In a 2014 profile of Elizabeth Holmes, she began what Ken Auletta termed a “comically vague” description of what happened inside of a Theranos blood-testing machine with the words, “A chemistry is performed.”New Yorker | The quote from Holmes: “A chemistry is performed so that a chemical reaction occurs and generates a signal from the chemical interaction with the sample, which is translated into a result, which is then reviewed by certified laboratory personnel.”  You know the rest of the tale by now, thanks to the outstanding journalistic efforts of John CarreyrouWall Street Journal | His reporting at the WSJ broke the story wide open, and he later recounted the story in his book, Bad Blood. and an ever-expanding number of media projects about Holmes and Theranos.

Indeed, a chemistry was performed, a powerful reaction among elements that included dreams of venture-capital riches, hopes for a scientific breakthrough, a heroine narrative, the cultivation of access and publicity, and perhaps a bit of sexual attraction.Twitter | Regarding the last point, Andi Zeisler said, “This isn’t difficult.”  That combustible mixture apparently caused blindness.

No one seemed particularly interested in nailing down the chemistry that was supposed to be happening in the machine or in the company itself, for that matter — investors were willing to accept fanciful projections and didn’t demand the audited financial statements that would have exposed the ongoing charade regarding the performance of the business.

The specific case of Theranos leads to a whole series of general questions for investors.  Have people who invest in early-stage companies changed their standards and practices as a result?  For example, what requirements should there be regarding an audit?  When you check around (this is not an area I know much about), you find that things are pretty loose given the amount of money and attention that early-stage companies can draw.

More broadly, asset owners and the intermediaries that act on their behalf should have serious discussions and agreed-upon beliefs regarding the transparency that they require from asset managers in any given situation.

As a case in point, Yale’s David Swensen has said, “I have never been a big fan of quantitative approaches to investment.  And the fundamental reason is that I can't understand what's in the black box.  And if I don't know what's in the black box, and there's underperformance, I don't know if the black box is broken or if it's out of favor.  And if it's broken, you want to stop.  And if it's out of favor, you want to increase your exposure.”Council on Foreign Relations | The quote is from a conversation with Robert Rubin.

You may disagree with him.  Obviously many people do, given the growth of quantitative management.the research puzzle | I covered a number of “quant questions” last fall.  But the core question is, what are your standards and why?

For example, what level of transparency do you require for evaluating 1) a long-only, multi-asset portfolio; 2) a long-only (traditional, fundamental) global equity manager; 3) a fixed income manager that invests in all parts of the asset class, and which uses the full range of bond-related derivatives;  4) a long-only quantitative equity manager that uses leverage; or 5) a long/short equity hedge fund?  (Or from the whole range of managers of other strategies in the public realm, to say nothing of those in private markets.)

Do you demand position-level information or aggregated risk exposures?  Transactions?  Access to models that are employed in a systematic fashion?

Coming from a different angle, who within an organization have you been allowed to interview in a one-on-one session?  Were you able to see their actual work environment, tools, and work product?

Of course, the questions could go on and on.  The designer Charles Eames said, “Never delegate understanding.”the research puzzle | I wrote a posting with that title in 2014.  But in an industry beset by principal-agent problems,SSRN | Here’s a look at those problems in a monograph by the CFA Institute Research Foundation. there are many gaps of understanding, to say nothing of basic facts.

Some believe that a lack of transparency is a benefit (and there is some evidence to that effect), that keeping positions and strategies secret can lead to a competitive advantage that can be sustained over time, but how do you know if you’re in a virtuous situation or a vicious one?  And, for people in a position of fiduciary responsibility, how do you square your obligations with the lack of detailed information inherent in some investment relationships?

There are many questions to be answered, including whether your standards regarding transparency are malleable and, if they are, what drives the decision to accept less visibility with one manager versus another?  Past performance?  Market power?  The actions of other investors who may have different standards than you?

At times, a manager’s answer to a question that you pose is the functional equivalent of “a chemistry is performed.”  You may be able to get past that intentional vagueness by asking other questions or doing some additional sleuthing, but eventually you’ll run into a line of demarcation.  From there you are reliant on the narrative that is provided, begging the question as to whether you are able to place your trust (faith?) in the other party.

That impasse may come early or late in the process, after much revelation or very little.  Then you have to decide whether you know enough.  It helps to have a set of beliefs in place about the value of transparency and the standards that you want to apply, so that you know what to do when you get there, otherwise you’ll be buffeted by the winds (and whims) of the day.