Research Economics meets Technology


New York – We have indicated on these pages over the past few years that the sell-side research model was broken and that alternative research and buy-side internal research staffs would gradually take up much of the slack. As such, the economics of the research industry strongly point towards greater buy-side research and alternative research in the future, at the expense of sell-side research departments. However, economics have not been enough to make this transition possible for many buy-side firms.

The problem for the buy-side is the fear that by engineering their own solutions to this research conundrum, they would be at risk of missing some vital, perhaps even obvious piece of information. But now, technology has made the pursuit of specialized information more accessible to all investors, including the buy-side. Companies like firstRain, Connotate and Relegence have developed a type of web-crawler application that can track information on public and non-public websites and sort it by level of relevance.  And these types of technology are beginning to create the next wave in the information technology space.

The combination of economics and technology has created an environment where the sell-side research model could erode at an accelerating pace.

Still, the sell-side is crafting its response to these forces, by creating research platforms and prime brokerage services that make their services more “sticky” for the buy-side.  Some sell-side firms have been busy taking strategic equity stakes in these new technologies. For example, Goldman is has recently taken an equity stake in Connotate and has been awarded a seat on Connotate’s Board.

We include the article below:

Many Buy Siders Are Taking on the Role of Researcher
Some buy-side fims have stopped using sell-side research in favor of search applications such as firstRain.
By Ivy Schmerken
Wall Street & Technology
February 15, 2007

While many buy-side institutions continue to try to place a value on sell-side research, others are beginning to do their own research and are starting to cut sell-side research out of their planning entirely. “We don’t really rely on the sell side,” says Charles Frumberg, founder and managing partner of Emancipation Capital, an activist value hedge fund.

“If you are a direct institutional investor, you either have a methodology that allows you to do your own work, or you’re in a heap of trouble,” continues Frumberg, who had a long career on the sell side as cohead of equities for SG Cowen Securities Corp., and as director of U.S. equity research and cohead of global research at UBS Securities. “To rely on the sell side is just not a viable investment strategy.”

In Frumberg’s view, the sell side has been disintermediated over the past five years by regulations put into effect in the post-Enron and WorldCom environment. First, he points to Regulation FD, which requires public companies to provide information to analysts evenly. As a result of the mandate, Frumberg says, the corporate world stopped providing any information, thus making it more difficult to be a sell-side analyst.

Second, according to Frumberg, the separation of research from investment banking cut off the funding. A third issue is the pricing, forcing the sell side to unbundle the services it provides to the buy side. All of these factors combined have led to a flight of financial and intellectual capital, according to Frumberg. While “the sell side had questionable value for a long time, its marginal value is greatly diminished,” he says.

For this reason, Frumberg began using firstRain, a search-based application that trolls the Internet looking for information across a wide variety of sources, including blogs, corporate Web sites, obscure trade journals, FDA drug trials, litigation filings and more. “We use it more for stocks that we already own,” explains Frumberg. “But we do use the inputs to shape our opinion, and that’s really the name of the game. Can you find that incremental piece of information that helps you with your investing?”

Delivered as a hosted software model, the company configures the system so that portfolio managers and analysts spend about 15 minutes with the company to indicate which companies and trends are of interest to them.

“The real value out of the product is the input you provide at the outset — the list of names, what sort of sources — which defines the ecosystem (i.e., companies, major suppliers and competitors) you are looking for without being very specific,” Frumberg says. “And the company does a very good job of piecing together the pieces of that ecosystem.”

“The problem for the buy side is time and how to deal with the information overload,” says Penny Herscher, president and CEO of Foster City, Calif.-based firstRain. “The results are delivered through e-mail before the market opens or at some frequency during the day or via a portal.”

Ultimately, Herscher adds, firstRain’s goal is to change the status quo. “The cost of doing nothing is missing information about your investment, which for the buy side is a nightmare,” she says.


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