For most of 2010, like everyone in the industry, I've been fixated on financial reform legislation. But quite frankly, there is so much doom and gloom surrounding the topic that I need a break.
Fortunately, there's a bright spot on the horizon in the research field - where an entire cottage industry of innovative companies is conducting primary research and channel checks as well as pursuing other non-traditional idea-generation techniques. For buy-side firms that have had to downsize their internal research efforts, this gives them an alternative source of alpha beyond the bulge bracket's proprietary research.
As we examine in The New Alpha Generators, agency brokers are investing in alternative research providers and offering them access to their networks of institutional customers, hoping to capture more of the buy-side commission wallet. For example, Investment Technology Group invested in Disclosure Insight, an independent firm that scours SEC filings and rates public companies on as many as 100 risk factors.
Traditionally, agency brokers have been viewed as places to go for alpha retention. And often, buy-side firms that need to pay a research bill at a bulge-bracket firm have had to tell agency brokers such as Liquidnet, Investment Technology Group or Instinet that they couldn't execute on the agency desks. In addition, execution commission rates have been shrinking overall.
But as the agency brokers expand into the alternative research area, they are becoming alpha generators, which turns out to be a more stable, if not growing, piece of the total commission pie. Part of what's driving the alpha-generation/agency broker distribution deals on Wall Street has been the growth of commission sharing agreements, or CSAs. CSAs make it easier for the buy side to allocate commission dollars to pay for research, enabling many of the small boutique research providers to get paid by the electronic trading desks and buy-side trading desks to meet their best execution obligations while paying a research bill.
"We have a significant CSA and soft dollar business, and clearly this is an extension of that," says ITG CEO Bob Gasser. "[The Disclosure Insight] content will be exclusive to us, and we expect clients to ... give us more execution dollars to pay for it."
The alternative research/agency broker partnerships can only fuel the agency brokers' business and help them compete with traditional trading desks. This competition just might set off a technology arms race as the agency brokers invent new ways to deliver value-added content to buy-side clients - more quickly and efficiently than their bulge-bracket rivals.