Friday, February 29, 2008

The RaaS Revolution

For all of us tech geeks, the past decade or so has brought about the evolution of an important enhancement to the software business – Software as a Service (SaaS.) Essentially, SaaS means that customers (as explained by Wikipedia) ‘do not pay for owning the software itself, but rather for using it.’ In other words, although the end user may not pay $100,000 to own the software, they will pay the software provider $1,000 a month to utilize the software.

This is a win-win scenario – it means that the end user makes a smaller commitment (often on a monthly, or quarterly basis) – so there is flexibility in case it doesn’t work out – which is often an enormous hurdle in the purchasing process; the software provider is servicing the account, so the end user has an ‘on call’ service center to help them with any issues; and it works in the favor of the software provider because the client is paying them on an ongoing basis, which helps the company to establish a more long term business model.

SaaS may have taken some time to evolve, because this is not the way people were used to paying for things, but we do believe it’s here to stay. As we said in a blog earlier this week: If you show people a more reasonable way to do something that they’re already doing, you can, over time, shift their behavior.

We believe that this model can be (and is being) effectively replicated in the investment research world – or, more specifically, how institutional investors pay for research.

“Just Because It’s Always Been Done That Way Doesn’t Make It Right”

Research has traditionally been provided to portfolio managers and investors as an ‘add on’ to a trade. More or less, a ‘pay-for-play’ for ideas, where a sales trader calls with a great idea, and the PM appreciates the idea, so he kicks a few hundred thousand shares to the trader to execute, and those commission dollars (or pennies, really, as the case may be) cover the expense of the idea.

However, as commissions shrink, this model faces a serious threat. If commission compression means that there are less commission dollars to put toward research (to cover the overhead of having a research desk at all) – then research becomes a cost that cannot be covered or justified by the firm. The only way a firm can then justify the research is on volume rather than pricing. However, to be dependent on volume alone because commissions are almost completely compressed is an extremely risky business model, because it means there is no ‘cushion’ built in to pricing that helps you weather dips in your volume.

RaaS: Creating the Category

Research-as-a-Service, we believe, is the future of the research business, in the same way that SaaS is the future for software. Providing access to analysts as well as research, on a limited distribution basis; a payment schedule and commitment period that is comfortable for the end user, but provides a steady income stream for the provider; encouraging provider-customer interaction and feedback – are the key components to an ongoingly successful business model in the RaaS category.

Monday, February 25, 2008

The Payment Paradigm

In this weekend’s New York Times, Joe Sharkey wrote an article titled ‘The Skies Are Alive With Fees,’ which points out some of the payment adjustments and ‘unbundling’ of services that many airlines are undertaking in order to generate revenue. Since most passengers have been conditioned to pay in a more conventional, ‘bundled’ manner for flights, many are immediately skeptical of this new payment model – even though at first glimpse, it does seem to make sense and have some advantages.

After all, wouldn’t you rather pay for what you want, than pay for ‘perks’ you have no interest in or have any intention of using?

We point to the airlines’ new payment models, because it draws an interesting parallel to the current payment transition in the investment research world. As the SEC this past week has proposed rules that will require further disclosures for soft dollar transactions, different payment options that simplify payments for research services will become a more common part of the equation. Despite the growing popularity of flat-fee type payments for research, many portfolio managers (PMs) seem to have a difficult time embracing the idea of paying for research as a full product, rather than paying for each individual idea (through trade commissions). However, as time ticks down for the SEC to fully implement new disclosure rules, flat fee payment for research will seem like a far more desirable option. Disclosing a flat fee payment for research services will minimize compliance confusion and bookkeeping nightmares.

As with the airlines, it will also become attractive to portfolio managers and investors to buy the research they use and want, rather than paying for ‘add on’ research that delivers no value.

For independent analysts, the shift to a model where they can be compensated for full access to their insights, rather than solely for specific ideas, means that they are finally getting some of the respect – and compensation – that they deserve. PMs also benefit, because by essentially having fractional ownership of the analyst, they are able to access the insights of an analyst whose insights they trust, at a fraction of what they would pay to put that analyst on their staff. The SEC is creating a win-win situation by taking steps that benefit analysts who generate actionable ideas and the portfolio managers that use/need them.

There was a lot of resistance to the internet when it was first born, too, and people who were used to handling their business and information gathering in other ways had a hard time adapting…but before long, it was widely embraced because the advantages were indisputable.

If perks to flat fee payment are implemented – such as selling the research solely on a limited distribution basis, and making the analysts accessible as an extension of the PMs own research team, independent research providers with payment models like StreetBrains’ will prove to have indisputable advantages over the conventional model, too.

