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Alpha Capture Systems Measure the Value of Sell-Side Trade Ideas

To drum up commissions, sell-side sales professionals increasingly are communicating trade ideas to buy-side clients via alpha capture systems such as youDevise's Trade Information Monitor, which provide performance metrics around the trade ideas.

The Evolution of Alpha Capture

After Marshall Wace kick-started the evolution of alpha capture systems, a consortium of four major brokers -- Citi, Credit Suisse, Dresdner Kleinwort and Merrill Lynch -- founded Trade Ideas Limited (TIL) with the idea of creating a central routing hub to enable sell- and buy-side firms to send and receive trade ideas regardless of their internal alpha capture systems. In 2005 the brokers commissioned

Approximately 4,300 professionals at 150 buy-side firms and 350 sell-side firms currently utilize the TIM alpha capture system to access the RDC, representing an increase of more than 50 percent in the past year, according to youDevise. Brokers pay youDevise a subscription fee for the service, but buy-side firms receive the service for free if they have an existing relationship with the sell-side firm. "The buy side pays commission to the brokers based on performance; the brokers pay a small fraction to us based on a fee we charge by user," youDevise's Berthoud relates.

Over the past few years, other alpha capture systems that aggregate and value trade ideas have sprung up. Denise Valentine, senior analyst at Aite Group, wrote a research report in 2008 categorizing vendor solutions as "aggregators" of independent or broker research, pointing out that some combined both types. Valentine noted that the concept of TIM is similar to other research delivery mechanisms, such as Jaywalk, which creates performance metrics around independent research reports. Other top aggregators include StarMine, which was acquired by Thomson Reuters and ranks the accuracy of analysts' earnings estimates, and First Coverage's Community Web-based platform, which features approximately 250 sell-side firms that contribute information, including research and sell-side trade ideas, to the buy side.

But Berthoud insists that youDevise's TIM has become the largest provider of trade ideas transmitted from the sell side to buy side firms. "Because these are community-based systems, the brokers tend to migrate to a single system," he says, claiming that 60 percent of the trade ideas that pass through vendor alpha capture systems are delivered via TIM.

Where's the Value?

TABB Group's Rowady acknowledges that there is a lot of value in the aggregation of sell-side trade ideas for pattern recognition and identifying trends, such as a preponderance of buy or sell signals or the movement in or out of a particular sector. For instance, youDevise publishes a weekly sentiment analysis quantifying the percentage of new trade ideas from U.S. and U.K. brokers that are bullish or bearish on stocks or certain sectors.

But Rowady cautions that there may not be room for several players in the alpha capture space. He doesn't see the sell side committing to the administrative burden of adding trade ideas, which he says largely is a manual process, to more than one or two of these systems unless the process is automated to some extent.

Aite Group's Valentine, however, questions altogether the value to the buy side of pushing sales teams' trade ideas via alpha capture systems. She suggests that the sell-side salespeople have an ulterior motive in promoting trade ideas: to generate commissions. "It may be that this helps the sell side more than the buy side," Valentine comments, noting that alpha capture systems also provide sell-side firms with feedback on how well their research and recommendations are performing as well as on the market's perception of them.

Indeed, Collins Stewart's Fraser confirms the value of alpha capture systems to the sell-side business. YouDevise's TIM, he relates, affords Fraser with efficient exposure to clients that he otherwise might not have access to. "I do send ideas out to groups," he explains, adding that the audit trail provided by TIM also is valuable.

YouDevise's Berthoud acknowledges the benefit of alpha capture systems to sell-side firms. "For once it's the salespeople who are [generating] money for the firm, rather than just the sales traders who are executing the deals," he says. But he argues that sell-side sales forces also are a valuable source of trade ideas for the buy side.

"They're the sharp point of all the economic briefings they're getting, and they know the client and put together ideas that are tailored for the client," Berthoud contends. "They may come out of a morning meeting, hear what the analysts say and then add their own ideas."

The question is, do those ideas truly add value to the sell side's relationship with the buy side?

The Genesis of a Trade Idea

Stuart Fraser, head of alpha capture at U.K. institutional broker Collins Stewart, leverages youDevise's Trade Information Monitor (TIM) alpha capture system to push out trade ideas to his buy-side clients. According to Fraser, he enters ideas on U.K. and European stocks prior to the opens of the London Stock Exchange and the New York Stock Exchange. But where does he get his ideas?

Focusing on the top 150 European names (out of 350 in his firm's database), Fraser says he culls his trade ideas from various sources, including Quest, the brokerage firm's proprietary cash flow model. "One looks at cash flow at a long time horizon, and stock prices move materially around that in the short run," he explains, adding that he uses cash flow analysis to generate both long and short trade ideas.

But while the cash flow model is an important part of the brokerage firm's valuation process, "It's not the only important part of that," Fraser stresses. He personally visits two or three companies a week and also obtains ideas from Collins Stewart analysts in a number of sectors as well as from clients and other sources.

In addition, "There's information in the market, client meetings with the companies, valuation in Quest, analysts, etc." Fraser says. "It's a fairly wide net one uses to capture ideas."

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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