Innovative institutional research methods

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In this article, I continue the discussion of new methods of investment research.

See: Crowdsourcing investment research: opportunities in OSINT and Free information and the Efficient Market Hypothesis and Crowdsourcing investment research: Capital Market Taxonomy and Innovation in investment research; dealing with free information

Investment bankers, fund managers, and institutional investors depend upon investment research to achieve their purposes. Those institutions that combine the most complete and accurate information intelligence with the best interpretative skills can best serve clients and gain competitive advantage.

New Technology

Investment research has a cost and there is a limit as to how much an institution can spend on this item.

When investment research is performed with respect to a portfolio, the limits on investment research are determined by the size of the portfolio, plausible returns, and practical ceilings to management fees that might be charged.

Competitive advantage in investment research depends upon getting the most accurate and complete information and then making decisions using the highest interpretive skills, at the least possible cost, within economic limits set by the nature of the business and the market.

As mentioned in previous articles, above, there is more information freely available today, than most institutions can afford to gather and process.

However, technologies are now available that can reduce information costs substantially, while giving practitioners a competitive advantage — at least  until these technologies become common practice.

Strategies for mining information

In today’s information rich environment, it costs more to gather, organize, filter, summarize, and present factual investment intelligence than it costs to make a rational, informed decision based on this data.

Gold buried in the archives

Although most of this information is free and available to anyone who has access to the Internet — often from official sources such as SEC archives — the quantity of information is so vast and the presentation so disorganized and confounded with irrelevant, repetitious, and obvious self-serving statements, that the time-cost of extracting relevant data is far greater than most institutions can expend.

In other words, critical information is there for anyone to see, but few have the time, organization, or staffing to take advantage of this opportunity.

The Crash of 2008 — in large part an informational crisis — provided the motivation for investment institutions to experiment with new methods of information mining.

A plausible strategy to take advantage of the current informational environment has three elements:

1. Find a way to process and turn raw investment information into actionable intelligence at less cost than one’s competitors.
2. Take action on this intelligence (buy or sell securities, make recommendations to clients, etc.) before competitors can do so.
3. Having taken action on the intelligence, make sure that the whole world has the same information as quickly as possible. The market will only react to what it knows. If you are the only one that knows the facts about stock ABC, the price will probably not be influenced by these facts.

No deception; no advice

Publishing investment intelligence that is not widely known may sound like a form of market manipulation or insider trading, but it is not, because the information is all open source, freely available to all.

However, information becomes more valuable when separated from irrelevant data, opinion, and unconfirmed facts.  Raw information, once thus transformed, becomes a new product.

Here is how the US SEC defines market manipulation:

Manipulation is intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security. Manipulation can involve a number of techniques to affect the supply of, or demand for, a stock. They include: spreading false or misleading information about a company; improperly limiting the number of publicly-available shares; or rigging quotes, prices or trades to create a false or deceptive picture of the demand for a security. Those who engage in manipulation are subject to various civil and criminal sanctions.

Stock manipulation (other than that permitted by the SEC under Rule 10b-18) was common in the information-poor markets of the early 20th century — a different world than today.

An information-poor market ...

Republishing facts (probably taken initially from SEC public files) with no intent to deceive — without recommendations, opinions, or advice — can hardly be considered market manipulation, otherwise, every Moody’s report would be considered market manipulation.

Furthermore, when information is published with footnotes linked to each source and is limited to factual information, with no buy, sell, or hold recommendations, without puffery that might be considered touting a particular security, it should not be considered a form of market manipulation.

Note: Information published on Capital Market Wiki — an example of the technology described in this article — is limited to facts, stripped of opinion. Facts are  presented in “recommended formats” in response to standard “implied questions” that reduce the likelihood of bias. Assertions are footnoted, with links to sources. Articles are subject to collaborative editing so that a single institution or editor cannot control output. The data is from free, open sources. Edits are documented  and time-stamped.

Cutting costs of information

The key to the collaborative investment research is knowing how to extract valuable facts from a sea of free, largely unexploited investment date, at less cost than competitors.

Part of the solution lies in applying new technology, such as crowd sourcing, semantic databases, and Capital Market Taxonomy, as described in Capital Market Wiki and in the references in the blue box at the top of this article.

High salaries, overtime, and high rent

The practical basis for cost-cutting is the  contracting methods and sourcing arrangements, and the separation of fact-gathering from intelligence analysis and decision-making.

The nut to crack is the cost of a credentialed, experienced security analyst sitting at a desk in a high-rent office of one of the world’s major financial centers, as a full-time employee with a year-end bonus, pension scheme, and with expenses paid for luncheons and taxis, and with the overhead of the inevitable organizational meetings (sensitivity training and such), as well as a share in the costs of staff support (human resources, building maintenance, expense account reviews, etc.).

The highest costs are with fact-gathering.

The trick is knowing how to organize and enlist low-cost, skilled fact gatherers, managed by a centralized decision-maker who controls the more expensive aspects  of data analysis, while seeking coverage and accuracy.

Organizational technology

There are tens of thousands of people — maybe more — with the necessary skills and who are willing and able to work in investment research at a fraction of the cost of those doing the same job in financial centers like New York City, London, or Singapore.

For example, let’s imagine a stay-at-home mom in Boise, Idaho, with a degree in finance, two young kids, and a home office.

