Welcome guest author Mark Thurston, founder and partner at consultancy firm Alpha Signal. Mark was previously head of equity manager research at Russell Investments, where he worked for 25 years.
Making good research decisions is more important than having the best organizational structure, but getting the basics right first can be critical to success. What are the main factors to consider when structuring a due diligence team?
Research professionals are typically divided into two broad categories: specialists and generalists. In short, specialists are optimal, but generalists have a role to play too. Building a team of specialists is significantly more expensive than a generalist model, and most new or small research organizations simply can’t afford more than a couple of specialists. However, if a team is well-resourced, it is better to employ both methods, combining specialists with general expertise.
Specialization really is key to getting the best results in manager research. In equity markets, for instance, many of the inefficiencies are common to different geographies, styles and market segments, meaning they could be covered by a generalist. However, there are large differences in excess return potential between, for example, US large caps and emerging market small caps. In this example, informational inefficiencies are rarer and less powerful in US large caps. Analysts specializing in emerging markets would therefore be more familiar with what constitutes a legitimate competitive advantage and would be better placed to access that.
In a world of limited resources, though, generalists may be the more sensible option. In many situations, generalists have advantages over specialists, as the latter can more easily fall prey to confirmation bias in seeking evidence that confirms their pre-existing beliefs. Specialists also tend to be more rigid and insular in their thinking, whereas generalist recommendations are more often based on common sense and are therefore more likely to be followed by clients.
Any successful manager research effort requires a substantial breadth of information too. Extensive education and training in economics, accounting and statistics are a precursor to understanding both financial markets and fund management. This general knowledge should help to form the basis of the research process.
It is important to understand and incorporate these different styles of decision making within your team. To achieve diversity, improve communication and get better outcomes from decisions, organizations need to study individuals’ decision making and behavioral styles. The tools below can be helpful in understanding individuals, achieving diversity in thought and approach, and designing processes based partly on the profiles of the research analysts in the team:
- Myers-Briggs Type Indicator – This personality survey attempts to categorize how individuals perceive the world and make decisions. It gives insight into their sensations, intuitions, feelings and thought patterns.
- Decision making styles – Relatively simple tests can be given to help understand analysts’ preferred approaches, which can be broadly broken down into the following categories: directive, analytical, conceptual or behavioral. Unsurprisingly, research roles attract individuals who have a strong preference for the analytical approach. Balancing natural analysts with others who are more directive and conceptual can improve the effectiveness and efficiency of decision making.
- Fundamental interpersonal relations orientation (Firo) – This theory looks at interpersonal needs when it comes to inclusion, control and affection. It mainly explains the preferred interactions of individuals working in groups.
- Birkman Method – This personality, social perception and occupational interest assessment is designed to provide insight into what drives an individual’s behavior and whether they are a doer, a communicator, a thinker or an analyzer.
While it is important to promote diversity of thought, control must also be maintained. A well-defined process overseen by more experienced analysts can help to promote consistency and make training more effective. However, these experienced analysts should be given discretion within a defined process but not of the process, helping to improve accountability and motivation without undermining the process by handing over total control.
One helpful principle for investment managers and manager research analysts is to promote specialization as far as possible. Once a research analyst has developed significant expertise, they should be given authority and discretion to make ranking calls in their coverage area.
However, transparency is paramount to promote checks and balances. Analysts should be required to develop and clearly articulate their rationales. The decision making process should include a thorough review by the most capable senior research leaders, which will help to reduce myopia. Speed is often beneficial to this but should not come at the expense of rigor.
The scale of the task
The largest manager research organizations employ more than 100 analysts and spend millions of dollars. The complexities of covering all products, promoting effective collaboration and developing analysts’ skills are massive. However, some of these challenges are very similar in smaller firms. Research directors should employ accountable specialists where possible, seek to create an environment where diverse ideas are considered, and ensure that decisions are subject to rigorous peer review.