Fund managers have long debated the relative merits of the quantitative versus the fundamental research approach to investing, with strong arguments on both sides. But in today’s highly uncertain environment, both camps can agree that one approach is not enough—a synthesis of the two is needed.
In a world in which the government is taking an increasingly larger role in markets, and in which regulation is changing quickly and unpredictably, quant models have difficulty predicting the future movement of prices. Data used in systematic models are generally historical, making it difficult for quant strategies to incorporate more forward-looking information. Furthermore, economic activity is being increasingly driven by markets that are less transparent and more susceptible to government interference. And even developed markets are facing greater state participation and will continue to do so as governments seek to drive the new green revolution in the global economy.
Quant strategies may struggle in the new investment environment, but traditional fundamental research also has its issues in markets where information is less reliable and not as easily available as it is in more developed countries, and in countries where politics and regulations are difficult to decipher.
What investment managers really need is an analysis that helps them understand the interaction between larger trends and the specific micro-environment of an investment target. For fund managers that want to gain that elusive extra edge over their competitors, specialist business intelligence (BI) firms can supply this missing information.
Digging deeper—An intelligence edge
Business intelligence is sometimes seen as either overly dependent on searches of publicly available material or on unverifiable—and sometimes unreliable—human sources. Carefully conceived and intelligently managed BI operations, however, are some of the most effective ways for asset management firms to improve their performance and to avoid potentially disastrous investment decisions.
Some BI providers have a reductive emphasis on due diligence alone—to the detriment of those other aspects of BI services that can actively create value for investment firms. Of course, due diligence is a crucial first step in the process and one that is mandated by regulators in many situations, but BI firms can also provide critical information that adds commercial value to investments and acquisitions.
To illustrate the value of the services BI firms can offer, let’s consider a hedge fund that is contemplating taking a large stake in an industrial conglomerate in a developing country. The target corporation has recently produced disappointing returns for shareholders. Although a public company, a complex organizational structure means that the family that originally founded the group still maintains a degree of control disproportionate to its actual equity stake. The group has an ambiguous relationship with key politicians: some believe that it has historically had too much power and needs to be regulated more strictly; others think that it is important for the government to give the conglomerate favorable treatment as it is an important contributor to the country’s economy. Even within the company, and the family that controls it, there are different opinions about strategy and succession plans.
Any competent due diligence work might identify cases of fraud and corruption linked to members of the controlling family. Research might also identify disputes with competitors, suppliers, and others. All of this is important: bad corporate governance and a lack of transparency can partly explain the poor performance of the company’s shares. Many other issues need to be understood, however, that may not raise any red flags from a due diligence perspective but could be crucial for the success of the investment: Which members of the controlling family are key? What are their strategies for the group? What is the succession plan? Which politicians are supporters of the group and which believe it needs to be reined in? What are the attitudes of the regulators? What do other shareholders believe and what alliances are there between various shareholders? Which managers are key and—if they are not family members—how are they incentivized? And so on.
In-depth analysis reveals the complete picture
It is not enough just to be able to summarize the questions; specialist BI firms provide convincing and actionable answers. These come from both analysis and research—using a variety of public and semi-public sources (for example, subscription-only databases)—and from knowledgeable in-country human sources. To deal with the research aspect first: some of the data being examined is relatively easy to find nowadays, whether archived press articles or corporate filings from an online registry. Accessing that data, however, is just the beginning. More important is understanding its real significance, which often can only be grasped when it is considered in juxtaposition with other, less accessible information and intelligence, which might only be gathered from human sources.
Many funds conduct their own research, some using relatively new sources of information: location tracking for shipping and air traffic, real-time camera feeds in specific locations, or social media posts. There can be an overlap between the work of BI firms and that of clients’ research teams. This only emphasizes, however, how important it is for BI companies to work closely with clients, to avoid duplication, and to maximize the added value of their work. They can also be an independent voice—it is easier for an outside firm to provide information to challenge an investment thesis than for internal staff, who might suffer from confirmation bias.
Not all BI firms are suited to working with hedge funds. Experienced providers, however, will ensure that there is no danger of clients inadvertently being sent material non-public information (MNPI). And high-level BI firms are not focused on looking for insider information but on supplying intelligence and analysis that will help clients develop a strategic framework for the investments they are considering. Whatever other elements clients are using to form their judgments—whether quantitative analysis or traditional fundamental research—BI firms can give them the additional edge that they need to outpace their competitors. And in today’s uncertain investment environment, that can make a big impact.