Our Founding Partner, Colin Berthoud’s, guest article for Integrity Research responds to the recent TABB Report on Alpha Capture:

The recent TABB report on Alpha Capture provides a timely reminder of the rising importance of objective measurement as research unbundling proceeds.  Historically, in the best case, buy-side firms allocated commission via a qualitative broker vote.  In the worst case decisions are based on more arbitrary factors such as the strength of a relationship.

Regulators are clearly expecting a significant improvement in assessing the value of research.  Portfolio Managers will need to justify their payment decisions quantitatively as well as qualitatively.  Alpha capture systems provide the right kind of measurements – including performance of research relative to benchmarks, duration of outperformance, consistency of output, participation, and risk-adjusted return measures.

As identified in “Quantifying the Future,” a report commissioned by TIM Group, we expect an even faster adoption of trade ideas by fundamental firms than suggested by TABB Group.

Gartner estimates that 20% of broker vote is related to sales coverage (alongside execution and research).  If brokers are to continue to receive anything like this amount in the future from client funds, it will need to be based on trade ideas. Trade ideas are substantive research under ESMA and FCA definitions.  No other sales service can meet these definitions.  This means that buy-sides can pay for trade ideas from client funds when they reward salespeople for their trade ideas.

While judgements on research are always likely to contain more subjective, qualitative elements, objective quantitative judgements will form the basis of most assessments of  research in the future.