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The Search for Clean Research

If you're lucky, you may have clients like Greg Glosser's, a financial consultant with RBC Dain Rauscher in Dallas with almost $400 million in assets under management. When the headlines about tainted research involving Enron, Tyco, WorldCom, etc. hit, Glosser's clients were not alarmed. The scandals didn't come as a total shock to my clients they were smart enough to know about the phenomenon before,

If you're lucky, you may have clients like Greg Glosser's, a financial consultant with RBC Dain Rauscher in Dallas with almost $400 million in assets under management. When the headlines about tainted research involving Enron, Tyco, WorldCom, etc. hit, Glosser's clients were not alarmed. “The scandals didn't come as a total shock to my clients — they were smart enough to know about the phenomenon before,” he says. “But they are much more focused on where the research comes from now.”

Other reps may still be nursing busted eardrums from hearing what less sophisticated investors had to say when they learned the real reason why sell-side analysts kept buys on dogs like Enron, even as they collapsed.

Either way, it's clear that clients now know better than to take sell-side research at face value. But, how does a rep make a sale without some “objective” analysis to justify the purchase? Because you like the stockfunds/money manager? Maybe. Maybe not.

So, where do you find nonconflicted data and analysis on investments to help you decide which to recommend to your clients? First, you can forget about the panacea of so-called brokerage-funded “independent” research. That's not going to happen anytime soon. Yes, NYSE Chairman Richard Grasso and others have been saying that Wall Street and its regulators will hammer out a “global settlement” by year-end that will include the creation of a $1 billion research consortium to disconnect equity analysis from investment banking.

Industry execs at the annual SIA conference in November all paid lip service to the quest for a 2002 settlement. But that sentiment was dampened during press Q&A sessions when it emerged that various interested parties had different positions. Robert Glauber, CEO of the NASD, told SIA attendees that the proposed $1 billion settlement was unfair because he says it would hit smaller firms disproportionately. And Hardwick Simmons, CEO of Nasdaq, says he'd rather give that money to “the homeless” than to fund an “independent” research consortium.

For now, at least, financial advisors must take matters into their own hands. The trouble is good independent research is hard to find and can be expensive. Independent research boutiques have been around for years, of course, but they have focused almost exclusively on institutional clients, such as mutual funds and hedge funds. The arrangement has been built on soft dollars, whereby a money manager directs trades to the research firm's trading desk in exchange for stock-picking intelligence.

Now, however, the time is ripe for bringing boutique research to a wider audience, including financial advisors who are willing to pony up hard dollars. Historically, the firms frowned on anything but in-house research. Nevertheless, today, in most cases, they encourage it. Merrill Lynch, for instance, allows its financial advisors to use whatever research they want, even if it comes from a competing brokerage. Yet, like most other brokerages, Merrill draws the line when brokers recommend an issue not on its approved list.

So, if your firm allows outside research, where can you go to find it? The first step is to look at the big rating services Standard & Poor's, Value Line, Lipper (owned by Reuters) and Morningstar. The first two have been producing short but exhaustive research reports on stocks for decades and are both well-respected research tools for the retail and professional investor alike. Lipper and Morningstar also need no introduction, since most readers of this magazine have been using their data for years.

Some of the most well-known boutique research is institutional in orientation and can cost tens of thousands in hard dollars or, if you can direct trades, in soft dollars. There are a handful of boutiques without an investment banking division, including Sanford C. Bernstein, now owned by Alliance Capital, which widely distributes its investment banking-free research. (Sallie Krawcheck, formerly CEO of Bernstein, was tapped by Sandy Weill to fix Citigroup's problem at its Salomon Smith Barney unit.) Also, Prudential sold its investment banking group back in 2000. And Charles Schwab & Co. is rolling out its own stock research, a quant model ranking 3,500 issues.

Nevertheless, the fact is the newsletter industry is where you have to go for affordable independent analysis. More than 5,000 newsletters exist today, authored by people of various backgrounds and talent levels. The problem is that there are many cranks out there, and some have been nailed for having vested interests in the investments touted. Just as many others advocate cockamamie theories and strategies. Indeed, the SEC cracked down on what was dubbed “financial pornography” in 1998.

