Winning at Active Management. Welhoelter Michael A.
target="_blank" rel="nofollow" href="#n24" type="note">24 The best decisions are reached from considering the best ideas, rather than one person’s opinion, and the ability to participate in decision making will encourage all team members to make a contribution.
Schmidt and Rosenberg also believe that team members have an obligation to speak up when inferior ideas make their way to the table, and that they later share the responsibility for decisions that don’t work out: “If they don’t [raise their concerns], and the subpar idea wins the day, then they are culpable… [D]issent must be an obligation, not an option.”25
“An organization is like a tree full of monkeys, all on different limbs at different levels. The monkeys on top look down and see a tree full of smiling faces. The monkeys at the bottom look up and see an entirely different perspective.”
A companion to interdependence is support among team members, although it operates more at a personal level. Support includes encouraging people to advance their ideas, as well as formal and informal coaching and mentoring.
An equally important aspect of such support is offering candid feedback on the decisions of team members – simply stated, discussing their mistakes as well as their successes. Hospitals hold regular reviews of mortality and morbidity, which look into the how and why of patients’ outcomes, with an eye toward safety and quality improvement. Professional firms can conduct similar postmortem reviews and make them a regular part of the management process, in a forum that is not critical or threatening, but intended instead to gain understanding of how mistakes have come about, and how to minimize and avoid repeating them.
Support also calls for raising concerns, both at an individual level and for the benefit of the organization as a whole, when an individual believes a mistake or incorrect judgment is “in process.” For this facet of support to have value, however, individuals and managers have to be receptive to such ideas and seek them out, even when they face challenges or criticisms.
Ray Dalio, the founder of Bridgewater Associates, a highly successful investment organization, has codified over 100 pages of cultural and management principles published on the firm’s web site.26 On the topic of support (of both sorts – coaching and candid feedback), he states that he expects people in his organization to:
■ Stress-test their opinions by having the smartest people they can find to challenge them;
■ [Be] wary about overconfidence, and [be] good at not knowing; and
■ Wrestle with reality, experiencing the results of their decisions, and reflecting on what they did to produce them so that they can improve.
It’s a part of human nature to avoid these sorts of conflicts, but in an open and thoughtful professional partnership, people need to feel free to take the other side – even if it means questioning a decision by the boss – and point out something that might have been missed. By the same token, it’s up to senior people in the firm to both advocate – and accept – that sort of candor.
“If you don’t know what you don’t know, you can get the organization into a lot of trouble, but if you do know what you don’t know, you can seek help from others, and everyone just gets better.”
Because so many people in professional organizations have direct input and influence to the success and quality of client engagements, everyone in the firm owns the responsibility to move the firm forward. In turn, for individuals to be motivated to engage and commit deeply with clients and colleagues, they need to have a significant financial interest in the firm’s performance. This calls not just for an expectation of bonuses every year to reward good work, but a participation in both the potential upside and downside, and a long-term tie to the firm that comes from equity ownership (or often in the case of an investment management firm, a stake in the strategies it offers to clients).
A shared financial interest requires a great commitment from a firm’s partners. Aside from the long and hard working hours and commitment of personal life, there can be significant financial commitments – contributing to the firm in times of financial difficulty, of course, but often during good times as well, when a firm is growing and requires reinvestment of profits that might otherwise be paid out to the owners. Accordingly, balancing short-term rewards with the best interests of the firm through compensation policies is a crucial role for senior management.
Partnerships’ policies vary on what they emphasize in professional compensation – events of individual merit, or collaboration that contributes to firm continuity. A “lockstep” model is formulaic, with compensation based on seniority and contributions to the firm over time, while a discretionary “eat what you kill” model, paying out bonuses tied to specific revenue events, recognizes particular successes in a given year.27 Most firms, including Epoch, opt for the flexibility of combining the two in some fashion, to allow both fairness and justice in compensation.
“Tell me how a person is paid, and I’ll tell you how he’ll behave.”
Justice and Fairness
“Fairness seems to have three main features: equality, agreement, and transparency,” wrote Paul Woodruff, professor of philosophy at the University of Texas at Austin.28 With respect to compensation, he adds, “transparency allows anyone to predict accurately what results to expect.” Woodruff goes on to caution leaders, however, that “fairness is a trap, because once you commit yourself to it, you must submit to it. You are no longer in control because you have waived the right to exercise good judgment,” and any deviations from established rules would appear unfair.
Justice in a corporate culture is a subtly different concept, Woodruff says, calling for judgment and leadership rather than formulas. Having a discretionary component in compensation combines fairness and justice, giving a firm’s leaders leeway, and the ability to reward both individual achievement and teamwork, and thus reinforce the culture.
Justice has the greater challenge. It goes to the heart of preserving “the community,” and the attributes valued by the community – frequently at times when the application of rules based in fairness might have the opposite and negative effect.
For a professional firm to be viable for the long term, however, the shared interest of the partners has to transcend the financial rewards, and include the intangible achievement of helping to build a quality organization. This calls for assembling a group of partners with complementary values and temperaments who will be able to work together, to understand each other, and to put up with each other during hard times over many years.
Chapter 2
Culture in Investment Management
Investment managers present a puzzle to understanding the prospective value of their work, even when compared to other services business. The measurement of portfolio performance has evolved considerably in the past 30 years: evaluated against a particular benchmark, the wisdom of a manager’s past decisions can be analyzed in great detail, with a galaxy of custom- designed statistics.
That said, portfolio mathematics still have trouble in definitively distinguishing luck from skill in historical results (particularly over short periods). Even the most skillful active managers sometimes underperform their benchmarks, and less skilled managers can be blessed with lucky streaks. A great active manager might outperform 60 percent of the time, but still underperform during the other 40 percent (and in truly challenging market environments, such as the one following the global financial crisis, it’s likely that many active managers will fall short).
Even more challenging is the prediction of future performance from the results of the past: some of the earliest research from financial academics went in search of predicting performance, although its success has been fleeting. One early example is the Sharpe ratio, proposed 50 years ago
Ibid.
Ray Dalio,
Maxine Boersma, “My Job Is to Protect the Firm’s Culture,”
Paul Woodruff,