Few topics are as interesting to most investment professionals as how best to organize an investment organization. Yet over the long term, most investment firms, despite their best intentions and good efforts, do not achieve superior results for their clients. They don't even keep up with market indexes. One reason is the cost of operations. Another reason is high fees. For individuals, another is taxes. But, the main reason appears to be the superb quality of the competition and the great “equalizer” because almost all institutional market participants have equally superb computer power, Bloomberg terminals, internet access and equally capable investment managers and almost everyone knows almost all the same information at the very same time.
It should, in theory, be quite easy to develop a first-rate professional firm. We all know the recipe. Get top people. Have a clear purpose. Have high professional standards. Take a long-term view. Always remember that clients come ahead of the firm. Always remember that the firm comes ahead of the individual. And always remember that as an individual, professional commitments come ahead of the financial rewards. Maintain discipline at all times, and you shall succeed. Or as Mr. Morgan put it, “Run a first-class business in a first-class way.”
The recipe is the same one for successful management that Marvin Bower of McKinsey & Co. wrote about in his book, The Will to Manage. The title says it all. There wasn't anything unusual about what the management of any really good company was doing. They had the same recipe every other management had, but they were doing it. That made all the difference.
David Ogilvy has written a third book, Ogilvy on Advertising. It's fun to read, has lots of pictures—and a good deal of real insight. He discusses five great advertising agencies and comes to the conclusion that the principal factor required for success was and is persistence.
One of the problems with identifying great and successful investment management firms is that most organizations doing very well now will not still be doing very well 10 years from now. Most of the organizations we admired most 10 years ago are not those we would put on our shortest list of the great successful firms today. There is nothing quite so temporary as success in an intense, dynamic, “people” business like ours.
Many observers believe there is a basic conflict between the professional goals and the business goals of an investment management organization, and that these two spheres work against each other. There's no doubt that they will be in direct conflict if either is mediocre. Any semi-good professional commitment or semi-good business goal will sooner or later corrode any organization.
But there is no conflict between really good business goals and really good professional goals if each strives for excellence and if the respect for both is sufficient. For example, it is only business strength that gives professionals the independence of mind and sureness of purpose that allow them to do first-rate professional work. Only professional independence is likely to result in the really good work that is needed to make a really good business. There is no conflict as long as each is truly strong. Most organizations, however, find it very hard to achieve and sustain excellence in both areas, a matter that requires attention. The culture or the climate of the organization must always favor the professional dimension. When in doubt, lean toward the professional side because there must be that kind of favoritism.
Fees are one of the most powerful forces in the success or failure of an investment management organization. The fee level you set determines the market you will serve. Once you have chosen the market you will serve—which you do indirectly when setting your fees—you can then identify the key factors for success and the rules of the game in that particular market.
In strategy, clarity and simplicity are critical. Most organizations are uncomfortable identifying what they will not do. It is not what you are willing to do, but what you will not do that most clearly defines who you really are. Peter Drucker has a lot to say on this. It can be easily summarized. Focus your attention on areas of excellence; as professionals, do those things that you do quite well and try not to waste time doing the other things in which you are only moderately good. The external focus should be on the major opportunities.
In the formation of business strategy, many organizations fail to recognize that it is a completely different line of work from their investment management activity or their routine business administration. Go to a different environment—in a different timeframe—taking two or three days away from your offices and clearly separated from your regular work. Otherwise, the time-urgent decisions will drain away the time you might have had for those things that might be more important.
We never take too much, or even sufficient, time for the big decisions: those soft, subtle, avoidable decisions on basic policy and strategy that can and will lead to very hard decisions later on if they are not attended to when “soft.” The “soft” decisions are not easy. They are difficult because they are of basic value: the selection of young people and the training, coaching; the trust put in them; decisions on which areas of development to give special emphasis; on the quality of the commitment you will make to your clients. It is in these areas of “softness” that the really important decisions will be made, and they cannot be made wisely and well in the press of daily activity.
