Once thought inconceivable, an interesting trend was uncovered in the October 29th The Wall Street Journal, there are a number of debt issuing firms foregoing the traditional credit rating process.  In an article titled Credit Rating Now Optional, Firms Find, the Journal points out some globally prominent firms and governments have decided not to have their bonds and debt backed securities to be offered rated by any of the major credit rating agencies.  Instead, these issuers are insisting that their investors do their own analysis of the cash flows and risks involved in each security.

This is a noteworthy trend as ratings from the major rating firms like Moody’s (MCO) and Standard & Poor’s (MHP) in some cases were seen as a rubber stamp authenticating debt and its associated risks.  However, these agencies have come under scrutiny during the credit crisis as many of their ratings have been proven unreliable.  Some would argue that the credit crisis exposed risks in highly rated debt issues that seemed to catch the agencies asleep at the wheel.  The emergence of non-rated debt does suggest a lack of confidence or at least lack of necessity of these established guidelines.  As the CEO of Italy’s Gruppo Campari was quoted as saying, “Our reputation is good….I don’t think a rating would have mattered that much.”

The lost credibility is clearly not the only contributing factor to the rise of unrated debt securities.  Possibly more influential in these unrated issues is the speed at which the financing can be gained without a credit rating.  Credit rating firms can take months to issue a rating on debt, and not to mention this is not a cheap undertaking.  If a company needs capital more quickly, they can simply raise the rate slightly to attract more interest from institutional lenders who will be conducting their own due diligence with or without a rating anyway.  For the issuer, it is obviously a tradeoff between cost of capital and speed of the deal. 

For now, it appears there are enough lenders ready and willing to undertake their own review in order to attain a higher return.  With many institutional managers and hedge funds still smarting from the credit crisis, an extra return can easily compensate for doing more of their own research.  In some cases the extra interest earned over the course of the loan can be substantial, as the article points to this specific instance from Dubai.

“The Persian Gulf emirate’s economy has been hard hit by downturns in real estate and the financial markets, but its unrated bonds attracted risk-taking investors looking for yield.  The Dubai government sold the debt for a yield over 6%, compared with 3.85% yields on comparable debt of neighbor Abu Dhabi, which has a strong credit rating of double-A and recently provided Dubai with financial support.” — Credit Ratings Now Optional, Firms Find

The point of this post is not to pass judgment on the major ratings firms, as we all know plenty has been written and said about their short comings.  Rather, the point is to highlight an intriguing trend in debt instruments; a trend that has been used by firms such as Highland Capital Management, Heineken NV, Gruppo Campari and Credit Suisse (CS).  The credit rating firms provide a service that many investors cannot do without, and the evolution of unrated bonds should motivate them to improve and not repeat mistakes that have harmed their credibility.  However, the emergence of independent research and due diligence is what is more interesting to us at Ockham. 

At Ockham, we try to make a point of telling clients that no investors should rely on one source of information for an investment decision.  We think of our research as a baseline for understanding and an aggregator of information, but it cannot supplant additional due diligence.  Investments should be rooted in a true understanding of where you are putting your money, and risks should always be weighed.  The ultimate responsibility for an investment lay with the investor who has taken on the risk.

Client Therapy
The iTunes Financial Adviser
Christian Ward 02.11.09, 10:45 AM ET

If anything is clear from the current financial crisis, it is that financial advisers need to become adaptive. Servicing investors’ financial wealth solely using a monthly statement will not suffice much longer. Clients deserve and demand a more interactive experience. Hand holding becomes archaic when information is everywhere.

So how should a financial adviser go about empowering their client base while maintaining a key position in each client’s investing value chain? The answer lies in the adviser recognizing that there is a new way to do business and that their own clients are driving this change.

Perhaps a look at digital music can be informative. While seemingly disruptive to music labels and software providers upon its launch, Apple’s iTunes quickly became the most dominant music outlet by allowing customers to have an interactive “dialogue” with their media and media providers on their own terms. Customers said things like, “I don’t want the whole CD,” and “I want to try a song before I buy it.” They also said, “Don’t tell me how great something is unless I ask, and don’t push products on me. Give me great access to my media from anywhere and give me human contact when I want answers fast.”

The success of Apple and iTunes is that they heard these demands and answered them. The iTunes model empowers each client by putting the best tools and information at their fingertips, while leaving the door open to additional services many don’t even realize exist. In return, iTunes has the most loyal client base in the highly aggressive world of online music and software distribution. (Remember, we are discussing items with a $0.99 price point.)

