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First Coverage Proves Sell-Side Ideas Outperform the Market

Sell-side investment ideas in First Coverage's system for Q4 2006 through Q1 2007 outperformed their relative benchmark for the past two quarters by 300 basis points, or 3 percent.

First Coverage announced yesterday performance results for sell-side trading ideas sent to buy-side customers via the vendor's Web-based application, which allows the buy side to quantify the value of sell-side information sent through the system.

According to CEO Randy Cass, sell-side investment ideas in First Coverage's (booth #1728) system for Q4 2006 through Q1 2007 outperformed their relative benchmark for the past two quarters by 300 basis points, or 3 percent. The benchmark is a blend of the S&P 500 and the TSX (Toronto Stock Exchange) index of stocks.

"There's massive value to be found in the sell side," says Cass, who notes that the First Coverage Index was comprised of about 80 percent long ideas and 20 percent short and hedged ideas.

"All the buy-side has needed is a tool to organize and measure the value of their different relationships," contends Cass. "By creating a system that allows the sell-side to efficiently communicate their ideas and keep track of them, you're creating a system of self-selection where the portfolio managers are only going to get the best of the best ... information."

The Toronto-based software company, which opened a Boston office in February, launched the trading-ideas communications platform in Q4 2006 and now has more than 100 participating buy and sell side firms, ranging from large pension funds down to small hedge funds, according to the CEO. "We've always made the assumption that if you created a system that created accountability and transparency, then the sell side would provide better information," says Cass. "We're gathering the data points that lead to the evaluation."

Larry Tabb, CEO of TABB Group in Westborough, Mass., says that First Coverage addresses a major challenge facing the sell side. "Every time [the sell side has] a good discussion with the buy side, the buy side says, 'What did you do for me lately,' explains Tabb. "And the sell side has a very difficult time qualifying all of their investment ideas ... to answer that question."

This is not important when everyone is making money, says Tabb. But with commission rates declining for the past three or four years since the take-off of algorithmic trading, "The brokers are having a much more difficult time defending their commission profiles," he notes.

"If the sell side can point to an independent valuation authority ... and they can say, 'They gave [the buy-side firm] these investment ideas on that day, and if [the client] had implemented them, [the client] would have made X on that day,' then the sell side could show that it's having a positive impact on alpha," Tabb adds.

Because buy-side firms often are inundated with information from the sell side, some investment firms have given up on sell-side research ideas, contends Cass. Yet buy-side firms are spending $9 billion to $10 billion a year in directed commission in North America to pay for bundled services, including research, he says. "As the need for alpha generation becomes more intense, there's a great need to find the people who can generate the most value for every dollar you spend," Cass says.

The First Coverage system also benefits the buy side, observes Tabb, because it doesn't have time to track every investment idea sent by the sell side. "If you can get a third party to validate everybody's results and then everybody agrees to the methodology, then it becomes easier to look at an independent rating agency to say, 'We should either trade more or less with you,'" he suggests. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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