Showing posts with label portfolio managers. Show all posts
Showing posts with label portfolio managers. Show all posts

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, December 11, 2007

Fund Fees: What are you paying for?

It’s probably safe to say that anyone with money to put into a hedge fund doesn’t mind paying a high percentage management fee as long as you’re getting a phenomenal return. It all comes down to value.

Same goes for Manhattan real estate – if a broker shows you your dream townhouse, but you have to pay a 20% broker fee, you wouldn’t blink. You’d be ecstatic that you could stop sifting through all of the unsuitable apartments, and the value of finding what you’re looking for would justify the expense attached to finding it.

In both of these scenarios, the ends justify the means. Unfortunately, for less risky investments, the returns are not high enough to eliminate the question:

What are you paying for?

In the case of mutual funds and pension funds, which, by design, are not typically risky investments, of course the rewards are not usually as exponential as might come from a hedge fund investment. Yet, they have more hidden fees attached to them than Paris has boy-toys. The lack of transparency in fund administrator services and 12b-1 fees as well as management fees, loads, expense ratios, turnover rate, taxes…goes on and on.

(Is your head spinning yet?)

The unbundling initiative that is being largely lead by the independent investment research world would likely help alleviate some of these incurred costs, while also putting money back in the pocket of the Portfolio Managers (PM).

Say what?

That’s right. The guy making you money, should make good money. No one disagrees with that statement. His management fee – if he’s made you 30% this year - is a non-issue. The part that should be called to question is – what other fees are you paying that are unjustified, or being billed to you for unused or under utilized resources?

Like that $150 gym membership you pay each month to have access to something you don’t use – at some point it’s time to reassess the fees you pay and ask: What exactly am I paying for?

Bundled research – the research provided as an ‘add on’ to execution - falls into that camp. This research is often redundant, lacking of value, and gets as much use as your dormant gym membership. Yet it continues to be purchased because it is as common practice in the industry.

Part of the reason this cycle has yet to be broken is that PMs fear unbundling would create more work for them. Though it may take some work on the front end to seek out the top providers for execution and research, respectively – the pay off on the back end of having insightful, actionable research on one hand, and best execution on the other would alleviate headaches for both PMs as well as investors.

The clock is already ticking for PMs to jump on the unbundling bandwagon. Regulators are taking a look at how unbundling can help paint a much clearer picture of incurred fund fees and now it’s only a matter of time before requirements are enacted here in the US as they have been in the UK.

Unbundling could potentially revolutionize the way that funds do business, and bring in some serious revenue for those who embrace it. In a business where being late to the game can cost you everything, we think we will continue to see firms jump on board the unbundling bandwagon.