Ian Conway doesn’t just give away his best trading ideas. He pays to post them online.
That’s how Conway, his colleagues at London-based Avalon Capital Markets and, increasingly, thousands of market professionals promote their wares. In return, investors pay whatever they think the idea is worth.
In a world turned upside down by new rules on how research is paid for, this is one model — known as “alpha capture” — that is gaining traction. It’s a tool for investors to help establish the value of ideas now that banks are about to be barred from bundling research costs into trading commissions.
“We’ve seen quite a big change in demand from more fundamental firms for trade ideas,” said Colin Berthoud, whose TIM Group provides one of the biggest alpha capture platforms. “We’re also seeing big new firms who haven’t had a trade idea program in the past. There is a need for a quantitative assessment in a way that there hasn’t been historically.”
The demand stems from European regulators’ rewrite of their financial rulebook known as MiFID II, which comes into force in January. What was once a buffet of services attached to trading will soon transform into a system where research, corporate access and trade-execution services must be bought and sold a la carte.
Alpha capture platforms have been tracking and ranking trading ideas from brokers for more than a decade — they’ve been a staple at some hedge funds for years. But they’re growing. Research firm Tabb Group says 2017 spending on alpha capture will represent about 5.8 percent of total global paid commissions, from about 4.8 percent last year. It’s a market that Berthoud estimates could be valued at as much as $1 billion.
Brokers pay about 5,000 pounds ($6,481) a year to post on alpha capture platforms. Fund managers who like what they see then send the trader a check. Some high-performing brokers who use the TIM platform say they have received payments from clients they had never previously met or spoken with.
One winner from this system: Smaller brokerages that lack the established relationships of investment firm Goliaths can now win clients by showing that their advice is superior. That worked for Conway, a quantitative analyst who says he has received payments for his trading ideas posted on TIM Group.
“Nobody had considered the performance angle before, it used to be only about price” of trading execution, said Conway. “Now, there’s an audited record of ideas. It’s a very clinical system, but it’s proven to work.”
The MiFID II regulations, which seek to separate research payment from trading commissions, will spur more than $300 million in research budget cuts in the U.S. and Europe, according to consulting firm Greenwich Associates.
Other startups offering a la carte services such as corporate access or analyst researchare seeing upticks in client interest ahead of the law’s January deadline. Data-backed systems like alpha capture are likely to similarly benefit, Tabb Group says, giving brokers an additional channel for payment as well as bragging rights for generating the top-ranked ideas.
One problem, though, is that payment isn’t guaranteed as it’s an honor system, says Geoffrey Mills at Oppenheimer Europe, a TIM client.
“If the buy-side wants to engage the sell-side on alpha capture, they have to properly incentivize the top performers,’’ said Mills, a sales director at Oppenheimer in London. “At the moment, whether they are doing that, or just making use of the data points and signals is an open question.”
Still, TIM Group says that it has almost every large broker in the world as a client — more than 4,000 contributors. On the buy side, it has lured 250 firms ranging from hedge funds to long-only funds.
Hedge funds including Marshall Wace LLP and Two Sigma Investments LP were among pioneers in using in-house alpha-capture platforms. Third-party rivals are likely to benefit as more funds review fee policies ahead of MiFID II, Tabb Group says. For now, TIM Group has few major outside rivals. (One of them is Bloomberg LP, parent of Bloomberg News.)
“It’s evolved from nothing to being a globally accepted practice,” said Niki Beattie, a Merrill Lynch alumna who now heads adviser Market Structure Partners. “With MIFID II, clients will have to be more discerning about the information they take, how they use it and how they pay for it.”