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Business Strategy Issues for Investment Leaders

Last summer and fall Atherton Consulting Group interviewed twenty top leaders in a variety of investment-related businesses (see chart).

Atherton Consulting Group lists the businesses below and desires to respect the confidential nature of these conversations.  As such, we will not attribute specific issues to the organizations unless approved by that organization, or reference the executives interviewed.

  1. Advisor Partners
  2. Bailard
  3. Blue Oak Capital
  4. City National Bank
  5. Comprehensive Financial Management
  6. Dodge & Cox
  7. First Republic Investment Management
  8. Forward Funds
  9. Goldman Sachs Wealth Management
  10. Index Universe
  11. J.P King & Associates
  12. Mercer Consulting
  13. Nelson Capital Management
  14. Osborne Capital Partners
  15. Private Ocean
  16. Sonen Capital
  17. Sterling Stamos
  18. Transamerica Investment Management (most recent firm executive was with)
  19. Wells Fargo Asset Management
  20. WHV

 

Investment survey breakdown

Investment survey breakdown

The intent of the interviews was to get a sense of the key strategic issues these leaders are working with and, in some cases, struggling with.  Results were highly insightful with the potential for meaningful rethinking and potential reshaping of business models.  We will post the key insights from the interviews over the course of several blog writings.

Certain perspectives arose out of those conversations.

Firms are either moving toward manufacturing of products or distribution.  It is rarer for firms to tackle both these days.  Firms that both manufacture and distribute aren’t totally abandoning their models, but are looking at ways to focus on where they add the highest value – a rethinking of their models.  One example is the increasing use of sub-advisors on investment products (think of Wellington Asset Management, GMO or Acadian).  So what does this mean?  For one, firms have increasingly decided to focus on what they are really good at, instead of trying to do all things well.  While there is certainly debate (due to mixed results) of whether to use sub-advisors or in-house investment teams, in theory this separation practice bodes well for the end consumer (investor) – better investment results with more efficient operations allowing potential for lower costs (or higher profits to investment entities).

 

As a focused distributor or manufacturer seeking partners, a key challenge is to find groups that have the right cultures and complementary skill sets.  There is a decidedly different skill set involved to be a world class investment manufacturer (investment analysis and judgment, process selection, sourcing best ideas, portfolio construction, risk management) than there is to be a great product distributor (network and business development, problem definition and problem solving, contract negotiations, relationship skills, communication).  Some implications of this are that we may see increased Chief Investment Officer outsourcing (e.g., PIMCO All Asset Fund of Funds using Rob Arnott’s group at Research Affiliates, Mercer taking over the CIO function of DB plans that are winding down).  In other words, you do what you are good at and we’ll do what we are good at.  Firms are taking an increasing perspective that they can’t be all things to all people (with some noted exceptions).

 

The appeal of increased separation of the investment groups from the distribution groups is also supported by culture differences.  Previous consulting work I have been involved with evaluated the sub-cultures within investment organizations.  There was a clear distinction between the values of the investment and distribution sides of the business.  Investment sub-cultures are characterized by values (in order) of analytic/research, discipline, creativity/innovation, meritocracy, long-term perspective/vision and passion/energy.  These make a lot of sense and align with what I have seen in successful investment organizations.  The flip side to this is that if these are not some of the highest values in the organization, those businesses tend to be “sales” focused.  As a contrast, the top values (in order) of distribution sub-cultures are competitive/win, passion/energy/positive, humor/fun, respect, appreciation, and empowerment.  Effective sales organizations I have seen have a healthy respect for fun, are incredibly competitive (particularly with themselves, but also across the sales group and with outside firms) and display outwardly a positive temperament (cynics tend toward the legal staff).

 

If the investment and distribution groups are housed in different companies (as in the sub-advisor scenario), the “friction” resulting from cultural differences is likely to be minimized.  If the groups are under the same roof, the resulting “friction” manifests itself in the need for respect, appreciation and empowerment by the sales team from the investment culture – traits not commonly expressed by innately introverted analytical investment types. The keys to success of the separate company investment and distribution functions will be based on real aligned interests between the firms, true competency differences, great trust and respect for the benefits of different cultures.  The point here is to know what you and your partners are good at, have complementary skill sets and competencies, structure an aligned interest relationship and know how to create mutually advantageous collaborations and partnerships.

 

Future blogs will cover additional timely and impactful themes surfaced during our interviews last year, including alignment of interest issues, the state of innovation in the industry and individual firms, technology strategies, the impact of regulatory compliance changes and what these all mean for investment and wealth management leadership.   We hope you enjoyed our initial blog post.  E-mail jkeene@athertonconsultinggroup.com if you want to discuss how we can help you with strategy and leadership development, including performance-focused executive coaching.

