Monday, December 22nd, 2008
the art of triangulation

Like the other basic forms that we learned in geometry class, the triangle is omnipresent in our lives.  Some of us still need the formulas and properties that we learned by rote to make things, from buildings and bridges to perfectly proportioned Christmas trees crafted out of red and green construction paper.  Triangles also find their way into puzzles and mathematical tricks that might show up under your tree this year.If not, just play with Pascal’s triangle for awhile. Since I try to use this space to deliver little gifts of insight regarding investment decision making, often with ribbons of analogy decorating them, we’ll wrap a triangular one now.

A critical element of analyzing a problem well is looking at it from a variety of different perspectives.  Three seems to be a minimum in many situations:

For example, ensuring data quality is an often under-appreciated but extremely important function within an investment operation.  Many firms don’t spend enough time and money to build the processes to minimize errors.  Having good two-way comparisons between independent sources gets you most of the way, which can be easily accomplished using today’s electronic tools, but often a third view is needed.  It can take a variety of forms, but what is most powerful is the more expensive option of having someone with extensive investment knowledge checking to see that the two sources not only agree but make sense.

As I have written before, the creation of new investment products is too often dominated by the marketing side of the equation.  To skate to where the puck is going to be rather than where it is, like the great Gretzky, you need the additional point of view offered by investment professionals.  Even more important is that offered by true outsiders who focus on considering the next trend rather than riding the current one.

The investment process, of course, should include many sources that truly differ as to their orientation.  A relatively simple model that uses fundamental, quantitative, and technical information tends to be more powerful than one that misses a variety of clues by focusing exclusively on one of those disciplines — which doesn’t mean that they need to be equal in any respect.  Finding the right recipe varies by firm and by strategy.

Regulators also need to think about reworking their processes to view the investment business from a variety of angles.  The nature of the function can lead to a check-the-box mentality that treats the constantly evolving markets as if they were static, causing emerging issues to be ignored or misunderstood.  The current approach needs to be rethought structurally, but more important is to find a way to incorporate in a more robust fashion independent analysis from academics and thought leaders in the investment community (yes, those who aren’t in the business of spinning their input to benefit their own organizations).  Above all, there needs to be a commitment to detailed research of the markets as a significant component of the regulatory regime.

Finally, by definition, good due diligence is a process of triangulation, looking for confirmation of something observed from one perspective by examining it from others.  Just think about the errors of the victims of Bernard Madoff:  They relied on a profile of returns that inspired their confidence, but detailed analysis of which should have at least raised questions for further review.  To the extent they then posed the questions, they relied on the word of Madoff or the conduits that shared in the lucre.  Everything they did was one-dimensional.

Such an approach is weak and subject to failure.  Like the three-legged stool, a triangle is a picture of strength.  Remove a leg and you have instability.  While that’s a matter of physics for the stool, this post is titled “the art of triangulation”; the process is not a science.  And it also won’t happen on its own.  The best gift that you could give your organization this year is a commitment to examine how it makes decisions and to seek improvement.