Paid-For Model in 08


New York – Now that the large cap companies, particularly the financial firms, are hunting for capital instead of buying back shares, the question becomes, what happens to the small cap companies seeking to tap the market? We know that the small-, micro- and nano-cap firms already have a difficult time issuing equity and the focus of the larger firms will potentially squeeze even more juice out of the market. Will this competitive pressure rekindle the paid-for research model?

There is certainly a need for research coverage among the myriad of small cap companies that exist in the market today. In fact, Integrity research issued this summer a report on the US small cap equity research industry. But this is not the topic of our missive today. Today, we are going to discuss the paid-for research model. Specifically, where is the model headed?

There are 43 paid-for equity research shops in our database. In fact we added a new paid-for firm this week called Pitre Equity Research.

Paid-for research depends upon two key factors. First, there needs to be adequate demand from small cap companies and money managers to support the business. Second, the model and its obvious potential conflicts, needs to have enough controls and/or evidence of solid recommendation history, to allay the fears of institutional investors.

Paid-for Demand

First we need to clarify that the small caps are adequately covered by quantitative research and other systems that utilize data sets to assess health or future share price direction. To be effective, however, companies need to be covered by at least three analysts be said to have “adequate coverage”.

With the big boys hunting for capital and the CSA model tending to concentrate trade flow with the bulge bracket firms, the sell-side continuing to reduce coverage and research staffs there is clearly an increasing need for analyst coverage from other sources. Hence the demand for good paid-for research has probably increased over the past two years.

Finally, its that time of the year again when traditionally investors sell their losing stocks and buy back in at cheaper prices in January. This impacts smaller cap stocks more than the mid and large caps. This movement should be exacerabated this year by the weakness in stocks in general.

Paid-For Supply

The obvious desire for money managers to have no conflicts in their research alongside expected increased in demand created several firms that were in the business of paid-for risk mitigation. Of the four that we now of, at least two of them are gone.

The market continues to be dominated by smaller shops with a solid reputation and track record. Here, there may be no protection or policy that protects or confirms the unbiasedness of the research. Over the year, we have been able to assess the recommendations of these shops, only if they have been covered by an equity research performance measurement system. Investars has an excellent dataset pf performance that could indicate, over the full course of a business cycle, whether the recommendations have paid off or not for the paid for shop.

In addition, investors seem somewhat more at ease if the analysts have professional designations, such as CFAs, since this implies that they are at least bound by the rules of the CFA organization.

In light of the demand and supply conditions in the current market, we remain cautiously optimistic that the paid-for model will continue to gain traction with the small cap firms. However, over the longer term, it will be incumbent upon the paid-for research provides to have adequate controls in place and for them to demonstrate that their recommendations are fruitful in up markets and in down. 


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