Tuesday, February 19, 2008

Movin’ On Up – Or, In StreetBrains’ Case, Down

Pardon the departure from our typical subject matter, but, today, we’d just like to gush a little bit about the new office space we moved into over the weekend, located in the Flatiron neighborhood of Manhattan.

After 3 long days of grueling work to get our new space up and operational, today is our first day up and running at 72 Madison Ave. So far, so good - save for the slight high we all have from the paint fumes.

The office itself is a wide open loft space (5,000 sf), with high ceilings, exposed industrial piping, hard wood floors, and just overall ‘downtown cool.’ Dark wood furniture, a few Carolina-Tar-heel-blue accent walls, and a pool table separating the two sides of the office give the space a StreetBrains ‘edginess.’

As cool as the space itself is, the true pride of the office is the enormous StreetBrains road sign that we had custom made to hang over our reception area (identical to our logo, except this is 5x7 feet, 150 lbs, and made of reflective highway sign material!). Once that was hung, it really felt like home. See picture above.

We still have some decorating to do, but overall, we are extremely proud of our new space, and can’t wait to host our first big social gathering to bring our clients, friends and family together to celebrate with us.

To read the full press announcement about our move, please click here.

Thursday, February 14, 2008

Will Wall Street ‘Misremember’ the Lessons of the Global Settlement?

It’s safe to say that not much good came out of yesterday’s Clemens vs. McNamee battle on Capitol Hill. Both parties seemed to be on a crusade to display the most loathsome qualities of humanity, as Congress (having no more pertinent matters to tend to) refereed the clash.

If nothing else, the one good thing that came out of yesterday’s battle royale was that Mr. Clemens, in his infinite wisdom, pulled out his finest Bush-ism, and reminded us all that sometimes people simply “misremember.”

This got us thinking – misremembering is not a plight suffered solely by fallen heroes representing our national pastime. Misremembering runs rampant in our financial markets as well. We won’t delve deeply into this topic (we think you can probably recall enough instances on your own) but as one example, the brilliant financial wizards putting together subprime loans (as well as the mindless lemmings who jumped into this market with both feet) must have ‘misremembered’ the tale of The Junk Bond King. You get our gist.

With the global research settlement set to end in April 2009, we couldn’t help but wonder: Will Wall Street ‘misremember’ its lessons from 2003?

A Journey Back in Time, To Avoid Misremembering

To briefly recap history, the global settlement was the result of Spitzer’s investigation into Wall Street research which found that many (primarily bulge bracket) firms were providing tainted/conflicted research to their investors. The firms were forced to pay fines, and also to offer independent (i.e. outside) research in addition to ‘cleaning up’ their own research offerings.

Much has changed in the research world since 2003, as many new Independent Research Providers (IRPs) have jumped into the market – if for no other reason than to capitalize on the terms of the global settlement. With so many IRPs in the market, the definition of an IRP has expanded greatly as well. From expert networks, to quants and research tools, to traditional research providers – these offerings all fall under the IRP banner.

While it is a very positive move for firms to utilize and offer more independent research, it seems they may misremember the problem at hand. In-house research at the large firms has not made any great strides to improve quality or be less tainted. As a matter of fact, in December, the Wall Street Journal reported that Wall Street research hadn’t cleaned up its act at all – there were still only 7% ‘Sell’ ratings in Street research as of then.

Given the current state of the markets, we find it hard to believe that only 7% of stocks deserved sell ratings as of last December. So, either the analysts a) are in a stranglehold by their trading desk or investment banking counterparts, or b) they’re incompetent. As much as we do not believe the waffling accounts of either McNamee OR Clemens, we also do not believe Wall Street analysts are incompetent. We do believe, however, that many are the puppets of their bullying investment banking and trading brethren.

So, the question remains what will happen as of April 2009? Will Wall Street immediately drop its IRP counterparts, and open itself up to closer SEC scrutiny of their internal research? It wouldn’t seem to make sense, but, as firms look to eliminate any and all expenses that can help alleviate some of the pain of the subprime woes, it’s not entirely out of the question.

The SEC plays a major role as well, as they still have not issued guidance to require unbundling that mirrors the requirements in the UK. Although unbundling has steadily gained traction in the past couple of years, this key driver to the ongoing success of independent research has not yet been pushed through.

So, much like the Clemens/McNamee case, it’s hard to tell which way things will play out for the post-global-settlement research world – but we can only hope that the eventual outcome includes cleaner, clearer policies and programs designed to avoid these stumbling blocks in the future.

Tuesday, February 12, 2008

I Want it All, and I Want it Now!

