Narrative, Storytelling, and Qualitative Due Diligence

Abstract

Despite the overwhelming focus of researchers on quantitative analysis to measure manager skill or alpha generation, managers and investors still employ qualitative information and narrative as key decision support tools for investment manager selection. Both parties allocate significant time and effort reviewing and explaining investment processes through pitchbooks, meetings, and non-quantitative communication. This article explores the use of qualitative information linked to narrative, the description and interpretation of facts to tell a compelling story on manager skill, as a key forward-looking signal mechanism that supports asset management allocation decisions. We focus on how and why narrative is an important part of the due diligence process for transmitting and receiving unobservable information outside of performance track records, and a means for providing skill explanation.

Key Findings

• ▪ Past performance is a noisy signal of manager skill. Narratives reduce asymmetric information between manager and investor.

• ▪ Managers use narrative to differentiate themselves from their peers, given the limitations of performance data. Investors select hedge fund managers by blending quantitative and qualitative information based on differences in manager strategy as told through narratives and stories.

• ▪ Narrative and story-telling play an important role in the manager selection and due diligence of hedge funds by providing context for return performance, explaining outliers, and defining when the firm may be successful. Narrative is especially relevant for new managers, adding context to factor analysis and benchmarks.