The Future of the Investment Research Industry
The folks at Integrity Research Associates recently published an interesting forecast for the investment research industry. Integrity provides syndicated research and consulting services to the investment community. In short, the Integrity is forecasting a continued decline in “traditional” investment research consumption from investment banks and research analysts, coupled with a continued increase in demand for alternative research services. Integrity cites Regulation FD, soft dollar codification, and continuing technological innovation as the major drivers in the revolution. These trends are in large part what inspired the formation of KnowledgeBid over year ago. The full report can be viewed here.
Changing Client Demand
A decade ago, buy-side investors relied on detailed fundamental company analysis produced by sell-side investment banks and brokerage firms. However, in the past few years, Regulation Fair Disclosure and Sarbanes Oxley have effectively reduced the value of investment bank research as sell-side analysts have less and less access to company management. The reduction of this confidential information in sell-side research has prompted many buy-side investors to bring a great deal of their analytical needs in-house. In turn, this has changed the type of research that buy-side investors have found most valuable.
Today, most institutional investors value access to experts, company management, various sources of proprietary data including channel checks and custom market research, profitable trading ideas, and new and innovative analytical techniques. In addition, many buy-side investors (particularly hedge funds) value information that is not widely distributed to other investors.
This change in buy-side research tastes has had a negative impact on traditional fundamental company research – including that of most sell-side firms and many alternative (independent) research providers. At the same time, it has stimulated the growth of new types of research providers, including expert networks such as Gerson Lehrman, channel checking firms such as Off the Record Research and web-oriented research providers such as Connotate, Kapow and First Rain. It is the new, innovative types of research which are growing the fastest, increasing the demand for alternative research overall.
The Integrity Forecast
These developments lead us to conclude that the research industry will experience a significant amount of “barbelling” in the coming years as bulge bracket investment banks lose some share of the research market, second and third tier sell-side firms suffer deep losses of research revenue, and a number of alternative research providers experience increased demand for their services.
Our forecast indicates that sell-side research revenues will fall close to 18% from $4.9 billion in 2006 to $4.0 billion in 2011. This decline is consistent with a survey done this past summer by financial services consulting firm Greenwich Associates, which revealed that almost 20% of the buy-side analysts expect their firms to either “reduce” or “significantly reduce” their use of sell-side research in the coming year.
Integrity expects that alternative research providers will gain at the expense of the sell-side, growing from $1.81 billion in 2006 to $2.47 billion by 2011, thereby increasing their share of the market from a 14.5% in 2006 to 19.8% in 2011. However, we do not expect all boats to rise with this tide. The most innovative research providers should experience the best growth, while traditional fundamental research providers could actually decline over this period. This forecast is consistent with the recent Greenwich Associates survey which showed that 39% of buy-side analysts expect their firms to increase their use of independent or alternative research in the next 12 months.
Finally, the team at Integrity Research anticipates that buy-side institutions will increase their spending on their internal research capabilities by 28.8% over the next few years from $5.8 billion in 2006 to $7.4 billion in 2011 as they continue to rely less and less on sell-side research and they rely more on their own research capabilities.