By empowering consumers and clients to interact with information and products on their own, iTunes created a bridge between old concepts and new demands. The sheer volume of shoppers on iTunes that desired a better alternative was almost unimaginable, and today’s financial crisis and resulting crisis of confidence have created a similar volume of investors seeking a better financial advisory model. We are entering the age of the iTunes investor–enabled, interactive and informed.

Of course tracks from the Rolling Stones are not Dow stocks and ETFs will never be as original as Bob Dylan, but financial advisers must recognize that personal tastes are at the heart of any purchase or investment. Despite the best of intentions, an adviser cannot choose the music on a client’s iPod better than he can choose it himself.

Now I recognize that you may say, “My clients aren’t that sophisticated,” or “Picking music isn’t like picking stocks and funds.” To you, I offer two observations. First, there are more than 10 million songs on iTunes, and there have been over 6 billion downloads as of January 2009. Searching, sampling, reviewing, purchasing and installing these songs and applications from such a massive library has remarkable similarities to investments. Second, if your clients weren’t that sophisticated before October of 2008, they are learning that sophistication right now and searching for the tools to help them achieve that knowledge.

The iTunes investor has two options. Build the knowledge base necessary to go it alone, or work with a trusted adviser who will help him build that knowledge base. Either way, he is going to build his own knowledge base. The question is whether a financial adviser will be involved.

Einstein said, “Information is not knowledge.” Professional advisers know that this statement carries particular weight in their business. As information overload (or TMI in texting parlance) cuts into interaction with every client, it becomes increasingly important to help clients slice through information to get to what is necessary. The same way iTunes can whittle down 10 million song choices in three clicks, so too must a financial adviser. That is where you earn loyalty and provide value for your clients.

Investment advisers need to share their knowledge base with their clients. Advisers must cite and direct clients to informational tools that they respect and utilize so that a dialogue can be achieved. This will allow for more efficient communication for both of you by broadening the base of knowledge.

You must empower them to watch their portfolios and news pertinent to those holdings and be available when things don’t go as planned. Just because they will occasionally download a song they don’t like, doesn’t mean they’ll cancel their iTunes subscription. It just means that they may want to try another song from a different artist. They will seek counsel from their trusted ally and idea supplier, their adviser.

ITunes investors will value relationships that keep them enabled and informed. They will rely on those who share knowledge openly with them. They will demand an informed dialogue about their wealth and financial goals.

Keep your clients informed and your clients will keep you.

Christian J. Ward is CEO of Ockham Research, an information, content and financial research firm in Atlanta. Visit www.ockhamresearch.com for more information.

The immensely popular TechCrunch blog features an outstanding guest column by the founder of Mint.com, Aaron Patzer.  For those unfamiliar with Mint, it is a personal finance site that tracks user’s spending on various accounts (bank, credit card, loan, anything that can be tracked online) and aggregates personal finances into one convenient source.  The site allows for the collection and organization of a ton of data, and when considering its growing user base, now 900,000 users (or close to 1% of the US households), you can get an interesting cross-section of the economy. 

The backdrop of the article is the world economic forum in Davos.  Patzer is struck by the apparent triumph of rhetoric over data in many of the presentations given on the current global recession.  An interesting point, as we hear nearly everyday that we are in the worst economy since the Great Depression.  At least at Davos, there seemed little empirical data to support these claims other than the mention of equity market losses.  The catastrophic global slump was taken on faith as “everybody knows” its that bad.  Patzer, being an engineer, was not satisfied with settling on this dour premise from which to begin the summit without some proof of the dire circumstances as related through cold, hard data.

Lucky for us, Patzer is in a unique position to shed some light on the average Mint user, and in so doing, give us a clearer picture of the economy as a whole.  His study of mint users between August 6, 2008 and December 15, 2008 yielded these results,

“Is it Great Depression bad? That’s a qualitative question I can’t answer. But what the data, the hard facts, mean for you – if you run a consumer business – is that your customers are spending $400 less each month than they were a year ago, have burned through half of their savings, and on average have taken on an additional $5k in debt.”

Perhaps most refreshing is the fact that Patzer happily leaves the numbers to tell the story.  By contrast, many market commentators look for recognition by trying to time the market better than anyone or by being the most sensational out of their peers.

