Wednesday, May 14, 2008

2nd Degree Burn: The Information Loss Superhighway

Surfing is often considered a territorial sport. It’s likely that passionate enthusiasts are drawn to the ownership of a hot spot, compelled to keep it to themselves or within a tight group.

Before paddling out this past weekend, a fellow surfer came up to me and explained that I couldn’t surf his break and that I would have to find somewhere else to go, down the beach about a half mile. Looking up and down the unobstructed 18 miles of shoreline, I thought about how ridiculous this was, especially considering that he had no idea where I was intending on heading out in the first place. Also, I didn’t recognize him; having known this spot for years, this triggered a warning sign in my head.

We stood on the beach talking, motioning through our wetsuits, trying to come to some sort of understanding. I kept the focus on his total lack of solidarity while he was most concerned in why I was picking this particular zone to paddle out. After a few minutes, it was clear that he was just waiting for me to tell him where to get in the water because he didn’t even know the break and was ultimately looking to see what I was going to do.

I was going to paddle out where I originally intended, directly where he didn’t want me to go. Since he was terribly stubborn about it, I knew he would do the exact opposite of me just to have a quarter mile stretch all to himself (probably the only thing he wanted in the first place). Instead of asking me straight out what was good in the break, he tried to strong-arm me into giving him information.

He ended up paddling out where he had originally wanted me to go. I could have told him about the dip in the shoreline over there that made the waves short and the rip current strong. And I could have told him about the sandbar that would have killed any swell energy close to shore. But why would I want him to come back? Why would I want him to know what I know? He hadn’t earned it.

This got me thinking about protecting information that you value and respecting it enough to not risk contaminating it by providing it to others who haven’t done the legwork.

Insights in the Hands of Expert Networks

If your expert network isn’t yet causing a headache for your compliance department, then they probably have you wondering, “How can they potentially compromise my investments ideas?”

‘Information loss’ is the nice way of saying, “You just flushed your best ideas out to sea.” In speaking with an expert network, you probably let them in on your insights, giving them a starting point from which they can begin to help you build support for your idea. In this process, there is no definitive standard in place to keep your ideas out of the hands of others. In trying to grow your ideas and generate appeal for them, you’ve essentially released them to the market, uncertain of how they are being assessed and used. Your ideas are lost. You’ve opened the door on your security, your intellectual assets now in full view.

If one day you pick up the phone and gather some insights from an expert network participant based on your impending investment decisions, take pause and think about how vulnerable your idea is to being compromised.

Communicating your ideas to expert networks is a risky venture that can potentially put your private insight on the Street, making your unique idea fodder for the masses.

As we mentioned last week, expert networks are valuable in theory, but when weighing the risks, there can be many uncertainties.

You wouldn’t sit in the middle of Bobby Van’s Steakhouse spewing your next best idea in earshot of your competition. Why would you openly discuss this information with an expert network?

‘Information loss’ is going to happen in any business. It’s the reason why painters don’t talk about their brushstrokes; why scientists don’t share their notebooks; and why Street Brains doesn’t email reports through highly accessible PDF documents. You want to make sure that limited means limited.

In working with an expert network, an expert has to take into account any insights he’s gathered from his conversation with you – that information is now part of his knowledge and expertise. When the expert picks up the phone to discuss it with others seeking his “expertise,” your conversation with that expert may very well help to shape that expertise. If your goal is to generate alpha – as is the case for most institutional investors – you put it seriously at risk when you rely on a source that is not accountable to you.