The Tech Squeeze on Research

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New York-Sunday we wrote about the triple whammy that is hitting sell-side research: falling commissions, undifferentiated research product, and greater commissions transparency.  Today we look at another factor: technology, or, more precisely, technology’s democratization of both the production and distribution of research.  Although more subtle than the first three factors impacting sell-side research, technology’s impact will be no less profound.

Child Labor

Look no further than yesterday’s analysis of Chipotle’s latest earnings release on Yahoo! [click here to view] The piece covers what institutional investors want to know: analysis of the earnings release and management guidance with the analyst’s own interpretation and projections.  The piece is comprehensive and well written.  It has passion and conviction backed by a clear articulation of the buy rationale.

Was this analysis posted by a sell-side analyst?  Not exactly.  The author is a fourteen year old ninth grader from Nevada City, CA.  Motley Fool was going to hire him before they realized they would be violating child labor laws.

How did he get to be a security analyst featured on Yahoo?  Here we get to the distribution part of the equation.  Our fourteen-year old security analyst is one of the approved contributors to Seeking Alpha, a blog aggregation platform started by an ex-Morgan Stanley telecom analyst.  Seeking Alpha looks for good opinionated research by applying a set of editorial guidelines to financial blogs and other potential contributors.  The guidelines include a fairly rigorous set of disclosures, including personal stock positions and any conflicts.  Seeking Alpha is targeted to institutional investors and invites hedge funds to contribute (provided they abide by the disclosure rules.)

Impact on Sell-Side Research

Seeking Alpha is a good illustration of how economic forces are changing the production and distribution of research.   The democratization of research distribution is identical to the “Long Tail” forces that are transforming music or book distribution.  Wall Street no longer controls the research shelf space, and is losing market share to outsiders.

Why would hedge funds pay attention to a ninth grader?  This is an extreme example, but we hear portfolio managers and analysts consistently complain about the narrow dispersion of Street opinions and forecasts.  Hedge funds are looking for the outliers, and there are few to be found on the Street.  Street research is highly constrained by the compliance processes put in place three years ago.  The buy-side is increasingly looking in the long tail for diversity and fresh insights.  A platform like Seeking Alpha attempts to filter out some of the “noise” in the long tail of research, reducing some of the negatives that accompany the long tail: uneven quality, little or no regulation, an overwhelming volume of content.

Whether or not Seeking Alpha flourishes, others like it will.  The “Long Tail” phenomenon will impact Street research just as Amazon has transformed the book industry or downloads are changing the music industry.  Sell-side research will have to adapt to the changing forces of technology even as it is coping with the stresses of declining commissions and increasing commission transparency.  Not an easy task.

[For a complimentary copy of our white paper, The Long Tail of Research, write to info@integrity-research.com.]

Comment by Paul Ciasullo:

I wanted to comment on a recent your post mentioning SeekingAlpha and its identification of “research” for its site through a screening process in order to validate and editorialize content. You couldn’t describe it more accurately, but there are more sources then just the 200 SeekingAlpha identified. I think that the real challenge is not just finding good information (difficult enough), it is filtering it and prioritizing it and validating it.

At Soleil Securities Group, we’ve been working with Collective Intellect (www.collectiveintellect.com ) to develop a distribution process to institutional equity investors for their Media Intelligence research tool. Collective Intellect (CI) is one of a number of companies trying to identify and deliver relevant media information to investors. They’ve already identified some 25,000 locations of good online blog and other Internet content, a number expected to double in the next 6 months. That implies literally thousands of potentially good information points daily that are automatically tagged to particular stocks for delivery to subscribers. The data available already is much too large for any portfolio manager or research analyst or trader to process. And it is growing. CI uses artificial intelligence in language recognition algorithms to tag information to tickers automatically. But it also employs a human filtering element to pick out the best information and editorialize or validate some of it with a unique ranking capability that allows subscribers to see the information in which they would be the most interested. The idea is to give investors the best nuggets so they don’t have to waste time trying to comb through the enormous volume of content.

There is also valuable information sometimes in local news sources or even on company websites that aren’t always delivered to the newswires. Not only is the tail very long and getting longer, but an industry is springing up to bring it to customer desktops. The devil is in the detail of prioritization of relevant information.

We see inexorably greater facility for payment of non-traditional sources of research with CSAs and with 28(e) now clearly establishing the legitimate use of soft dollars to purchase research. This may be truly the beginning of a “destructive technology” revolution for knowledge delivery not only to the financial community, but to information consumers irrespective of their profession.

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