When we left the broker-dealer/investment bank universe of equity research we could certainly see the industry would have to work through a large and painful transition to a set of new products and business models.Â Given the huge size of the "industry" our guess was that it would take 10 years to work itself out.
When we saw news of unbundling and new funding for research startups several years ago we thought that changes might start to come quickly.Â These initial positive signs seemed to just die out.Â Recently we mused that we may have been off by a factor.Â The industry seems like it may need 20 years to things out.Â After going back to the drawing board we have decided to stick with the 10 year forecast but admit that it’s going to be as back end loaded as an enterprise software quarter.
Thanks to a number of industry changes in the broker-dealer/investment banking world we are now getting the "Street" research we asked for.Â That is, no research at all.Â The lack of value has only helped to accelerate the devaluation of the work product and create a pervasive unwillingness to pay for research in general.
Today the only high returns available from quality investment research come from investment management fees.Â This is why so much of the growth in research staffing has been on the so-called buy-side over the last five years.
It’s true that there have been some new and successful models.Â The most well-known and now broadly imitated is Gerson-Lehrman.Â Although their use of an expert network available to investors is fairly obvious and has been tried before, their structure of nearly all variable cost business model have been the key factors that have made them successful.Â There are also hundreds of small independent research shops focused on verticals or other data segments that have been able to build reasonable though less famous businesses from the institutional investment community.Â
Â That said we are still sitting in a transition stage where the basic value proposition for sell-side investment research is seriously in question.Â There is no better testament to this than the recent restructuring moves at Morgan Stanley.Â Â In the face of serious progress in their research ranking (moving from #8 to #6) in the widely respected Greeenwich Associates study, they have terminated a large number of their senior research staff.Â
In several large coverage areas: oil and gas E&P, health-care services, and automobiles and components, the analyst teams had vaulted from rankings in the pack to #1 or #2 before being fired.
Imagine their surprise… you work for years at Morgan Stanley, crank away and in the year you break through to be the #1 coverage in your industry… they fire you along with several others who obtained the same success.Â Â If that doesn’t send a message of "research isn’t worth anything" I don’t know what does.
It also says that we are very much in the same place that we were for broker-dealer research back in 2003-2004.Â During that time a huge investment in research on the part of what was then Adams, Harkness and Hill was undertaken.Â Despite a new focus on improved research and a big ramp in the number and quality of the analysts, it didn’t move the needle.Â Â It makes no sense to invest heavily in an aspect of the business that clients are either unwilling or unable to pay for.
Where does that leave us in 2008?Â We have some uncertainly as to picking the starting year for this 10 year transition.Â It was probably 2000 at the earliest and 2004 at the latest.Â We do see some clear and undeniable evidence that industry conditions might be improving.Â (Not for research at brokers or bankers but for independents.)Â That would put our 10 year transition into 2010 or 2014.Â Based on some of the things we are seeing we are expecting it to be closer to 2010.
Some investors are getting smarter.Â They are beginning to understand that they need to look beyond the consumption of analyst reports and meetings with company management if they hope to outperform.Â Under-performance has become more of a problem thanks to increased transparency and the rise of easy alternatives like ETFs.Â At the same time many firms are introducing new and useful research products based on data and facts that can be tied directly into business trends and future shifts in company fortunes.Â Â We’ve also seen a dramatic increase in the straight up payment for research versus so-called soft-dollar on trading commissions.
We’re working with some of these emerging data and fact-based research organizations to incorporate their information into products that are unique and of great value to institutions.Â By combining proprietary and meaningful data, industry expertise and insight, and financial/stock analysis we generate the type of product upon which performance-enhancing investment decisions can be made.Â It takes all three.
In conclusion the move by Morgan Stanley may mark the turning point for research.Â It signals that the current system is so broken that what is touted as a great success leads to the elimination of the effort.Â Reportedly Morgan Stanley is even taking a pass on subscribing to more detailed information about how their research group is performing.Â Adding a form of "we don’t care" to "it doesn’t matter."
To anyone not familiar with the modern sell-side research effort in a broker dealer, getting to be the number one team involves covering the largest and most well-covered stocks in a group and then setting out to market yourself to every large institution to that votes in the annual survey.Â It’s a ton of work.Â One has to be up on every blip and nuance surrounding an industry or a stock.Â It requires encyclopedic knowledge and hundreds of calls a week to voting institutions.Â Of course this leaves little, if any, time for actual research, finding new ideas, helping people really make money in stocks.Â But then again that’s the sell-side research we deserve.Â At least Morgan Stanley has made some moves that might bring the charade to an end.
— Kris Tuttle