“Dismantling” of fundamental research jeopardizes economic growth, warns MIT Sloan expert

Rebuilding research capacity key to investment in innovation, says John DeTore

John DeToreJohn DeTore, Senior Lecturer, Finance

CAMBRIDGE, Mass., March 1, 2010 — Beating up on Wall Street may be fashionable, but the “dismantling” of one critical piece of the financial sector – investment research – poses a serious threat to the nation’s economy, according to investment firm veteran and MIT Sloan School of Management lecturer John DeTore. The problem, he explains, is that portfolio managers and others now lack the informed guidance they need to make investment decisions, leaving the nation’s businesses less able to raise the capital they need to advance the innovations and products that fuel economic growth.

“Ten years ago, powerful research teams, both in investment firms and on Wall Street, had a deep understanding of the major public firms,” said DeTore, Chief Investment Officer of Boston-based Denver Alternatives. “The result was 30 to 60-page research reports with major conclusions. Maybe you didn’t like what the analysts said, but they were informed. Now, it sometimes seems we’re left with a bunch of bloggers who just want to know if you meet your quarter or not.”

The financial devastation that peaked in the fall of 2008 “led to the wholesale withdrawal of money from active fund managers,” said DeTore. Many research analysts were laid off and many funds went out of existence. “We’ve dismantled much of our research capability, without which there is no longer an invisible hand to intelligently guide capital allocations.”

”This capital allocation is what fuels a vibrant economy, said DeTore. “When our market system functions well, it’s through people buying and selling shares, taking capital from the weaker companies and giving it to the innovative ones.” Among other consequences, the 2008 “run on the banks” from active investment management left that capital allocation system in disarray.

DeTore acknowledges that many active managers produced poor returns in 2008. “Many investors were really angry with the active management community for screwing up their retirements. But we should understand that because of the wholesale withdrawal of money, it was very hard for active managers to invest in line with their research. In fact, they were forced to sell their best ideas.”

The active investment industry must rebuild its investment research capacity. “It may take years, but we must recover from this so that senior managers again have the information they need to give them an incentive to drive innovation, DeTore said. “Those investment firms that have maintained their dedication to excellent fundamental research will have a real edge in today’s markets.”

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