With buy-side firms turning to increasingly complex instruments, embracing independent research and beginning to aggregate information through open-system, web-based tools-technology spending to support research is set to go through the roof.
Buy-side spending on research technology will nearly double from $586 million this year to $1.1 billion in 2010, growing at a annual compound growth rate of 22%, according to a report from TowerGroup.
But that is expected to be a sound investment, as it could enable buy-side firms to reduce their research budgets and boost returns.
"We are riding a wave of increased investment in research and technology," said Mark Rice, CEO of Tamale Software.
Dushyant Shahrawat, research director at Tower and author of the report, maintains that increasing competition from hedge funds and alternative investments is prompting buy-side firms to take more responsibility for creating their own research streams.
As a result, buy-side research has become a complicated process comprised of internal analysis, broker research and independent research and analysis. In response to these varied inputs, investment managers are using more automation to integrate information from multiple sources.
Tower points to advances in Web-based technology such as XML-based tagging, application service providers, web 2.0 services and portal technology as relativity new technologies that will influence the shape of the adoption of automated research technology on the buy side.
Another driver of the increase in automated research technology is the jump in investments by buy-side institutions in a broader class of alternative assets, including venture capital, private equity and derivatives.
Denise Valentine, a senior analyst at Aite Group, said that as investment managers take on a wider range of financial instruments, they will rely more on tech systems. As instruments become more exotic and financial engineering becomes more complex, managers will need software to help them understand the infrastructure of these markets, Valentine said.
And whether the new technology tools are applied to alternative or traditional investments, one attractive feature, according to Valentine, is that they let funds determine which types of research are producing ideas that managers are profiting from. They also enable firms to rate how useful a particular analyst's contribution has been.
While the levels of spending that the buy-side will reach are debatable, industry experts said increased tech spending is a given.
"There's nothing I can point to that would substantiate Tower's figures, said John Feng, a principal at Greenwich Associates, a financial services consulting firm. But Feng agreed that technology-based research spending will increase.
He noted that asset managers' traditional dependence on their trading partners for research has declined. Whereas in the past, buy-side firms tended to trade with their research provider, now research and execution are less linked.
Feng pointed out that ever since regulators' investigations into sales and trading practices at fund companies, there has been a proliferation of independent research providers.
TowerGroup identifies seven categories of research tools that will be affected by the increased investment in tech spending: data aggregation, intelligent search and data mining, research performance measurement, research management, trading, idea platforms, and commission allocation and management.
Most buy-side firms use at least two of these software types, most commonly, data mining and data aggregation.
The expanded use of technology in buy-side research is expected to result in a number of benefits, most notably enhanced returns, as portfolio managers and analysts will be able to perform more sophisticated assessments.
It should also result in substantial cost savings, as technology replaces staff research functions.
Automating research processes and operations will also make it easier for firms to source it internally or outsource it to offshore sites or third-party analyst firms. It will also make it easier for firms to document research analysis for audits.
Some of the systems will enable asset managers to do cost-benefit analyses in order to justify continued spending on tech-based research.
"I think buy-side shops will have to put in place processes to manage the increased technology spend and make sure they're getting good value," Rice said.
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