New York, NY – In recent years, many financial market participants
have discussed how accessing “dark pools” of liquidity have become
increasingly important for buy-side clients looking to achieve “best
execution”. However, a small but growing number of institutional
investors have come to realize that “dark pools” of research also
exists. Consequently, finding ways to access these sources of unique
and exclusive research has become an important part of helping these
buy-side investors locate identify and leverage sources of alpha.
Definition of Dark Pools
According to Investopedia, “dark pool” is a slang term that refers
to the trading volume created from institutional orders which are
unavailable to the public. The bulk of dark pool liquidity is
represented by block trades facilitated away from the central
exchanges. The dark pool gets its name because details of these trades
are concealed from the public, clouding the transactions like murky
water.
While this term has traditionally been used to describe “hidden
liquidity” when speaking of private execution venues, it could also be
used to discuss restricted or hidden industry expertise or sources of
investment research.
Pareto’s Law
Interestingly, some institutional investors believe they know of all
the best sources of industry expertise and investment research. After
all, these money managers argue, don’t the largest investment banks and
most well-known alternative research firms actively market their best
research to the buy-side?
And while this is true, what these managers don’t know is that they
are seeing only the top 80% of all investment research and industry
sources. Unfortunately, 20% of the best providers rarely if ever
provide their research and expertise to a large universe of mutual and
hedge fund managers. The following is a partial list of some of these
“undiscovered” sources of research and insight.
Industry Experts / Consultants
The first obvious source of expertise that has become a “hot button”
topic for many investors has been sources of “industry experts”. As we
have discussed in past blogs, the team at Integrity Research Associates
has identified 26 Expert Network providers (though we also know of at
least half a dozen firms that are working on new offerings in this
space). And while it is true that the top seven firms generate 90% of
all industry revenue, investors remain interested in finding high
quality sources of unique industry experts.
It is also interesting to note that many industry consultants we
have spoken with over the past year rarely if ever sell their advice
and expertise to the buy-side. Instead, these experts sell their advice
back to the industries they cover. Of course, these consultants would
be extremely interested in providing their expertise and industry
research to this marketplace. Unfortunately, most of them don’t
understand the needs of institutional investors and they don’t know how
to translate their deep domain expertise into insight that might be
relevant to a sophisticated investor.
Restricted Investment Research
In the past few years, a number of research providers have decided
to build business models around the client demand for “proprietary”
content. As a result, these firms have decided to limit the number of
buy-side clients who can purchase their expertise. And while none of
these firms have moved to an “auction model” to value this research,
most have charged their clients a significant premium to gain access to
this restricted content.
It is important to note that most of these providers of “restricted
research” typically are not interested in becoming well known.
Consequently, they don’t market themselves aggressively and they try to
stay “fly below the radar”. In fact, many of these firms have
specifically asked the team at Integrity Research Associates not to put
them into our commercial database, and to recommend to a limited number
of clients who fit a specific profile. And while we have complied with
these requests, we do keep records of these firms so we can recommend
them to specific clients who might make sense to the research provider.
Custom Research
Another source of “dark pool” expertise is custom research produced
for a small number of investors. And while this type of research can
take a variety of forms, one of the most popular forms of custom
research is based on data gathered from primary interviews (channel
checks, industry market research, and other custom survey work).
Work we are currently conducting for a new ResearchFocus
report on channel checks reveals that slightly below half (49.6%) of
all buy-side investors surveyed indicated that they conduct regular
channel checks. Of this group, 31.7% use an external channel checking
service to augment their internal primary research capabilities.
The buy side cited a wide range of reasons for valuing channel
checking. Many indicated that channel checking is a great way to get
in-depth insights on industry trends, which can help with supply and
demand forecasting. Many others indicated that channel checking
provides company-specific insights from company insiders or industry
participants close to the company in question, which can help with
forecasting earnings or understanding company issues. Some cited the
independence of channel participants as an incentive for contacting
them - often, channel participants provide opinions that are out of
consensus with the opinions of company managers and Wall Street
analysts. A small number of respondents specifically said that channel
checking was a primary mechanism by which they generated new investment
ideas.
New and Innovative Sources
Another source of “dark pool” research and insight can be found in
new and innovative providers. Integrity has had the unique opportunity
to discover dozens of new research providers before they have
commercially released their products to the buy-side as they have
contacted our team of analysts to discuss current demand trends in the
industry. In addition, we have helped many firms that produce research,
consulting, databases, and other analytical tools for other markets
understand how they might serve long only asset managers and hedge
funds.
Of course, part of Integrity’s business lies in helping clients who
come up with new and innovative ideas to find relevant suppliers of
data, industry insight, software, etc. In many instances the clients
have defined a new type of content they want to evaluate, and we have
found them a variety of suppliers to meet their needs. Often, the kind
of content clients are seeking out are completely new sources of
“insight”.
So What?
The ultimate consequence of this trend is that buy-side investors
have more and more sources of high quality expertise, insight,
research, data, and analytic tools to include as part of their
investment management process. The problem is that many of these
sources are not easy to find as they don’t promote themselves to mutual
and hedge funds. However, therein lies the beauty of these “dark pool”
sources, as the value of this content is typically not discounted into
the current market.
This topic, and many others will be discussed at the upcoming AQ
Research conference called Reinventing Research that is slated to be
held at Dexter House, Royal Mint Court, Tower Hill in London, this
Tuesday and Wednesday, April 1st and 2nd. More information about this conference can be found here.