Strategy formation is not planning. Planning is a negative function in the sense that its whole intention is to eliminate errors, reduce uncertainty, and avoid mistakes. If we were so good that we could plan the right things two or three years ahead, wouldn't we simply do them now? Firms that are successful understand the value of a planning discipline, but it's a discipline against negatives.
The most important part of a very successful organization is first-rate, high-caliber people. However, most of us do not give enough time and attention to selecting or developing the truly first-rate young people in our organizations. It is difficult to give them the environment they need and the attention they want. First-rate people are so wonderfully rare that if we find them and bring them into our organizations, we should give them everything they need to flourish.
Successful firms have a tremendous consistency on basic values. The “really interesting” discussions seldom take place—because they are not needed. The organization that has deep agreement on the most important philosophical matters does not have “interesting” crisis discussions. The best firms have a consistent set of core values with a wonderful diversity of experience and orientation, ways of thinking and articulating, and personalities—all with deep mutual respect. It is out of that kind of common weal that an aristocracy of talent is likely to come forth.
The matter of size and market liquidity is a false issue for most investment management organizations. There are some for which it would be right to say that market considerations would put constraints on their ability to manage money. But most investment management organizations are not constrained externally. They are constrained, instead, by their internal difficulties, largely their difficulties of communication.
Consider, for a moment, the German U-boat fleet, which in the early part of the Second World War was dreadfully successful. Much as the American-British navies would like to say that they defeated the U-boats, the reality is that the U-boats defeated themselves. The reason is that the U-boat command was in Berlin. The original concept was that all U-boats would look for cargo ships, and if they found a ship they would radio back to Berlin, and Berlin would decide where every U-boat should go. When Germany had only 50 or 60 U-boats, that system worked well. When they got to 400 or 500 U-boats, the deluge of data piling in on Berlin so exceeded Berlin's capacity to process and organize the data that headquarters' decision-making could not keep up with the demand.
This same problem of data overload is characteristic of investment management firms that are in trouble. The enormous volume of data can overwhelm decision making and make it seem impossible to find time to think. Successful firms protect their decision makers from the tyranny of data and find ways to control the flow of information coming into their organizations. They make sure that the research is working for them—not the other way around. It does no good to “play the horse to someone else's Lady Godiva.”
For internal communication, the great problem is adding people. As you add people arithmetically, their relationships go up geometrically. There is a rapid progression toward decisions that are social or political, rather than objective and fact-founded; decisions that are made with inadequate reflection because so much time is spent talking. Direct, simple, short lines of communication are wonderfully powerful. One of the great organizations in the history of the world, the Catholic Church, has only four levels of communication between God and the average parishioner. That's a model communication system. The closer we get to simple, clear, direct communication, the greater our chances to succeed.
Growth and expansion are entirely different from one another—even though in the investment field, we tend to talk about expansion as though it were growth. Expansion is getting bigger. Growth is getting better. Doing more difficult, more valuable things—often for more substantial and demanding clients.
The great enemy of growth is expansion. Peter Drucker, once again, says that the easiest way to get first-rate resources that can be put to work on first-rate opportunities is to stop doing things you don't do particularly well and devote the liberated resources to things with which you could succeed greatly.
Getting bigger almost necessarily means that you will have fewer wonderful people joining your organization in larger numbers. It almost necessarily means that you will be doing more things for more customers. As you expand the volume of work, there is a grim tendency to enter lines of work that are less value-adding and to serve smaller clients. As the margin of value-added declines, so does the margin of profit—but both are hidden in the short run by expansion's increase in total profits. Expansion is almost always linked to a decline in quality offset by a rise in quantity.
Optimizing the balance between common commitment and diversity recommends average tenure of professionals of six and seven years. If it is less than that, people won't know each other well enough to work together most effectively. Beyond six and seven years, they'll know each other all too well and so be tempted stop listening carefully.
