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Tuesday, April 25th, 2017
site visits

In my work as a consultant advising investment organizations, I generally get access to the people that I would like to interview and am able to see the things that I would like to see.  That degree of openness is uncommon for others doing site visits (for the purpose of evaluating an investment in company, for example, or the selection of an asset manager), who face a more daunting challenge.

While those visiting are hoping for helpful transparency to aid in their analysis, those being visited are also trying to manage the encounter to their advantage.  One side is trying to create a narrative and the other should be focused on cracking it.the research puzzle | I wrote about creating the narrative versus cracking the narrative in this 2014 piece.  The success of a site visit by an analyst depends upon how that struggle unfolds.

Sometimes, virtually all of the interaction takes place in a conference room, with a limited number of people involved, and much of the information is delivered via prepared presentations.  That’s a setup for a failed visit.

The degree of freedom around each of those variables will tell you a lot about the opportunity for you to add value from your visit.  Exposure to different parts of the facility and different people gives you the chance to make observations that will help you paint a more complete picture.  And using your time — as much of the available time as possible — for your agenda and your questions, rather than scripted overviews, is critical.  One-on-one interviews are almost always preferable, although in situations where Reg DSecurities and Exchange Commission | The regulation bans the selective disclosure of information by securities issuers. issues are in play, you may not have that opportunity.  (On the other hand, if you are vetting an asset manager and you have money to invest, adopting such an approach is often just a matter of asking.)

Are site visits worth it?  As I indicated, that depends on the nature of the interactions.  Don’t ever be impressed by someone who says that they visited a impressive number of companies or asset managers as a part of their due diligence duties.  Showing up is easy; gleaning additive information is not.

There hasn’t been much academic research on the benefits of analyst visits to the companies they cover, because there typically aren’t information sources that record when analysts have conducted visits and whether they have subsequently issued recommendations (if on the sell-side) or made investment decisions (if on the buy-side).  However, such information is available since 2009 for companies listed on the Shenzehn Stock Exchange.  A working paperSSRN | Its title is “Seeing is Believing: Do Analysts Benefit from Site Visits?” uses that data to concluded that there was value added for sell-side analysts during one three-year window because of their site visits, especially under certain conditions.

There are, of course, stories of great discoveries.  For example, Carson Block of Muddy Waters stumbled onto an apparent fraud at Orient PaperInstitutional Investor | This II story provides some of the (interesting) details. (also in China).  But, as Jim Valentine notes, often you don’t learn much at all; visits to suppliers, customers, and competitors of the firm you are studying may be a better use of your time.AnalystSolutions | Valentine writes and consults about the equity research process.

As I mentioned, there is an artificiality to these encounters, which are often very well staged.  Contrast that with the notion of the “Gemba walk,” a Japanese management concept.  Gemba is variously translated as “the real thing” or “the real place.”  That is, to understand what’s going on, personal observation of where and how the the work is done is very powerful.

As a recent articleMIT Sloan Management Review | The article is about “the most underrated skill” for managers within an organization. in the MIT Sloan Management Review said, “Observing the work closely often shakes loose a variety of preconceptions.”  And, as a manager, “When you go see the work, if you aren’t embarrassed by what you find, you probably aren’t looking closely enough.”  Even though you’re coming at the operation from the outside, that’s the spirit you should also bring to your work.

When evaluating asset managers, two words can be very powerful:  “Show me.”  I’m always amazed when I ask asset management clients about the due diligence processes of those allocators who visit them.  Not only do few ask to see how the sausage is made — by looking at the systems and processes that decision makers use — but when offered transparency into such things by firms that are trying to be open, not many take them up on it.

Astonishing.

The Madoff fraud is legendary, as are the failures of due diligence that allowed it to thrive.  I was an expert witness on a case where a firm had purported to do due diligence on the firm.  There is no doubt that Bernie Madoff was a master manipulator, but it was striking how readily he could brush off the inquiries that did surface.  His ultimate weapon was the threatened loss of access to his investing acumen.

The fear of being left out (or, in the Madoff case, banished) is a significant factor in the evaluation of asset managers that are highly sought after.  Judgments about how hard to push for answers get distorted, and the relative power of the parties shifts from where it should be.  When everything is on the manager’s terms, a site visit will likely be no good at all.

I was doing due diligence on a firm last year and the person being interviewed talked about how quickly they had liquidated their Pimco holdings after Bill Gross left.  I asked the same question that I always do,research puzzle pieces | As I did here. “Given all of the firms doing due diligence on Pimco, why weren’t the issues that ripped it apart identified by anyone?”

The answer:  “They told a good story.  Bigger firms are harder to read; there are multiple levels of buffering.”

You need a plan, whether you are seeing a big firm or small.  And you need to assess how close to reality the picture being painted really is.  If you can’t remove the layers of varnish, you might as well stay home.