While sell-side research struggles to keep up its allure with the buy-side, many mutual fund companies are turning to alternative research, as it can offer unique and innovative ideas.
Alternative research, also known as independent research, has many types of formulas and models to produce research different than typical sell-side research.
At the expense of sell-side research, the alternative market will increase from its current 14.5% market share to 19.8% over the next five years, according to estimates by New York-based research consultancy Integrity Research Associates. Integrity deems that there are around 650 companies that are considered independent research providers in the market.
And by 2012, independent research firms' revenue will grow by 37% from $1.81 billion last year to $2.47 billion, Integrity estimates.
Besides the continued hunt for innovative ideas, the growth of the alternative space is expected to grow significantly due to buy-side investors looking for more cost-effective ways of obtaining research and some sell-side firms looking to outsource some of their research coverage, according to Integrity.
"Alternative research companies that offer successful research ideas, add valuable insight and are cost effective, are going to be the most profitable," said David Weild, chairman of Capital Markets Advisory Partners of New York and former vice chairman of the Nasdaq Stock Market. With sell-side research, everyone gets the same bite of the apple, he said.
While the large fundamental companies might produce good research, there is too much of an overlap, because everyone is covering the same companies, noted Paul Ciasullo, former founder of CreditSights and currently in the process of starting an alternative research product distribution company.
Sell-side research is not as coveted as it once was, but buy-side firms continue to use it because it gives them access to analysts, Weild said. However, analysts only have a finite amount of time, he noted.
According to Integrity, alternative research providers received $650 million in hard dollar payments from buy-side companies, retail investors, and companies seeking research.
A recent report published by consulting firm Greenwich Associates of Greenwich, Conn., notes that 39% of all buy-side analysts expect to increase their use of independent research over the next 12 months, and only 4% expect to decrease its coverage over the next year. Mutual fund analysts seem to want alternative research the most, and 56% stated they plan to use more in the next 12 months than they currently do.
The report from Greenwich Associates finds less hopeful numbers regarding sell-side research. Approximately 18% of buy-side analysts surveyed stated they expect to use less sell-side research over the next 12 months, and 9% stated they were going to use more sell-side research.
Alternative research that focuses on types of services such as data mining, expert network providers, emerging market research, short ideas, channel checks and targeted market research are all proving to be successful research strategies and will post the strongest gains over the coming years, Integrity notes.
Also, companies that use web crawls and new technology that allows research to be produced at marginal costs to operate are extremely profitable, Weild noted.
Companies that produce economic research, such as macro, policy, political and country risk, are likely to be successful over the next few years as hedge funds are starting to look for returns internationally, Integrity notes.
However, not all segments of the alternative market are expected to do well. Areas of quantitative research and technical analysis will not see as much business as many buy-side firms have brought those capabilities in-house, Integrity states.
Buy-side firms, especially hedge funds, will implement this type of research quicker than other companies, experts noted. Hedge funds, and they can easily adopt new services, Ciasullo pointed out. Also, hedge funds are constantly aggressively seeking out returns, he said.
Mutual funds are interested in the area, as well. There has been widespread adoption of mutual fund companies using alternative research methods such as surveys and channel checks to gain insight into markets, said Christine Benz, director of fund analysis at Chicago-based Morningstar.
Several companies are looking to build in-house teams of analysts to conduct alternative research, Benz noted.
The independent market will not see rapid success right away. A firm that has used sell-side research or a certain firm to obtain research for years will not turn around and start using alternative research overnight, Ciasullo noted.
Alternative research might on the verge of being in vogue soon, but eventually the unique ideas and methods will dwindle off as well. If companies start using alternative research providers, eventually the market will lose its competitive edge, as the unique ideas and methods will become widespread throughout the industry, Benz pointed out.
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