Dissecting Alternative Research
New York—Alternative research is a hot commodity. The 2007 Greenwich Associates US Equity Investors Study shows 39% of buy side analysts expecting to increase usage of alternative research in the next year. Let's take a closer look at the composition of alternative research, and where the growth is likely to be.
Integrity Research has developed a proprietary taxonomy for investment research which defines six major research sectors and over 40 sub-sectors. The six major sectors are:
1. Fundamental— Classic securities research focusing on the fundamental characteristics of the entity issuing the security. Fundamental research firms typically rely on securities analysts for generating research. An important sub-sector are sector specialists—firms which focus on stocks in specific industry sectors.
2. Economic— Firms which provide analysis of economies, markets, or sectors, typically providing "top down" analysis of external trends rather than company level analysis.
3. Primary--Firms which provide investors the ability to do their own primary securities research. Examples include expert networks, channel checkers, market research, access to management and search-based research.
4. Quantitative—Quantitative research firms rely on models to analyze securities. Quantitative firms typically use large databases, cover a large number of shares and generally offer less analytical interpretation than fundamental firms.
5. Specialized—Research firms which offer a particular type of research, typically focusing on a specific facet or discipline. Examples include forensic accounting, earnings quality, ESG, Corporate Governance, Insider Analysis, Patent Analysis, Mergers/Risk Arbitrage, Spin Off Analysis, among others.
6. Technical— Concentration on price patterns, including oscillators and momentum measurements, to analyze stocks. The intent of technical analysis is typically to determine the supply/demand for particular stocks. Technical indicators are more concerned with market timing rather than valuation.
If we look at the composition of alternative research, we see that Fundamental Research, including sector specialists, represents the largest sector, but, surprisingly, not the majority. Keep in mind that if we were looking at the composition of the entire research landscape—including investment banks—Fundamental Research would represent the dominant majority. The data driving this chart are Integrity's estimates of spending by research sector, derived on a bottom-up, firm-by-firm basis. If we included investment banks, Fundamental Research would represent 85-90% of the research spending.
In the alternative research world, however, Fundamental is the not the majority, and its growth is being far outpaced by other sectors suggesting that on a relative basis its share will decrease.
The fastest growing areas of alternative research are Primary, Specialized and Economic Research. Our forecasts for Primary and Specialized include healthy double-digit growth over the next five years, driven by increased buy side spending on internal research capabilities and hedge fund demand. The economic sector's outlook is generally good, but best for specialist economic firms such as policy, political risk or country risk firms.
In summary, the fastest growing areas are those which are most differentiated from the research offered by investment banks (that is, fundamental research). We can expect this trend to continue, especially since the investment banks themselves are beginning to diversify their research offerings. Alternative research will continue to be the laboratory for innovation and new approaches, so we will likely see new types of research emerge over the coming years. Overall, growth in the alternative research space is being driven by a number of factors ranging from buy side demand to cost factors. We'll look at this in more detail in future pieces.
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Posted at 08:49 am by Sanford (Sandy) Bragg
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