We know them as the men who collect Ecosse Titanium Series Motorcycles, Bugatti Veyrons, Ferraris and Aston Martins. Men who spend over $500 million on their art collections, and $12 million on tiger sharks encased in formaldehyde. Men with temperature-controlled wine cellars containing chronological libraries of Romanee-Contis and Chateau-Lafites – many well past their drinkable stages. Men who shop for trinkets for their wives and mistresses at Harry Winston and Cartier, and buy Richard James suits and Charvet shirts for no reason other than they can.

The men described above are covetous. They exude a sense of entitlement. They expect to be granted access to the best of the best the world has to offer – and they hold out altogether until those demands are fulfilled. Many of these men, as you might have already guessed, are hedge funders. Creators of their own fate, their sense of entitlement is earned, not given. These men “eat what they kill” so to speak, and they work tirelessly to ensure that doors swing open for them. They strive for excellence, deliver it, and expect it in return. “Work hard, play hard” was coined to describe men like these. With Veruca Salt-like determination, they want it all, and they want it now, and they simply will not take “no” for an answer.

Understanding the mentality of a (successful) hedge funder in his natural habitat (as above) is a critical component to building a business that exists to serve the needs of a hedge fund.

Make no mistake - despite the tongue-in-cheek Veruca Salt comparison, we are not faulting these men for insisting upon the best of everything. In fact, if they did not have a 'want it all, and deserve it' mentality, they would not be as successful as they are. We do submit, however, that many people have a misconception about this rare breed of personality, and how to effectively work with and appeal to their attitude and behavior.

Demand Drives the Market. No, Demands Drive the Market

Yesterday, Cheyenne Morgan of Advanced Trading wrote a story entitled “Customize My Dark Pool.” (click here to read the full story.) We bring up the mentality of a hedge funder today because after we read this story, we realized that many companies and people marketing to hedge funds may not truly grasp their audience, or simply don’t have the capacity or business model to be able to comply with a hedge fund’s needs and demands (while still remaining compliant with regulators).

The story points out several key ‘buzz words’ that properly describe what hedge funds look for in just about anything that they bother with (no different than how they operate in their personal lives): “Premier.” “Exclusive.” “Unique.” These qualities are of utmost importance to the hedge fund audience. However, first, a business needs to assess whether or not their model can support this limited type of access that hedge funds look for to begin with.

In the case of dark pools (as discussed in the AT article), the jury is still out. While of course it makes sense that hedge funds would much rather pump their trades through a ‘black box’ of trade matching rather than have the whole world try to ride their coattails by having their trade patterns revealed at a larger broker, there is also reason for skepticism when it comes to the allegiances of these ‘dark pool’ offerings.

It sort of reminds us of that girl or guy you might have dated in college, who, you knew had cheated on every person he/she had ever dated, but promised they would NEVER cheat on you – putting trust into a ‘dark pool’ and buying their shtick that ‘you’re their #1 customer’ as they go sing that song to twenty other firms can (and should be) a bit disconcerting. Many seem to be offering ‘security’ out of one side of their mouths and ‘open access’ from the other. Either they don’t know their capacity/capabilities, or they don’t know yet which one sells. If there are clear lines to be drawn that will help hedge funds clearly understand the draw for one dark pool offering over another, the marketing efforts are in need of some bolstering.

StreetBrains had the hedge fund mentality in mind when we developed our model, so we are able to rest easy. We provide limited distribution research and expert access, solely to qualified institutional investors. It doesn’t get any simpler than that, and it’s exactly what hedge funds covet. Unique…limited…premier. Check. Give them what others can’t have. That’s the key.

At the end of the day, whether it’s undrinkable wine, inedible food, ugly paintings or broken statues - value is in the eye of the beholder. (After all, wealth as we know it might cease to exist entirely if the affluent stopped buying $6k Neorest toilets and $15 Renova toilet paper based solely on the fact that other people can’t afford it….)

Thursday, February 7, 2008

Any Given Quarter

**Disclaimer: This entry was written by a disgruntled Pats fan who dropped $5k to take a whirlwind trip to AZ only to watch my team fall from grace in the most despicable fashion. The SuperBowl views reflected here are not supported, nor endorsed by the obnoxious, gloating Giants fans I contemptuously call "colleagues."

Whether you were a Patriots fan, a Giants fan, or an agnostic viewer, this weekend’s SuperBowl proved one thing:

The unthinkable can occur on Any Given Sunday...and it did.

If you were tuned in, what you might have seen was an up-until-today mediocre Eli Manning have the game (or 4th quarter, at least) of his career – which included the luckiest of all lucky plays when he scrambled away from an imminent sack and tossed a prayer up to Tyree for a miracle completion.

