Thursday, June 18, 2009

Paid Research versus Robert Shiller's Free Lectures

Last week I talked briefly about the subject of paid financial research. I had linked it to the work of management consultants who, in a reversal of roles, are very often young neophytes providing advice to seasoned and mature executives.

I just don’t get it. But the same phenomenon happens in the financial industry where research is often written by analysts who know much less than the typical experienced fund managers or buy-side analysts who purchase it. Granted many fund managers and buy-side analysts are also inexperienced. Thus, maybe a large segment of the financial research industry is just playing to the insecurity of these green investors by selling them unproven research.

Research is a topic of importance for Market Observers as the analysis and information provided by research firms are generally deemed valuable by most market participants as is supported by the phenomenal amount of money spent on buying research. It is supposed to provide significant insights and guidance to financial analysts and fund managers. Yet, it seldom adds any value. On the one hand, it often simply follows the flavour of the month, repeats the obvious or is produced by institutions that have products to sell. On the other hand, even valuable independent research is simply left unread on desks and computers by the very people who purchased it dearly. Just knowing this creates opportunities for hard working, experienced and knowledgeable fund managers and investors who do take advantage of valuable research that they can trust and know to be dependable and who “know better” than to believe the work of unproven or biased research vendors.

I will frequently revisit the topic in the next few weeks. As I said, I believe that the business and revenue model of this sector is broken and in need of a new formula; more adapted to the new information age brought to us by the Internet. It is an undeniable fact that most financial research is increasingly free. It does not mean that it is not valuable or relevant (a lot of it is bad but that is another issue). It means that it is not worth paying for because it is abundant. The best analogies are air and water. They are crucial to life but they are free (or almost free) because they are so abundant. In the case of air and water, there is today a real danger that we may run out of them sooner than later (again, that is another issue). But the opposite appears to be true for financial research. There is a lot of it and its quantity, regardless of its quality, is fast increasing; mostly because it is cheap to produce and distribute. As a consequence, the price of information, data, creation and analysis is going down fast because there is so much of it. Think Wikipedia.

When research was in short supply, it could be sold at a high price even if its quality was in doubt. But now that it is so abundant, and free at least somewhere on the net, why would anybody pay for it? Yet, most traditional research outfits' business model still relies on selling you information and analysis that can be found elsewhere on the Internet for free. The mix of over-abundance, low costs, easier distribution and uncertain quality is a powder keg waiting to explode for the paid research industry.

I believe that all research will become free within a few years. Service and customized research is what investors will be ready to pay for; they won't want to pay for something that was sold to someone else and that can be reproduced at will. The value for vendors will mostly reside in organising the information (i.e. helping to find the information and to separate what is good from what is not).

The same will apply to music and books in general by the way. Artists will have to go back to the old fashion way of making money: Live performance. That said they will still be able to earn a nice living. But the days when you would pocket millions of dollars by printing infinitum a piece of plastic without showing up in person are almost over.

I am not done on the topic but I am done for today. As a proof of what I am claiming above, I suggest that you visit Yale’s web site where you can access Robert Shiller’s Lectures for free. It’s high quality without a doubt. Yet, its free. But the true value is knowing that it exists.

Here is an excerpt of one of the lectures to wet your appetite:

“Magical thinking. This refers--this actually goes back to B.F. Skinner, a psychologist who flourished in the first half of this century. I actually had him as a next-door neighbor. It was a strange thing. I was visiting Harvard and MIT in Cambridge and I rented a house and this guy was next door. He and I both used to walk into work together--not together, I never really met him, but I always felt an affinity to him. He must have died twenty years ago by now. But anyway, he did a famous experiment with pigeons which, in the 1940s--1948--in which he induced strange behavior patterns in pigeons by the following simple experiment. The experiment was, he would put--the pigeon was in a cage and he'd let the pigeon get pretty hungry--hungry pigeons are not happy pigeons. Then he had a machine that granted each pigeon one piece of corn every fifteen seconds; that's very, frustratingly slow for a hungry pigeon to get one piece every fifteen seconds. Then he observed, through time, after subjecting pigeons to this torture for some time--it might be not approved by--it's not really torture, it's like dieting or something, you've all lived through that, right? Semi-torture for a pigeon. He noticed that the pigeons started behaving in strange ways and he kept them separate so they couldn't learn from each other.”

“One pigeon was jumping up and down a lot, another one was bobbing its head, and another one was doing kind of a little dance. What he concluded was, these pigeons were trying to figure out what makes those pieces of corn come and they started to think--well, they had to get the interval between corns right to make this work. But he started--the pigeons started to think, effectively, what was it I did just before that last piece of corn came? I was bobbing my head, so maybe I better bob my head again and sure enough another piece of corn comes. So, he started assuming that what they were doing is making the corn come. But each one does a different thing. If they're all in isolation they would all be doing different things. I think our financial markets are like that. That people--they develop some investment strategy and through pure chance it does well. But they--because of over confidence and magical thinking, it starts to go to their ego. They think, I'm really a smart investor, I figured it out,; it can reinforce the behavior until they get to maybe some terrible end. It doesn't necessarily work out as well. B.F. Skinner never let his pigeons starve; they all made it out alright.”

Stay tune, I'll be back on the topic. I promise.

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