It's a fact of life on Wall Street: The buy side is drowning in information, and much of it comes from the sell side in the form of trading ideas, research reports, e-mails, phone calls and invitations to meetings. But with regulatory scrutiny of how the buy side spends its client assets to pay for research and executions, and the industry's movement toward unbundling commissions, buy-side firms are struggling to place a value on the research and services provided by the sell side. As a result, the status quo is no longer acceptable.
Rather than continue doing business as usual, the buy side is tapping innovative technologies to help quantify the value of the sell side's contributions. One provider that is targeting the buy side is Toronto-based First Coverage. The vendor's system acts as a depository for the sell side's short-term trading ideas, research reports, meeting invitations and other offerings.
"In dealing with the sell side, you can get swamped with boat loads of research that may or may not be relevant," says David Burrows, president of Barometer Capital Management in Toronto. Burrows began using the First Coverage system about six months ago and so far finds it "pretty interesting."
So Much Information, So Little Time
"For us, to be able to drill down through that is a very useful thing," says Burrows, whose firm manages more than $900 million for private investors and endowment funds. As the head of a quantitative asset management firm, Burrows says, he is looking for specific securities and sectors from the sell side at different times. "There's only so much time. You've got to pick who you can listen to and on what topics," says the portfolio manager. More important, portfolio managers can go back and find the trading ideas they missed and see which sell-side firms they are not talking to that have sent valuable ideas.
According to Burrows, First Coverage helps him answer the question, "Am I getting the best value out of the people I'm listening to, or are there other people I should be talking to?" he says. "We felt this would be a useful funnel of a lot of information that comes in over the transom in a database that allows us to quantify success over time."
Randy Cass, CEO of First Coverage, says one question that the buy side has never been able to answer is, "What if I spent my money differently? What if I spoke to other people?" Because First Coverage stores all the data points, he continues, portfolio managers such as Burrows actually can go back and search for analysts that published research on certain sectors. For example, a portfolio manager can query the system for the top five sales traders or analysts in mid-cap technology stocks, claims Cass, who adds that there currently are 100 buy- and sell-side firms using the system since it debuted last November.
Investment managers have a fiduciary duty to answer these questions because they're constantly striving to find hidden sources of alpha -- extra market returns not tied to the performance of any benchmark -- contends Cass. The rise of so-called alpha-capture systems -- such as First Coverage, London-based youDevise's Trade Idea Monitor (TIM) and Norwalk, Conn.-based FactSet's AlphaNetwork and Alpha Pool (for internal research teams) -- provide the buy side with tools to objectively measure the value of the research, which helps them in their broker-voting process and commission allocations.
"Until the buy side assigns value to the research, there's no way to tell how valuable the research is," says a spokesman for youDevise, whose service began in the U.K. in 2004 and was launched in the U.S. in February of 2006.
And there's another concern. With $13 billion in annual institutional commissions flowing from the buy side to the sell side, there's still a lack of transparency and accountability as to how much the buy side is paying for services provided by the sell side. Of that total, 30 percent, or $4 billion, is going toward paying for electronic executions at penny or subpenny rates, says First Coverage's Cass. This means the industry is still spending $9 billion a year on bundled services, including executions, research and access to management.
"It's not the firm's money they're spending -- it's investors' money," says Cass. "If you're going to spend somebody's money, you should be prepared to demonstrate what you got in return for it."
Portfolio managers, including Burrows, agree that there is a need for more accountability and transparency, but in the end, Burrows says, it's about returns. "It's our job to find any firm that can help generate return for our investors," says Burrows. "If this can help, then you've got to try it." In the past, salespeople would blanket the firm with every piece of research. But now that they're being judged, they become more selective in the ideas they're throwing your way, he adds. "They're only sending us the ideas that they have convictions in," says Burrows. 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