Investing In An Interconnected World
Investment managers are increasingly evaluating stocks through a global lens, as markets become more interconnected and supply chains and trading partners are more closely linked. How can the evolving nature of financial markets and their extensive linkages create a broader and exciting new opportunity set for quantitative investors? This new research brief includes discussion of three key strategies that PGIM Quantitative Solutions’ Quantitative Equity team uses to generate alpha:
- Exploit linkages and information asymmetry: investment managers who can identify and understand the linkages and information diffusion dynamics for companies in a given industry can reap more alpha opportunities. Company price dynamics can by impacted by a direct shock, but also due to an indirect ripple effect. An appealing aspect of exploiting indirect information is that even without direct information about a company, such as analyst coverage and conference calls, various linkages lead to indirect information that can yield insights about future performance prospects.
- Employ information diffusion effects: Information typically diffuses from developed to emerging markets and from large-cap to smaller-cap stocks. Evaluating leaders and laggards through an information diffusion lens can lead to positive performance effects. Here’s a recent example: returns are strongest in Emerging Markets stocks relative to US equities, and in small-cap relative to large-cap stocks.
- Examine information diffusion delays for different time periods to identify the most compelling linkages between industry leaders and laggards. How long does it take for leader information to fully diffuse into the price of laggards for different universes, and which markets are inherently more inefficient and therefore present slower decay of information?
