Paris-based research portal Alphametry published a whitepaper on assessing research, one of the new research procurement requirements under MiFID II. The paper promotes a research valuation approach based on ratings generated internally by asset managers.
Authored by Alphametry co-founder Fabrice Bouland, the paper argues that asset managers will need to structure their procurement process more formally. Budgeting at the strategy level will entail mapping and segmenting the different types of needed research and having a specific action plan for each research type. Purchasing practices will involve developing selection processes for each type of required research, establishing written contracts for the research services, and maintaining a quality control process.
A more structured procurement process implies more attention paid the characteristics of the research providers, such as the research methodology used, information inputs used in the research, organization size, analyst quality, and research product.
Research Procurement Best Practices
Nevertheless, Bouland acknowledges that research does not lend itself easily to formal procurement procedures. One challenge is that research can take many forms — written documents, valuation models, analyst or investor meetings, idea generation and recommendations sent by the sales teams, to name a few.
Also, research value can vary by customer. Different stages of the investment process value different types of research, from idea generation during early stages to due diligence in final stages. Market cycles can affect the value of research, cycling through sectors of interest or impacting the importance of short ideas versus longs. Even bad research can have some value in shaping a portfolio manager’s perspective or adding market color.
The paper attacks broker vote systems arguing that they do not assess the value of research in monetary terms but allocate payments as a percentage of the brokerage commissions. Votes are calculated based on commission volumes and do not correlate to research needs. Moreover, broker vote systems are ex-post, whereas regulators expect research procurement to be ex-ante.
Ultimately research value comes down to the analyst, but assessing analysts is not straightforward. The paper is critical of existing analyst rating systems such as Institutional Investor’s surveys, awards given by the Wall Street Journal and Extel’s surveys.
The paper posits the creation of a rating process which might evaluate analysts along various dimensions, such as the components which define the UK Financial Conduct Authority’s definition of ‘substantive research’, such as original thought, intellectual rigor, critical approach, etc. If asset managers implement their own rating systems, Bouland raises the possibility that they might share those evaluations with competitors to develop broader sets of inputs.
Online ratings systems are likely to emerge to assist the industry (not surprisingly Alphametry is working on developing a rating process.) Successful research distribution platforms will network users rather than simply pushing content (a dig at some of Alphametry’s competitors). Alternative data will transform fundamental research.
Alphametry’s whitepaper is thoughtful and well-argued. The primary agenda seems to be to lay the groundwork for offering tools to help asset managers develop internal rating systems. We suspect we will hear more from Alphametry on ratings systems later this year. Substantive Research, a curator of daily macroeconomic research, recently launched its own rating system intended to help the buy-side find research of interest.
We believe the paper is too dismissive of broker voting systems, which can be adapted to a budget process. Some asset managers already set an a priori amount for their voting, assigning specific values to each vote and allocating a pre-defined budgets to each voter. It is also likely that currently bundled research will have an initial subscription value, but the bulk of the payments will continue to be ex-post, delivered through upgraded broker voting systems (rebranded as research valuation systems).
Nevertheless, ratings can be integrated with the new, improved broker vote process. There is nothing to preclude votes being driven by ratings systems. The two approaches are not mutually exclusive, and it would not be surprising if we see a future not unlike the one outlined in Alphametry’s whitepaper.