Thursday, April 4, 2013

Research Alpha and Research Beta

Research Alpha and Research Beta 

I've been researching and writing about Asian conglomerates and business groups off-and-on since 1990.  In the last two years I've started to look at the price performance of companies controlled by 'good' vs, 'not so good' corporate owners.  What is clear is that buying quality at a good price has been a very good strategy.

I'm not the first, nor will I be the last, to make this observation. However my methodology of separating good from bad may be unique.  I've found that the group research methodology I've been using is a fast way (or not too slow way) to weed out the 'not so good', from the 'good'. 

I'm also currently in the process of expanding the work I've been doing on business groups and corporate backgrounds in Asia.  The goal is to get more clients to look at this.  As such I need to better explain what I do and why it adds value.

One way to explain this is to separate investment research into ‘Research Alpha' and ‘Research Beta'.

'Research Beta' I define as that which what is done by most sell-side analysts.  Sell-side research is very much focused on trying to accurately predict next quarter's profit and EPS.  Analysts typically decide if they will be above or below consensus earnings forecasts.  Once done these forecasts get factored into the very same consensus earnings forecasts that was used as benchmark.  These are then compiled by all the main data providers and are likely quickly reflected in stock prices.

Everything else I call 'Research Alpha'.   These are the factors that I focus on in my research.  They include items such as a deep dive into a company's background and structure, spending as much time researching the non-core as the core businesses, looking at both listed and unlisted entities, taking an objective view of owners/management and their background, return of cash and treatment of minority shareholders, scope for adverse transfer pricing, etc.  

These are qualitative factors that the sell-side spends almost no time researching.  They are in my opinion are not reflected in the consensus earnings forecasts that 'the Street' likes so much.  Logically, concentrating on these 'Research Alpha' factors should lead to non-consensus investments and performance. Non-consensus research that should produce non-consensus results.

The argument for not concentrating on these types of factors - at least from my sell-side contacts - is that they don't change much and are already factored into share prices.  

Easy to argue both ways.

However, my perception is that the sell-side can't do, or won’t publish, this type of research for three reasons. Firstly, most sell-side analysts spend a great deal of time marketing.  They don't have enough time to do this type of research.  Secondly, the sell-side, mostly at its client's request, is increasingly short-term oriented.  Thirdly, analysts are under pressure to stay friendly with management. They run the risk of straining the bank’s, or their own relationship, with the company by publishing anything negative or too revealing.  

However concentrating on qualitative factors suits my style of investing - long-term, fact based and evidence driven.  It is also very fun and, so far, rewarding.

I find that after I've done my work I can sleep at night as I feel comfortable with the stewards of my capital and that their interests are aligned with mine.

And what could be more important than a good night's sleep?

1 comment:

  1. Rereading this a day after posting, it is important to note that I have a lot of respect for sell-side analysts. Many are doing a great job, especially in their sector research, staying in-touch with companies, and providing insight that the buy-side is looking for. Most are working under tough conditions - declining research budgets, pressure from I-bankers, and need to balance their own views with giving clients access to the corporate C-Level.

    "Beta Research", or the stuff that goes into consensus earnings forecasts, is very important. Disregarding this information wholeheartedly does not make sense. I personally don’t emphasize it, but would be lying if I don’t look at number of analysts covering a company and consensus earnings revision trends.

    Also, as an investor I don't separate alpha and beta. I'm an absolute investor. I 'absolutely' don't want to lose money, and I 'absolutely' want to make money. I don't really care how much of the return is alpha and beta.

    But even hear I contradict myself, as I track my individual calls against an index or ETF as a way to determine if I’m wasting time or not. This is because it is much easier to buy an ETF when I get a market or sector idea, than to spend time on the bottom-up research that I love.

    Luckily, it has not been time wasted. And more importantly, I’m not kept up at night worrying about my investments.