Still, there are many respected newsletter writers who have decent long-term track records and interesting insights into individual securities and markets. “Some of the best people on Wall Street are writing newsletters, and the only people that get to see their work are their subscribers,” says Mark Hulbert of Hulbert Digest in Annandale, Va., which tracks the performance of hundreds of investment newsletters, and is an excellent place to start researching research.

Unfortunately, subscribing to multiple newsletters can be an expensive proposition, especially since most of them specialize in a tiny niche that isn't serviced by the rest of the research community. “The newsletters that a broker would get the most value out of are the ones that look at stocks or industries that don't have a herd of analysts,” says Hulbert.

There is also more institutional-quality research around than ever. One well-established boutique that supplies it is Argus Research, which began selling independent research at the height of a much worse bear market — in 1934.

“We're reaching a stage in the development of the financial markets where people are willing to pay for quality information,” says John Eade, president of Argus. “Other firms are going to realize that our business model, which has worked for us so well for so long, makes sense. Then the market will become a lot more crowded.” Typically, Argus charges “upwards of $1,000” a month, depending on what each individual firm requires.

Right now, Argus sells most of its research to the brokerage community, but it's often repackaged as private-label, in-house research for small brokerage firms, such as Tampa-based Invest Financial and Investment Centers of America. Depending on the deal, this can cost as much as $25,000 a month. Argus also has several packages for individual brokers who just want to get the research reports.

If you can't afford to pay a big monthly tab for research, there's always the retail option. Using the Web service Multex ( you can buy what you need when you need it. The site collects research reports of all types — from the large wirehouses to independent boutiques — and sells them on a pay-per-view basis. Costs can range from $5 to $10 for a morning call to as much as $50 for an industry review.

Multex also has an institutional service, starting at $5,000 per user per year that may interest some retail-oriented brokers. But that's not how most brokers use Multex. “Our internal research leads us to believe that a sizable proportion of our customer base is in the brokerage community,” says Robert Skea, the company's vice president of sales, who wouldn't reveal the exact percentage. “They're clearly very interested in finding research produced outside of their own firm. And the trend is growing.”

Skea says that Multex is in the process of preparing a special package for high-net-worth individuals and brokers that will be slightly pricier than the retail site, but will have more timely research. According to Skea, the annual cost can “get into the tens of thousands of dollars, though it's usually just south of that.”

Right now, most research firms embargo their research reports for seven days before allowing them to appear on Multex. The new product, which will probably launch early next year, will have a shorter embargo period. It will also function on a subscription model, rather than pay-per-view, “at a price point that would be palatable to most people in the financial advisor community,” says Skea.

There is a catch, however: Most of the research available on Multex still comes from the large investment banks. “I prefer independent research,” says John Rafal, an Essex, Conn., financial consultant for Raymond James, who manages more than $1.1 billion in assets. “I like to know where their allegiance is and its quality tends to be a cut above what comes out of the wirehouse.” Yet, the supply of research from purely independent firms is still just a trickle.

It's also wise to remember that there is not a direct correlation between independence and out-sized returns. The fact is, independent analysts' portfolios are not appreciably better than are those of their cohorts who work for investment banks.

In The Wall Street Journal's latest analyst rankings, it found that the picks of independent research firms did outperform the recommendations of other analysts. Over a 12-month stretch, the picks of six noted Wall Street firms racked up a 6.2 percent decline. Those of six well-known indie research firms were down 3.9 percent. Looks good, but that figure was buoyed significantly by one firm's (Florida-based Avalon Research Group) astounding 36 percent portfolio gain. By comparison, Morgan Stanley and Prudential suffered 7 percent and 9 percent losses, respectively. Bernstein, one of the larger independent groups, notched an 8.15 percent loss from November 2001 to November 2002. New York-based independent Argus lost 2 percent for the 12 months ending Oct. 14.

Independent research is a growth industry, and now has its own trade group, called Investorside Research Association. IRA was founded in July and already has 13 members. Dozens of other firms have been born in the last two years and are still in their infancy stage. “Right now, in the bottom of a bear market, it's hard to get people to pay for research. It's expected to be free. But that's changing,” says Argus' Eade. “A lot of people are putting down roots for when the bull market comes back. By then, independent research will be the norm, not the exception.”

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