The following note was provided by Todd Enders, who recently joined Research Edge, an alternative research provider founded by an ex-hedge fund portfolio manager. Todd brings a left-coast perspective to the research marketplace which we thought our readers would find interesting. His full bio is listed at the end.
I’m a Silicon Valley guy who has spent most of my career marketing to large corporations. When I was invited to join an up and coming alternative research provider to the buy-side (FirstRain) just over 3 years ago, I got dropped cold into the world of institutional research. The timing couldn’t have been better — sell-side business-stresses were pushing down the quantity of company coverage, and the web was making market moving data increasingly pervasive and free. When joined my old friend Keith McCullough at Research Edge this Spring, I realized that the changing research model was a natural progression of what has also been driving FirstRain’s growth — and more strikingly, the technology sector’s growth for decades — outsourcing. Talking with Sandy Bragg about this a few weeks ago, he asked if I would guest-blog about what a “former outsider” sees.
Mostly I see continued pressure on the sell-side research model. Integrity Research has been covering how this pressure drives growth for “Alternative Research,” but this time it’s different. No longer backstopped by the Global Research Settlement’s subsidies, a renaissance of outsourced research is emerging under its own steam — and to the buy-side’s benefit. Ivy Zellman at Zellman & Associates has a sterling reputation in housing. Ed Wolfe at Wolfe Research offers a deep team on the transportation segment. Gerson Lehrman Group has made outsourced expert networks standard. It seems like a week doesn’t go by without another outsourced research boutique launching. See “Where the Bears Are” March 18th http://www.integrity-research.com/cms/2009/03/18/where-the-bears-are/.
I have struggled to figure out why outsourcing should be emerging at scale now in the investment research world. The answer from my friends on the buy-side and sell-side has lacked clarity as to why, much less why now. By contrast, now that I’ve joined Research Edge, which has hired more than 10 former sell side and buy side analysts over the last 11 months, it has become obvious how different the focus and methods of top analysts are in an outsourced shop. I’ve observed healthcare analysts being heavy users of expert networks, and technology analysts seeking data at a much higher rate. Footwear and Apparel teams focus on channel checks. Gaming and lodging have unique geographic factors combined with a debt / cashflow cycle that can overwhelm all other factors.
The common thread emerges that the renaissance of outsourced research is specialized. For a Silicon Valley guy, it’s a familiar pattern. 15 years ago, corporations owned most of their manufacturing capacity, ran their own data centers and networks, built their own software, and even managed their own benefits processing. All of these are now outsourced, and capital is more efficient for it. Outsourcing lets companies focus their spending on core business areas, while lowering costs and improving control over non-core spending.
However, while this notion looks good on paper, it is the specialty outsourcers that first gained ground with global corporations. Their specialized focus kicked structural change into gear: whether PeopleSoft’s human resources applications or SAP’s manufacturing tools — specialization allowed global corporations to see enough of a specific benefit to move from manual, in-house processes to best-in-class outsourced ones.
For investment researchers (who have cheered outsourcing all the while) the trend has finally come home to roost. Where vast, comprehensive banking giants muddied and tangled the chain of value between banking, research, and trading; Reg FD, unbundling and the Global Research Settlement laid the groundwork for a New Reality — one which the recent credit crisis has caused to explode.
And it’s already paying off. Unbundling cleared the fog and illuminated paths for outside research to deliver the highest value to asset managers. With outsourced research, free-market competition drives providers to deliver the sharpest edge possible for a given domain. The obvious next question is about the lesson this holds for the buy-side.
Neither portfolio managers nor buy-side analysts are likely to be outsourced anytime soon. But even a large firm can’t make the economics work to hire deep expertise on global restaurants, or a senior team with 20 years of global commodities experience. More obviously, only a handful of buy-side firms can afford to build and maintain a proprietary expert network, or deploy the technology required to keep up with high-frequency sectors like technology, healthcare IT, or a dozen other wildly dynamic industries.
To give you a taste of what the old research model looks like, I’ll describe a simple scenario. A large clothing company is raising money and makes its way into your firm to do a presentation. During the next 20 minutes, the CEO describes his plans to build and staff all of his own manufacturing capacity, an in-house program to manage temporary labor, its own custom software to run the payroll, and will immediately begin laying its own fiber-optic network to connect its offices with each of its customers. It sounds funny when you put it that way, doesn’t it?
Todd A. Enders is VP, Marketing at Research Edge, an outsourced investment research firm that delivers actionable investment ideas to a limited number of clients through a combination of Macro analysis with fundamental, sector-specific research. Prior to joining Research Edge in 2009, he was head of marketing for FirstRain, a leading search-based research firm. Todd was Director of Product Strategy at Oracle and was a product manager for Primavera Systems and Evolve Software. He is a graduate of Yale University and lives in San Francisco.