Impressive? Yes. The result of a calculated and well-designed play? Not so much.

The SuperBowl MVP-crowned quarterback, happens to also be the leader of a much less glamorous NFL category: Turnovers. And Sunday certainly didn’t go by without a few near additions to this category, as Eli, on three separate occasions, threw the football directly into the fumbling hands of the Patriots defenders. Despite being in the right place at many of the right times, the Patriots were unable to capitalize on these errors.

Not to take anything away from the well-executed Giants defeat of the New England Patriots, but our question is this:

Despite one All-Star performance on a random Sunday in February, who would you rather have as your QB:

An 18-1, League MVP, Tom Brady or 14-6, Turnover-leader, Eli Manning?

Take Care of the Ball

We ask about Tom versus Eli, because we think it makes for an interesting parallel to how firms identify their top independent research providers (IRPs). You’re probably wondering, “How so?”

First off, let's understand how many IRPs receive payment. Some firms who utilize the research and insights of IRPs have implemented broker votes for paying outside IRPs. These votes are ultimately set up so that brokers can provide payouts to analysts who make the most accurate calls. Some of those broker vote systems use analytics that will help them to ‘calculate’ who provided top results, and others are arbitrarily decided upon.

I guess our question is really, is this the most reasonable way to pay for – and encourage the consistent production of - quality research? Wouldn’t firms rather pay an analyst that consistently provides quality insights and information, rather than one who happens to accurately nail a quarterly EPS down to the penny? It could happen any given quarter, and you might just be the one to capitalize on this lucky call. But that doesn’t mean his prediction is indicative of future success - just a lucky, one-off guesstimate.

Analysts that provide accurate information should absolutely be rewarded – however, a ‘call-by-call’ comparison against their peers seems to be a flawed model for identifying top quality research and insight.

Bottom line: I’m sure most of us secretly pull for a Cinderella story…but more times than not, smart money is best placed on proven success. When in doubt, it may not be as glamorous, but it’s probably best to hand over the reigns to the guy who’s proven time and again he can take care of the ball.

Monday, February 4, 2008

Lessons Learned From Sporks

If you made it through elementary school, chances are, you’ve used a spork at some point in your lifetime. Upon introduction to this odd tool, you likely thought to yourself “in theory, this makes a lot of sense.” After all – why have two separate utensils when you can just have one?

But as you moved on through life, this tool seldom reemerged. It seems that most people preferred to have two separate utensils, each to be used at the appropriate time and for its designated purpose, despite the convenience of the bundled item. Apparently, the multi-use tool often proves not to perform either of its jobs as efficiently as the separate utensils.

And therein lies the key differentiator between success and failure of bundling. The services or items bundled must produce equal or enhanced quality performance than the a la carte items or services.

Why are we talking about sporks?

The spork is a fitting parallel to the ‘bundling’ of execution and research that takes place in the financial industry – while it makes sense in theory, it fails in practice.

Like the spork, neither function is able to deliver optimal performance in the bundled model, and therefore, the bundled model is flawed and unsustainable. Like a TV with a built in VCR, the convenience and seeming practicality is undercut by the problems that occur when one of the bundled pieces or services fails. Upon failure, the entire system needs to be replaced, and worse, it can be difficult to assess which piece actually caused the issue so that future problems can be avoided.

The bundling of execution and research has the same inherent problem. Consider this:

Joe pays $.03 a share for execution, despite the fact that best execution pricing could get him execution for less than a penny. But Joe gets research as an ‘add-on’ because he pays $.03 a share, so he pays more for the ‘bundled’ service.

But now, Joe’s paying outrageous fees for minimal returns, and he doesn’t know why so he can’t figure out how to fix the problem. Is he paying too much for execution? Is the research he’s buying poor quality so it isn’t delivering trade ideas that will generate great returns? There’s no way to tell, because the services are bundled together, therefore masking which piece of the bundled product is the source of the failure. This is a detrimental disservice to Joe – and to all investors.

The UK has already implemented requirements for execution and research to be unbundled. It is still unclear whether or not the US will implement similar rules, but hopefully the SEC will acknowledge the inefficiencies that occur in the bundled model. Many firms are taking the shift in the UK as a cue that similar requirements will be imminent in the US, and are using this as an opportunity to offer more transparency to their investors.


In case you’re curious, here are some other bundled items that seem practical in theory, but never quite made it big:

Smell-O-Vision (movies with scent)
Flowbee (vaccum/haircut system)
Umbrella Hats
Windshield-wiper glasses