Research–Do you get What you Paid-for?

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New York – An article in the Vancouver Sun last week talked about the paid-for research model in unkind terms. The issue revolves around firms that are basically marketing the companies they cover.  This resurrects the visibility and vulnerability of the paid-for research model.

Of course, there is a difference between a marketing firm and a paid-for research provider, since many of the paid for providers make an attempt to live within the regulations and best practices. What is surprising is that a large proportion of providers make little or no effort to distinguish themselves meaningfully from marketing firms. To look into the space we looked at the paid-for research providers in our database and did some simple analysis.

In our database there are 49 firms that we have classified as following a paid-for model. Of these, 32 are currently published to the client side of the database, while the others are awaiting more information or clarifications on certain data elements.  Of the published firms, the average number of years in business of these firms is an impressive 9 years, which indicates that the economics of this type of research can work.

Paid For Research Provider Information  
Total Number of firms

49

Total Number of Firms in Active database

32

Firms with Research Disclaimers

21

Firms that Indicate they are Advertising for Client Firms

2

Average Number of Analysts

10

Average Number of CFAs

5

Average Number of Stocks covered

67

Average Number of years in business

9

Number of Registered Investment Advisors

2

On average, each firm covers about 67 stocks with an average of 10 analysts, so the stocks-per-analyst ratio is on par with the top fundamental shops. Also, the average number of CFAs in these shops (5) is high relative to the number of analysts (10). CFAs have attested to the rules and regulations of the CFAI outside of any other responsibilities assumed by the research provider, which means that they have at least a base level of compliance.

When looking at the paid-for firm’s research disclosures on their web sites and we found that only 65% of these firms currently have prominent research disclosures. Two firms disclosed that they are actually marketing the firms they represent, while the rest had language to the effect that they could “not guarantee the accuracy of the data…thought to be reliable…etc.”  While we did get a sense of the strength of the disclosures from an ethical standpoint, we made no attempt to categorize the firms with regard to the strength of their disclosures. Nevertheless, we feel that the best practices in this space should, at the very least, include full and prominent disclosure of the paid-for model.

In some cases there is a good deal of digging to be done to determine that the firm had a paid-for model, while in other cases the firms stated this in the first sentence of the disclosure and the disclosures were accessible directly from the home page of the research provider’s web site.  Only 2 of these firms have taken it upon themselves to become registered Investment advisors and to therefore have fiduciary responsibilities to their institutional investor clients. This does not necessarily mean that the research is less conflicted, since they may be distributing research to different investors than they ones to which they have an advisory role.

One final non-regulatory suggestion for the paid-for firms is to be tracked by an equity research performance firm, such as Investars.  If the research is actually over-generous to the researched companies, then the performance of the research recommendations should be worse than the non-paid-for research providers. Indeed, when the Investars data for these firms is averaged, the performance of the buy – sell recommendation is weaker than the Investars average by a few percentage points. Of the four paid-for firms that are tracked only one has any sell recommendations at all. Of the three firms that only have buy recommendations, only one has a positive 3 year performance.

We have talked in the past about the paid-for model and the fact that while the model is certainly conflicted, if analysts and firms take the appropriate steps, they can add value to both the firms they cover and to institutional investors.  However, given that only 65% of these firms have prominent research disclosures, it would seem that there are a number of these firms that simply have not taken the appropriate steps to protect their reputational integrity.

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