Independent Research On Rocky Ground

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Recently, the conventional wisdom has had it that the best opportunities for analysts lie among independent research houses. But a closer look shows the landscape there is far from settled.

While over 300 independent research firms operate today, surveys show small investors don't even know many of them exist. And many institutional investors would rather develop their own research capacities instead of paying for independent research. In addition, the continued downward pressure on trading commissions impacts the amount of money that can be diverted to research, since much of the sector's fees are paid for with a chunk of commission money.

"It's a product that's increasingly difficult to get paid for, particularly if you're a small firm," says Richard Lipstein, managing director at Boyden Global Executive Search in New York. On top of that, Lipstein observes that many small research firms have been launched by people who are good analysts, but not necessarily good salesmen. Thus, they may struggle to bring in business.

Worse, while some bulge bracket firms are reducing the size of their research departments, none are parting with their all-stars. So some of the analysts winding up at independent firms may not be the best or the brightest. "A lot of analysts who spent their early years working on transactions were not properly trained as fundamental research analysts," Lipstein says. "It's coming back to haunt them now."

As a result, many observers expect a shakeout in the independent arena, reducing the number of firms by more than 50 percent by next year. That's when the term expires on a $14 billion settlement resulting from alleged conflicts of interest between the investment banking and research operations of large Wall Street firms. The 2002 settlement mandated that 10 of Wall Street's largest investment banks spend $450 million over five years to provide independent research alongside their own proprietary services. Much of that settlement business has gone to well-known research firms, like Morningstar Inc., Standard & Poor's Corp. and BNY Jaywalk, a subsidiary of Bank of New York.

Consolidation and closures have already begun: Fulcrum Global Advisors, which sold most of its assets last year to Soleil, closed its doors this week. Precursor Group, which had been in the independent research arena for half a decade, left the business earlier this year to focus on consulting. Second Opinion Research, which was launched three years ago, has also left the business.

The independent firms making money right now are those that produce proprietary information. Firms like Vista Research LLC and Gerson Lehrman Group, for example, connect institutional investors with industry experts, essentially handing them a rolodex of contacts that are kept on retainer for about $500 an hour. That's particularly helpful to hedge funds, which want specific fast information on a variety of sectors, and don't want the whole market to hear it. They've been willing to pay as much as $120,000 a year for such services.