom research. As a result, these firms cannot charge institutional investors much for their research. Again, one cannot conclude that firms that exist in the bottom half of the Research Value Quadrant cannot build a lucrative business. For example, firms that focus on producing quantitative or fundamental investment research for retail clients might have a less comprehensive research product and very high distribution. Nevertheless, these research providers could have an attractive research business.
