Will Primary Research Remain Primary?


New York – Primary research has been a key driver of the growth of the alternative research industry. Primary research represents nearly one quarter of alternative research revenues, and has been increasing at a double-digit pace. Will this continue in the current environment, or will primary research prove to have been a passing research fad, going the way of hula hoops and large investment banks?

One of the key factors in the growth of primary research has been the buy side investment in additional research staff. That investment is going into reverse, and the only question is how deeply will investors cut their research staff. Hedge funds have already begun to cut, or in some cases, fold their operations altogether. Larger firms have been slower to cut research, but it may only be a matter of time. Fidelity made a $100 million commitment in 2005 to expanding research staff to 500 analysts as of April of 2008. Initial cuts by Fidelity were in back office and support staff, not investment personnel, but as the markets continue to languish, Fidelity may begin to pare back its analysts.

The original catalyst for the growth in primary research was the implementation of Regulation Fair Disclosure (Reg FD) in late 2000. Reg FD had a profound impact on the research process, which previously incorporated insights that sell side analysts received from company management. Reg FD forced the buy side to increase the level of its own research, hence the growing demand for primary research tools such as expert networks and channel checkers.

Reg FD isn’t likely to be rescinded, so structurally the question is whether the research process will alter as a result of market distress. We don’t think it will. Expert networks in particular are deeply embedded in the research process for many firms. According to the COO of a major hedge fund we spoke with last week, the firm is more likely to cut its allocations to the sell side rather than its spending on expert networks and other alternative research.

At last week’s AQ Research ‘Masters of Change’ conference, Bloomberg presented the results of a recent survey of 1000 buy side clients which indicated that 63% of respondents plan to increase their spending on alternative research. We interpret this as an increase relative to spending on sell side research, rather than an absolute increase in spending on alternative research. In this environment, spending will be down across the board.

In talking to expert networks, channel checkers and other firms that provide tools for primary research, they acknowledge that the sales environment has become much more difficult. As hedge funds close and consolidate, this impacts existing revenues of primary research. However, we also see that primary research firms are still investing in new capabilities, ranging from infrastructure to improve billing processes to compliance capabilities to geographic expansion. Expert networks in particular are expecting to grow, but not at much lower rates than previously. Our forecast had single digit growth in 2008 followed by low double digit growth the following years. We were probably too early in our forecast-the more likely scenario is single digit growth in 2009 followed by high single digit/low double digit growth as markets recover.

The risk to this forecast lies in how deeply the buy side restructures. Clients of long/short hedge funds and long only equity funds can be forgiven if they question how effective the current research process has been, or whether buy side analysts are truly adding value. Suzanne Duncan of IBM, a speaker at last week’s AQ conference, predicted that institutional assets will shift over the next decade from 90% actively managed to 90% passively managed. If correct, the impact on investment research would be huge, and the only way for primary research to continue to grow would be to dramatically expand its share of research spending. This is not out of the question. Primary research can become the primary form of investment research, but many obstacles remain.


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