Ever since Regulation Fair Disclosure was implemented in 2000 in the U.S., there has been a growing impetus for investors to do more primary research. Although the catalyst was in the U.S., the phenomenon is global. The trend has had a major impact on alternative research, which has responded to the burgeoning demand by offering investors various research tools to facilitate primary research. These tools include expert networks, channel checkers, marketing research firms, data mining specialists, and web scrapers and other search-based research. The conundrum for hedge funds and asset managers is to understand the various available options, and effectively put them to use.
Most investment analysts are not trained in market research. Those with business degrees probably took a marketing course or two, but most would have opted out of courses designed for colleagues headed to, say, Procter and Gamble or Tesco. Yet they have no compunction about conducting market research to test investment hypotheses. And often they do it without even realizing they are conducting market research…
Take expert networks. Use of expert networks is widespread in the U.S., EMEA and APAC. A recent survey of Asian based hedge funds and long-only investors found that 47% used expert networks. Geographically focused expert networks are springing up in London, Paris, Beijing and Singapore. Gerson Lehrman has offices in London, Hong Kong, Shanghai and Sydney. Yet how many of their growing army of users realize they are conducting market research every time they arrange an expert consultation?
There are two general types of market research: qualitative and quantitative. Market research professionals use qualitative research methods primarily to define a problem and generate hypotheses. They are typically used as the prelude to quantitative market research to identify determinants, and develop quantitative research designs. Because of the low number of respondents involved, qualitative research methods aren’t typically used to generalize to the whole population. In other words, qualitative research methods rarely provide statistically valid conclusions.
Let’s pause a moment and reflect on how this applies to investment research. Expert networks are a form of qualitative market research. In fact, market research has a term for them: ‘depth interviews.’ Depth interviews are one-on-one interviews, typically 30 to 60 minutes long. They are unstructured compared to surveys, and, while they provide a rich depth of information, they are not as easily comparable as surveys, making generalizations more difficult. Interviewer bias–prompting responses that otherwise might not have been provided or overlooking responses that otherwise should be elaborated–is a major risk of depth interviews. It is easy for interviewers, particularly if they have a point of view, to steer the interview in a particular direction. For this reason, market research professionals use skilled interviewers who are objective and not affiliated with the group commissioning the research. Further protection is provided by the way depth interviews are used–to develop hypotheses, not to test them.
Which brings us to how investors use expert networks… Expert consultations are essentially depth interviews. Consultations typically last no longer than an hour, they are unstructured, and they often provide rich, detailed information. When used to gain background on an unfamiliar sector, technology, or product, expert networks are an excellent tool. In other words, they are well suited to help investors formulate investment hypotheses. For example, I might use expert networks to understand what is Tesco’s strategy for launching in the U.S., how they are positioning themselves versus the competition, what will be their pricing tactics, and so on.
But that is not how many investors are using expert networks. Expert networks are often used to test investment hypotheses, not formulate them. This is risky at best. Using our Tesco example, if my objective is not to understand Tesco’s U.S. strategy, but to gauge its success, talking to a few experts won’t cut it. I need to ensure that my market research techniques will provide me with valid results before I make my investment. Channel checking is a valid technique (if used properly), and some expert networks offer channel checking services. Surveys, panels, field tests, and observational techniques are also part of the market research toolkit. All are available to investors, but, sad to say, infrequently used.
There are instances when testing hypotheses through expert networks is appropriate. For example, if my hypothesis involves the purchase intentions of major U.S. airlines, I can use my expert network to set up interviews with purchasing managers from 8 of the 11 U.S. carriers. By speaking to the majority, I can be reasonably confident in my findings despite the small population. Moreover, the expert networks may be the best way to reach them, since they may be too busy to respond to other forms of market research.
The reality, however, is that most investors are not thinking rigorously about how they are using their market research tools. They formulate an investment hypothesis, and then (consciously or unconsciously) seek confirmation of the hypothesis. Expert networks provide a convenient crutch. They are easy to use, quick, and provide instant gratification. But if used incorrectly, they can be hazardous to investment health.