Research 2.0

Friday, May 05, 2006

Turning research departments into hedge funds?

[This was previously posted on another blog and I moved it here where it fits better.]

This my response to a recent FT article that talked about taking all the research analysts producing currently useless content and putting them to work doing proprietary projects for investment banks and hedge funds.


I am responding to your column on April 18th. I've been in equity research for years and a DoR for the last few when I worked for investment banks. (I left to start my own research business.)

You observations regarding the astonishingly vapid quality of what is passed off these days as "research" is spot on. It's embarrassing. One just has to look at the Barron's listing of research report summaries because so many of them read "Company XYZ is doing very well. We remain neutral however because the stock is fairly valued. If the company continues to show strong and improving results in the future we would be more positive." And wouldn't that then be reflected in an even higher share price? Ever hear the idea that the market is a *discounting* mechanism?! It's really ridiculous.

It has always difficult to produce investment research that actually focused predicting the future events for companies and stocks, backed it up with real data and enabled investors to make money. We did it back at SoundView in the 1990's. Of course at the time there wasn't much to get in the way. Analysts were free from logging hundreds of client calls, marketing to be II, playing compensation politics, navigating complex compliance and regulatory requirements and all other forms of wasted effort. Furthermore analysts like myself could "put our money where our mouth was" and invest our own money in our best ideas (after giving our clients all the information with a waiting period.) Analysts were driven to find real investment opportunities instead of covering the news and pushing spreadsheets around.

I could go on enough to fill a book about what it takes to do this right but I can let you know that the conclusion is that it can no longer be done within the structure of a broker or investment bank - at least none that I am aware of.

Your idea about hedge funds makes sense... however: the truth is less than 5% of equity analysts are really stock focused enough to make that work. The vast majority of analysts leave it to others to manage their money or actually put the bulk of their cash in bonds. A few I know invest in blue chip stocks and actively right calls on their positions with a view towards income versus risk. In fact when they are allowed to few analysts actually invest in their own sectors. Many are also terrible portfolio managers and investors when given the chance. Of course there are a few that are and I suspect those are the ones that have migrated to hedge funds.

My biased view is that the way to fix this is to create a wholly new approach to research outside of the broker-dealer, investment banking, regulatory world. If you want research analysts to focus the bulk of their time finding and figuring out great investment opportunities they just need everything else taken off their plate. This includes client marketing, sales and trading support, research reports on news items and earnings releases, meetings with regulators whenever a rating has to be changed, etc.

It's already been a nasty five years but I believe it will still take several more years for such firms (hopefully mine will be one of them) can really demonstrate highly effective research of this ilk and make an impact in the market.

Kris Tuttle
Founder & CEO of Research 2.0