Quants and investigators–Business intelligence beyond due diligence

Both sides have argued for years about the relative merits of quantitative and fundamental research approaches to investing. Both sides agree that a synthesis between the two systems is necessary in today’s highly unpredictable environment.

Quant models cannot predict future price movement in a world where the government plays an increasing role in the markets and regulations change quickly and without warning. Quant strategies find integrating more future-looking data into systematic models challenging, as the data used is usually historical. Moreover, economic activity is increasingly driven by markets that must be more transparent and resist government intervention. Even developed markets will see greater state involvement as governments continue to push the green revolution.

Quantitative strategies struggle with the new investment environment. But traditional fundamental research has problems in markets that lack reliable information and are not as accessible as in developed countries. They also have issues in countries where regulations and politics can be challenging to understand.

Investment managers need an analysis to help them understand the relationship between macro-trends and the micro-environment in which an investment target is located. Specialist business intelligence (BI) firms can provide fund managers with the missing information they need to get that extra edge over their competitors.

Digging Deeper–An Intelligence edge

Business intelligence can be viewed as needing to rely more on publically available information or unreliable human sources. BI operations that are intelligently planned and managed can be one of the best ways for asset managers to improve performance and avoid making potentially disastrous investments.

Some BI service providers place a disproportionate emphasis on due diligence to the detriment of other aspects of BI that can create active value for investment firms. Due diligence is a critical first step and is often mandated by regulators. However, BI firms can provide valuable information that can add commercial value to acquisitions and investments.

Let’s look at a hedge fund considering a significant investment in an industrial conglomerate in a developing nation. Recently, the target corporation produced disappointing returns for its shareholders. A complex organizational structure allows the founding family to retain control disproportionate to their equity stake, even though the company is public. The group’s relationship with politicians is ambiguous: some think it has too much power in the past and should be regulated more severely; others believe it is essential that the government give the conglomerate favorable treatment because it is a significant contributor to the country’s economy. There are differing opinions on strategy and succession planning within the company and the family that control it.

A competent due diligence investigation could identify fraud and corruption cases involving members of the family control. The research could also reveal disputes with suppliers, competitors, and other parties. This is all-important. A lack of transparency and bad corporate governance can partly explain the poor performance of a company’s stock. There are many other factors to consider that might be obscure from the perspective of due diligence but which could be critical for the success or failure of an investment. What are the strategies of each family member for the group? What is the succession strategy? What politicians support the group, and which think it should be reined? What is the attitude of the regulators towards the group? What are the opinions of other shareholders, and how do they form alliances? What are the key managers and–if not family members, how are they motivated? The list goes on.

A detailed analysis reveals the complete picture.

Specialist BI firms can provide actionable and convincing answers. They are based on research and analysis, using a range of semi-public and public sources (such as subscription-only databases) and from human sources who know about the country. First, let’s look at the research side. Some of the data that is being examined can be found easily today. But accessing the data is only the first step. It is more important to understand its true significance. This can often only be understood compared to less accessible intelligence and information, which may only come from human sources.

Some funds do their research. They may use relatively new sources, such as location tracking of shipping and air traffic, live camera feeds at specific locations, or social media posts. The research done by BI companies and clients’ teams overlap. BI firms need to maintain close contact with their clients to minimize duplication and maximize the value of their work. It is also possible for them to be a voice of reason. An outside firm can provide more information and challenge an investment thesis.

Some BI companies are not suited to work with hedge funds. However, experienced providers will ensure clients are not accidentally sent MNPI. High-level BI companies are focused on something other than finding insider information but instead on providing intelligence and analysis to help clients create a strategic framework for investments they are considering. BI firms can give clients the edge they need to beat their competition, regardless of whether their decisions are based on quantitative analysis or fundamental research. In today’s uncertain investing environment, this can have a significant impact.

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