Investing In An Interconnected World: Cross-Industry LinkagesInvestingInAnInterconnectedWorld:Cross-IndustryLinkages

Overview

Capturing companies’ relationships and interconnections across industries in the course of the investment process can help identify new opportunities and limit portfolio risks: 
 

• Identifying the nature of business relationships is critical for understanding and predicting a company’s business opportunities, risk exposure, and ultimately its performance potential. 
   
• The cross-industry linkage factor helps uncover a company’s interdependent business relationships in different industries and their impact on future performance. 
   
• The factor’s consistent long-term performance across markets and sectors and its low correlation with our existing factors can help lead to greater portfolio diversification and potentially more compelling returns.

 

THE LABYRINTH OF LINKAGES

The world is interconnected. Companies operate within an ecosystem, intricately connected to one another through a multitude of relationships such as customer-supplier relationships, partnerships, collaborations, and as competitors. We believe capturing these global interconnections in the course of the investment process can help identify new investment opportunities and limit portfolio risks. Given an increasing awareness of environmental, social, and governance (ESG) issues globally, cross-industry linkages are also helpful in scrutinizing all of a company’s connections up and down the supply chain and with business partners.

Exploiting the linkages between companies can yield insights about future performance prospects. Utilizing linkages and information asymmetry, by evaluating information diffusion effects and examining information diffusion delays among companies within a single industry or business segment, can provide investment insights and be used to help generate alpha. Quantitative investment processes typically focus on direct information, such as sell-side analyst forecasts, but the returns of stocks can also be affected by indirect company information, which can often be captured by identifying and assessing the linkages between companies. In our first piece on company linkages, Investing in an Interconnected World, we explored this topic within the same industry/business segment. In this paper, we explore how utilizing linkages among firms in different industries/business segments can add value to the existing factors we use to help identify more profitable investment opportunities for quantitative investors.