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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Wednesday, September 5, 2012

Sell side research is dead; long live the sell side

The environment for sell side research is distinctly negative. Comments I hear when networking for work:  "This is a business in secular decline." ... "Can't sustain the number of analysts with penny per share commissions" ... "the traditional model is broken" ... "all the smart people have moved to the buyside" ... "the sooner this moves to a subscription model the better" ... "regulations have killed the business" ... "correlation has killed the business" ... "high frequency trading has killed the business".

The contrarian in me says this must be best time to go into sell side research, but that's an irrational knee jerk response; the traditional business model, where information is indirectly paid for with trading commissions and banking revenues, has been broken for a long time. Whether or not the sell side requires two high-fixed cost businesses - banking and trading desks - to drive compensation ought to be reconsidered.

Three reasons why there is still value in good sell side research and why it could stand on its own as a subscription model:

1) Incremental information is still valued. It's harder to find - the analyst can't just ask management for it - but that just makes it more valuable. You have to walk around asking for it, everywhere.

2) It's expensive to find incremental information, but it scales well. The buyside, particularly smaller shops, can't afford to do the work. Travel and conferences are expensive. Cultivating sources is time consuming. Tracking projects and performance is tedious. The ability of a good sell side analyst covering one industry as the eyes and ears on the ground, feeling the pulse of an industry, and offering tidbits and perspective, can't be replicated by a buyside analyst covering 10 industries.

3) Sell side could do a better job turning regulations into a marketing point. While a client faces regulatory risk using expert networks, that risk declines using regulated sell side research. When it rains, it rains on everybody so why not sell an umbrella?

Unfortunately, organizations tend to be inherently slow to evolve and risk averse. It is unusual - in fact quite amazing - when institutions, corporations or sports teams, outperform their peers on the basis of good decisions over extended periods. Dynasties are rare. When it happens, its because they evolve, something the traditional sell side model has resisted for far too long.