First of all, her living costs are far less than if she lived in New York City. Second, she is available only part time, on her own schedule (taking the kids to school, buying groceries, ballet lessons, and all that). Third, she would be willing to work for a flat fee per job, with no pension or fringes. She doesn’t have to pay the triple taxes of residents of New York City and she wants to be able to take a vacation whenever she feels like it, not when the boss says she can. Working from a home office, she can deduct part of her living costs (depreciation, electrical bills, Internet service, etc) and she can even set up her own pension plan — also tax deductible.

Home office, teddy bears, diplomas, computer, Internet ... ready to work

The costs of doing home-based factual research on a fixed-fee basis, without strict delivery deadlines, can represent a savings of as much as 80% compared to the same service provided by a full-time employee of a financial institution in New York City ($96,000). That amounts to about $50 per hour (before bonuses, over-head, and down-time). The true cost is probably double that.

This suggests that a 75 man-hour research project performed by a salaried security analyst in New York City, taking into consideration overhead and downtime, might cost $7,500, where the same job done by a stay-at-home mom, with equal professional qualifications in Boise, Idaho, on a fixed-fee basis, without a deadline, might cost $1,500 — or less, with payment only on delivery.

Furthermore, after taxes and the cost-of-living differential, the stay-at-home mom in Boise, Idaho may end up with more money in her pocket than her colleague in New York City.

So, if home-sourcing factual research can save money, the question becomes how to manage such work?

Wiki assignment templates

The Capital Market Wiki Project comes with programmable research assignment templates, tied into Capital Market Taxonomy and a system of recommended formats, that simplifies the task of managing remote researchers.

Easily programable research assignment templates

The system, designed initially for professors assigning open source research projects to students, works just as well in a business environment in managing a distant team of fact-gathering researchers.

These templates are easily programmable, as are the templates for the recommended format system for specific types of research.

The combination of research assignment templates, Capital Market Taxonomy, and the recommended format templates provides a simple way to organize a group of out-sourced researchers at minimum cost.

The Capital Market Wiki Project, is a non-profit organization and access and use is free. The project has extensive help files and requires the same computer skills that millions of editors of Wikipedia possess.

Capital Market Wiki technology is ready-to-go, out-of-the-box, and free. Furthermore, the system is easily adaptable to the needs of any particular organization.

Out-sourcing factual research

So far, we have only explored the possibility of home-sourcing factual research assignments. This works for people like a stay-at-home mom, a retired banker, or someone who has been down-sized from a major institution after the Crash of 2008.

Organization by function and cost-basis

However, there are a variety of sourcing strategies that all work off of the same system:

• Student-sourcing.
• Offshore-sourcing.
• Prize-based-sourcing.
• Home-sourcing.
• Collaborative project sourcing.

Student-souring involves working together with a professor at a university who is interested in teaching open source investment research techniques.

Capital Market Wiki comes complete with a system that allows professors to assign and monitor financial research projects to students. An institution may make an arrangement with a professor whereby both students and teachers may receive compensation for directing such projects to an area of research that is of interest to the financial institution. The students learn how to do research and improves chances for employment on graduation, both students and the professor earn some money, and the institution gets basic research done at far less cost.

The same system used for home-sourcing research describe above, can work just as well with researchers in a foreign country. In this case, the advantage is not just cost, but also gaining access to data that is difficult to obtain in the home country. For example, a finance professional in India may provide factual research on stocks traded on Indian markets, with access to data not easily obtained in the United States or Europe.

Students learn while earning ...

Capital Market Wiki also allows financial institutions to act as patrons, offering prizes to free-lance editors for the best research in whatever area interests the institution. This system can be useful in finding talent for home-sourcing or offshore-sourcing arrangements, or for broadening coverage of certain market areas.

Finally, there is also the possibility of working together in a collaborative project with another financial institution. The research assignment template system allows for multi-institutional research assignment management.

For example, Fund Manager A and Fund Manager B are both interested in investment in REITs. By working together in managing out-sourced factual research, using Capital Market Wiki templates, they can reduce costs even further. Fund A might handle health service REITs, while Fund B handles office/industrial REITs. They both share the factual output, but each keeps the decision-making, interpretive function in house.

Going public with data

The Capital Market Wiki system allows editors to prepare data in private sandboxes, not connected to the semantic database. This allows complete control over the research, although postings are done on a public wiki.

Once the research assignment is done, a copy can be printed, filed, and the article transferred to the public encyclopedia, with full links to the semantic database and indexing by Internet search engines. This “going public” phase provides additional advantages to the research project.

Prizes recruit and expand coverage

1. Information is open to editing by all. Errors may be found. Important information that had been over-looked may be added.
2. The institution that has an interest in this data can set the wiki to send an email advising of any changes made by third parties to the article. This essentially enlists the whole world in the research project, an no additional cost.
3. The facts, although probably already available in SEC files or Internet articles, are now organized in a succinct manner, stripped of fluff and superfluous text. The information is also better linked into the major search engines and therefore more visible to readers worldwide. This serves the purpose of providing the market with the same quality of information available to the institution — increasing the chances that market prices will reflect intrinsic value.

Learn by doing

The most effective way to understand the potential of Capital Market Wiki is to actually register, read the help files, and start to create a research article on a topic that interests you.

You may register using a randomly-generated pseudonym (actually, this is the recommended procedure).

It is not difficult to edit articles — the system is very similar to Wikipedia. However, to learn the intricacies of Capital Market Taxonomy, recommended formats, and templates takes a little time.