The great silent enemy of vibrant, effective strategy is structure. The strategy, created to meet a market's requirement, needs a structure for implementation. As soon as the structure is in place, however, it strives to wrest control of the organization away from strategy. Structure, over time, almost always wins. Structure resists change if it possibly can. It holds on to the familiar past and keeps us from advancing toward our future with a bold, contemporary strategy.
Beware the normal tendency toward the “Peter Principle.” Don't take your best investment manager and make him a not-very-good organization manager. Keep the best investment achievers, if you are lucky enough to have them, free to invest. Try to make it possible for them to invest 100% of the time. There are many more good general managers than there are good investment managers. The basic talents that lead to great success in an investment manager are not likely to lead to great success in an organization manager.
Compensation is the great driving force in any organization's strategy. It is not just the financial compensation that's important; and, most particularly, it's not the current dollar compensation.
Do you have distributive justice? If everybody knew exactly what everybody was being paid, would it make good sense to them? The best test of that is one every organization ought seriously to consider: total disclosure of compensation policy. Fair play is the essential factor in compensation. Without fair play, no organization will be successful for long.
Beyond current compensation, there is a looming problem for the most successful of the independent investment management firms. In many of these firms, a great confrontation will come between three generational groups. One group will say, “We started this firm. We were here when there was almost no one here. We did the first pieces of business. We took all the risks. It should be ours.” The next group will say, “The first arrivals may have started this company, but it wasn't much of an organization or much or a business when we first got here. We are the ones who brought in the really big accounts. We are the ones that made the really important strategy moves. We are the ones that made it a really successful business, so it should be ours.” And the third generation will say, “We are the future. We are moving into more and more client relationships. If you lose us, the future will be rough. The firm should be ours.” Usually, those “generations” will not be more than 10–15 years apart.
Stature, respect, and recognized importance are vital aspects of compensation. There certainly ought to be no one in the investment management business inadequately compensated today. The pay is, frankly, spectacular. The prospects are even more charming. But there are people who will be unhappy because they are not treated with the respect as professionals that they are entitled to. In successful organizations there is a high level, even a surplus, of respect, recognition, and admiration among the professionals and collective pride in the organization and its commitment to professional excellence in serving clients.
Knowledge is not a constant. Insight is certainly not a constant. Big ideas of real value seldom come along. The best investment management organizations seem to be good at pausing to see those good ideas and exploiting them.
An important dimension of successful investment management organizations—true of great organizations in many fields—is having great clients. If you have clients you do not enjoy or admire, or clients that do not expect much of you, you should seriously consider terminating your relationships with them. They will hold you back. If you have great clients, reach out to them, and ask them to demand even more of you, to challenge you to be the very best you can be.
What makes for successful firms? Business success in investment management is not hard to come by. Fees are high. Costs are relatively modest. Technological risks are minimal. Foreign competition is not consequential. Growth comes easily. Customers are unusually loyal. Competition is docile. Demand exceeds supply. It's a wonderfully easy place to have a business success.
In terms of professional success, however, I would ask some questions.
First, how many of the really important developments in investment management have come from within—from within your own organization or from within our profession—as opposed to coming from outside?
Have we, as a profession, truly contributed to our national society? Have we added net value? I confess to having some genuine doubts. If you took all the fees paid to all the investment managers, added up all the transaction costs incurred by these managers, and then compared the total to the risk adjusted incremental returns of the portfolios, which would be larger?
Have we truly advanced young people in their professional development? Have we succeeded in educating our clients, particularly with regard to the importance of setting long-term policies on asset mix and risk levels? Have we taught them how to avoid market timing? I suspect that, on those dimensions of professional success, we're not yet very successful. In the long run, however, satisfying the real and legitimate needs of clients will be the best part of our professional success.
Leadership is the final characteristic of successful firms. To become excellent, a firm needs strong leadership—not an individual, but ideally a group of leaders committed to concept of how to deliver real value and glad to make the time needed to pursue that idea with great and substantial vigor.