Sad state of affairs in sell-side research

Hat tip to Steve Waite of Research 2.0 for bringing this story to our attention:

Integrity Research Associates recently commented on an unpublished study from the IBM Institute for Business Value which concluded that the asset management industry is "paid too much for the value it delivers." Among other factors, sell-side research and excessive trading are cited as contributing to the problem.*

A recent Financial Times article on the subject reports: "Liz Rae, senior adviser, investment and markets at the UK Investment Management Association, said fund houses were already bringing more research activities in-house, partly driven by a view that sell side was irredeemably conflicted."

We have written about this subject in the past, for example in "The benefits of in-house research," published in February of this year.

We also believe that the increased reliance of Wall Street on the mathematics of large sample sizes rather than fundamental analysis of the individual underlying investments may have contributed to the decline in sell-side research over the past decade and a half.

We wrote about this phenomenon in "The ideology of modern finance," and noted that authors Andrew Redleaf and Richard Vigilante convincingly argue that this problem was at the heart of the financial crisis of 2008-2009.

While the IBM report anticipates a major shift towards greater reliance on so-called "passive investing" and indexing, we would argue that if the problem is caused in part by lack of scrutiny of the business prospects of individual underlying investments, running to something that rejects scrutiny of the underlying business entirely is hardly the appropriate response. We have put forward several reasons why we don't believe in "passive investing," some of which can be found here, here, here, and here.

We believe investors should be aware of the major changes that have taken place in the investment research world in the past years, and that should realize the importance of close scrutiny of the individual securities to which they commit their investment capital.

* At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by IBM (IBM).