Furthermore, this article highlights a new and developing trend in research in the web 2.0 world.  There is so much information available these days on the web that there will be increasingly meaningful data produced by aggregators like Mint.  You are seeing the beginning of this trend in little ways around the web with various sites listing most popular articles, products and searches.  Can you imagine the value of information stored at Google (GOOG)?  Thank goodness their motto is “Don’t be evil.”  Of course, social media sites like MySpace (NWSA) and Facebook have an incredible amount of data with their massive user base.  They just have not yet figured out a way to harness it in a way that does not offend users, who often put very personal information on display.  However, there is little more personal to an individual that your personal finance, and users are readily making tangible and meaningful data available to Mint.

As the saying goes, knowledge is power and new tools on the web are expanding people’s everyday uses for the web all the time.  As Patzer said to end his article,

“Good decisions are based on good data. And data – in itself – may be one of the most valuable by-products of any startup.”

File under the “a picture is worth a thousand words” category, or at least worth a 300 plus day in the Dow.  Again, not that we think the volatility will subside any time soon, nor do we think that companies values and earnings numbers are really close to their bottoms, but you do have to question the market psychologists.  In terms of market psychology, I have seen many studies and research services that track sentiment in print, media, television and other sources to correlate market movements with the general tone of media.  Almost all of them demonstrate that, at a certain point (and they each describe that point differently) there becomes a good news / bad news saturation of media.  In other words, the human investor can simply not absorb any more bad news to make them sell.

Last week we saved many screen shots from the web that highlight this phenomenon.  The question remains, are we fed up enough with bad news to believe that “its got to get better from here.”  And does that have any economic correlation to the real world?

This is an often written about topic, so let’s beat this horse a bit more, shall we?  Every year, in the October issue of Institutional Investor magazine, the investment management community is surveyed to find out what they like most (and least) about brokerage research.  In other words, what does the Buyside think of the research from the Sellside.

The categories to be sorted are a bit odd and incongruent in that some are products or accuracy ratings while others are more of a personality trait or eHarmony opinion.  For example, “industry knowledge” is something of a subjective thought, and “analyst integrity/professionalism” is even worse in that I have no idea how that is calibrated.  On the other hand, “analyst accessibility” is something concrete and can actually be measured with how much time an analyst allocates to direct client interaction.  Our opinion is that the categories (like the analysis) is somewhat flawed due to these nebulous descriptions of attributes that range from personality, to personal (dis)likes, to actual products and analytical skills.

Regardless of whether it is a good ranking mechanism or not, it is always interesting to see how institutional money managers rate analysts.  Not surprisingly (because it is the same every year it seems), industry knowledge and analyst access rate the highest.  These two even trump integrity and professionalism, which means that if you are really knowledgeable in an industry and enjoy taking clients out to grab drinks every night, you really don’t need to be graced with great morals or manners.

Also not surprisingly, “stock selection” has once again come in dead last.  Research delivery, earnings estimates, and financial modeling skills round out the bottom of the list.  Now let’s take a moment to digest what the investment managers are once again trying to tell Wall Street.  Let me see if we can boil it down in one succinct phrase…

“STOP RATING COMPANIES!” screamed the professional money managers…

It is completely amazing how the people and firms who use Wall Street research more than everyone else have been screaming the same thing for years to a seemingly deaf audience.  Investment managers want analysts who have deep industry knowledge and are looking for who can provide the best “Why?” analysis.  They want access to these specialists and real time interaction and content.  The belief that hedge fund managers are anxiously awaiting the release of an earnings estimate or initiation of coverage report from a top investment bank is insane.  The survey, year in and year out, says that the Buyside just doesn’t care about those things.

So if the Buyside doesn’t care about ratings and earnings estimates from the investment banking research analyst community, why provide them at all?  The answer, is and has always been, retail. The investment advisors and registered representatives at the major investment banks have always used those ratings and the ill-conceived “Buy-Hold-Sell” reports to drum up interest, transactions, and the gathering of assets.  It’s a failed model that has done more harm than good to individual investors for decades.  If professionals view investment banking research ratings as useless, why do we keep allowing those ratings to be peddled to individual investors?

Now nothing I am saying is new, and it certainly isn’t a surprise.  Most or our analyst friends at the major firms would absolutely love to stop having to produce 30 to 40 page research reports and quarterly earnings models that, in the end, don’t bring them any additional love (or compensation) from their institutional clients.  It just appears that the machine doesn’t know how to turn itself off.

Unfortunately, it may be turned off by the collapse of the financial services industry.  With Citi (C) possibly following suit of Bear and Lehman, who knows how many research houses will be left from the bulge brackets.  In fact, Institutional Investor magazine might have some really interesting new categories of ratings next year.  Perhaps “Still in Business” will be the top ranked attribute of investment banking research.