Wednesday, February 5, 2020

The "last mile" problem and investment management



The last mile problem traditionally has referred to the telecommunication issue of connecting to the final customer, or in supply chains, the final delivery of the goods. It is the most expensive, the most labor intensive, and the most complex part of any business at getting right. Every firm wants to solve the cost and implementation issues of the last mile.

The "last mile" problem for an asset management firm or hedge fund is the connection between research ideas and research implementation. There are transaction and systems cost with implemented research ideas that are not trivial. Research ideas are plentiful but good implementation skills are scarce.

Reading all of the quant research on portfolio construction, I am always impressed by the elegance of the math and the ingenuity of the ideas, but I find limited implementation. Some of this is lack of implementation is a function of education. The  connection between the research idea and customer understanding and appreciation is not easy to solve. Client education is expensive and the value of better research is often not apparent in a normal market environment; however, cost is another driver for why ideas are not used.  

Ideas implementation is limited because the costs of thelast mile problem rears its ugly head as a core asset management problem. Converting research to a workable plan is not easy and requires a tremendous coordination between research, trading, accounting, and portfolio management. Many ideas require more transactions, the sourcing of liquidity, strong accounting (performance contribution and attribution), and skilled management. 

The cost of idea generation is often lower than the cost of implementation. Transaction costs often trump a good theory. Hence, it is critical to define and measure the cost implementation for a strategy. 

Simplicity beats complexity, so there is value with taking complex math and breaking it down to the core value-added. A management standard should be to test research complexity versus management simplicity.

Does this mean investors should fore go new research? No. The  focus has to be on the translation of research into action. When it is done right, management fees are earned and value is created.

No comments: