What is Investment Research?
Investment research is the process of poring through information and using personal skills and understanding to make sound choices about putting money to work. It is a subset of financial research that analyzes and provides advice on investments. Research is conducted using one or more of the following: fundamental analysis, technical analysis, quantitative analysis, credit analysis and alpha generation.
While many think that investing is simply a matter of buying stocks, bonds, mutual funds or other securities, watching them grow and then cashing them in at a later date, this is only true for some investors. The truth is that there’s much more to it which makes the subject of investment research all the more important.
Generally, investment advice is communicated in the form of an opinion about whether an investment will be profitable for the adviser’s client. If such opinions are prepared with a reasonable degree of care, skill and diligence they may be thought to be exempt from liability under securities legislation in most countries.
What are the Components of Investment research?
1. Fundamental analysis: the study and interpretation of available information and data related to a prospective investment or investment entity and how it will perform in the future. The key criteria for analyzing a prospective investment is usually profitability, usually measured as return on capital. Fundamental analysis also involves gaining an understanding of the company organisation and its financial status as well as due dilligence into background information such as financial statements, legal documents, records etc.
2. Technical analysis: the study of financial market price/volume/product/or credit history. The goal is typically to identify patterns that can be used to forecast future prices and determine more precise entry and exit points for a position. Technical indicators such as moving averages, trendlines and support and resistance levels are often utilized.
3. Quantitative analysis: this is an umbrella term for a wide range of mathematical models used to evaluate prospective investments or investment entities. These models range from hypothesis testing to more complex econometric models such as linear regression, cointegration, vector autoregression models among many others. Different types of quantitative analysis include:
4. Credit analysis: the study of a company’s ability to pay back/repay its current and future debt. This involves studying a company’s financial statements, business plan and any collateral backing the debt. The main types of debt that need to be analyzed are: normal commercial loans, secured loans, stock market securities, bonds and other derivatives.
5. Alpha generation: the process of looking at an investment from a perspective other than its traditional use as an asset class or as security for money management purposes. In addition to normal analysis there may also be value created from strategic planning, corporate restructuring or even portfolio optimization. For example, a company may receive a takeover offer which would affect all shareholders in different ways depending on their holdings and holding structures.
Most countries have a set of rules which govern investment research and investment advice. In the US, the SEC has a set of rules governing financial advisers and investment research which are contained in Rule 205-3 under the Advisers Act of 1940.
How does Investment Research differ Investment Advice?
Investment advice differs from Investment research in that Investment advice is generally not required to be given with reasonable care, skill or diligence. The content is generally different as well as the knowledge needed to give it – Investment advice may include statements about future performance whereas Investment research is normally restricted to past performance.
The key differences are however, that Investment advice is generally not required to be given with reasonable care, skill or diligence. The content is generally different as well as the knowledge needed to give it. Investment advice may include statements about future performance whereas Investment research is normally restricted to past performance.
In the US, Investment advice is regulated by the US Department of Labor and subject to fiduciary responsibility and disclosure under ERISA. Generally, Investment advice is exempt from liability under securities laws but not from civil liability for fraud or negligence. In the UK the UK Financial Services Authority is responsible for regulating investment advice – they have a set of rules called “The Client Assets Sourcebook” which covers both investment research and investment advice. In South Africa there is no official regulation of Investment Guidance per se, however, an entity may form a Section 21 Company with a mandate to provide financial guidance.
In general Investment research involves a degree of skepticism about a prospective investment whereas Investment advice usually assumes an optimistic bias in its statements. Investment research is more likely to have an objective approach to a prospective investment whereas Investment advice is more likely to be biased towards the client’s own interests.
Who can provide Investment Research?
It is commonplace for investment research and investment advice to be provided by the same organization, although this is not necessarily required. There are however, two main types of provider: pure research and product providers and hybrid providers.
Many large financial institutions such as banks and asset managers generally provide both services using different classes of licenses/registrations and different departments (see for example J.P. Morgan). Further, some pure research providers also provide informal investment advice or vice versa.
One of the most popular models is the “hybrid” model. This is where an external financial adviser provides advice on what investments are appropriate, but then delegates execution of transactions (buying and selling) to the client. The key requirement is that the “investment advisor” must not be involved in making trades. A common practice for this type of provider is to use a front-end offshore execution platform for trades, and then provide ongoing advisory services using an asset management company which uses an onshore license/registration. Another common practice is to provide execution services by using a third party service provider e.g. Interactive Brokers.
While investing in the stock market may look like an easy and straightforward way to accumulate riches, it is not always as easy as it appears and some may argue it is the opposite. Without deliberate and informed plans, identifying a profitable venture is a herculean task. The presence of professional investment researchers however makes the process a lot more easier and straightforward as they:
- Aid in building a portfolio
- Help to monitor the ever-changing markets
- Conduct research to build appropriate strategies
- Help in preparing for the future of investments
Engaging a professional investment researcher would, from the foregoing, no doubt go a long way in helping investors realize their broad investment goals.