Perspective on Financial Alignment of Interests

Alignment of interests is a key to success. This almost sounds too obvious to even state, but the truth is that firms don’t always operate with this principle. One senior executive I interviewed at a very large institutional asset management group (> $500 billion in AUM) described a mal-aligned situation at Janus Capital. Janus employees were paid what many considered to be a very high percentage of total income as current compensation. There was not enough emphasis on compensation directly related to investment performance and company operating performance. Others apparently thought the same way as suggested in a shareholder lawsuit alleging that the Janus Board did not live by its “pay for performance” commitment . Janus apparently recognized this as an issue and in March 2012 came out with a preliminary proxy statement resulting in a new compensation philosophy aimed at aligning shareholder and employee interests better. Kudos to both parties for working to try and align interests better.

This begs the questions: What does an aligned compensation system look like? Aligned with whom? Shareholders? Investors? What amount of compensation should be relatively fixed and paid currently and what amount should be paid in variable compensation? What should the variable compensation look like? Should everyone in the firm be treated the same way? We won’t attempt answers to all these questions. We take the position here that the alignment question relates to employees of the firm being aligned with shareholders – employees “win” when shareholders “win.” We also believe the question of alignment exists between investors and employees – whether the measurement is performance versus a benchmark (public equities/fixed income), profits above a preferred rate of return (hedge funds and private equity/real estate) or a straight profits participation (venture capital), the investment professional should be incented to share excellent investment returns with the investor of capital in a “win-win” structure, consistent with thinking from Stephen Covey and others.

The first alignment scenario bears our attention (shareholder-employee). What about the basic question of fixed compensation versus variable compensation (bonus profits pool for the company and long-term incentives for investment performance)? The CFA Institute compiles information on types of compensation for equity and fixed income investment professionals (segregated by portfolio managers, research analysts and traders). According to the most recent information published (The CFA Institute 2007 Member Compensation Survey), equity investment professional compensation is split as follows (% of overall compensation):

Compensation

Key insights here are that the portfolio managers, those most typically responsible for investment performance, have the highest level of variable compensation (cash bonus and long-term incentives). We think this makes sense relative to research analysts and traders who are usually a step removed from portfolio performance responsibility. The key question for the cash bonus is how much of this is based on investment performance and operating performance versus other metrics such as revenues (which generally aligns with the business development function of asset gathering), client retention (which aligns with the client service function). To be most effective, the cash bonus needs to be truly variable to important metrics such as investment performance (adjusted for risk) and entity operating income (investment fund and/or company entity) to create accountability around revenues and expenses – the efficiency of delivery of the funds. The above data should be used as a frame of reference when developing compensation systems for investment professionals, not as an absolute. Clearly, companies may have adjusted their compensation structures subsequent to the Global Financial Crisis. Having said that, principals at Atherton Consulting Group have done some separate research in the San Francisco Bay Area on compensation shifts (and other changes) updated through early 2010 and found only a small aggregate reduction in compensation levels and only a slight shift in the composition of pay.

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ihttp://www.law.du.edu/documents/corporate-governance/say-on-pay/swanson/Plaintiff-s-Brief-in-Opposition-to-Janus-Capital-Group-Inc-s-Motion-to-Dismiss-Swanson-v-Weil-Civil-Action-No-11-CV-02142-WYD-KLM-2012-WL-4442795-D-Colo-Sept-26-2012.pdf

Strategy in a Venture-Backed Firm

Most of the start-ups I have had connection with have had great ideas and passionate founders working to bring those ideas to fruition. Yet many of these firms fail – either to get to market or even to get financing. It’s not usually because they lack smarts or heart. In fact, those are probably the most common things that founders of start-ups have. A contributing factor to firm’s lack of success and under-performance is connected to how strategy is developed and executed in the firm (otherwise known as decision-making process and implementation).

Whose responsibility is strategy in an early venture – founders, management or board? We think that at the end of the day it’s really the joint responsibility of the Board and CEO to set strategy, relying on strong recommendations and information gathering by the founders and management team. So what are some of the common strategy development mistakes at venture-backed firms? We think there are four key areas to look at:

1. Lack of Role Clarity – Often Boards are not clear on what their role is in determining strategic direction of the firm. It’s common that Boards of Directors rely on the CEO and his or her team to develop and implement strategy with the result that Board meetings are about communicating pitfalls and progress. While this approach is common and not without merit, it doesn’t take full advantage of the Board’s knowledge or of their responsibility for strategy development and decision-making. If thoughtfully selected, the Board will have members with deep industry knowledge, or at least deep knowledge of the issues the firm will face. Boards should focus on developing the strategic direction of the firm with significant input from the management team. All should be involved with the process in order to surface the best ideas, gain a diversity of perspective and maximize buy-in to the strategic plan. Strategy development should ideally be viewed as a partnership between the Board and Management.

2. Limited Board Agenda – Boards at private companies tend to meet six times a year. The time together is valuable and it’s often under-utilized. At one firm we have worked with the CEO sets the agenda for the Board meetings and is the driver of discussions. It seems he is trying to prove how smart he is to the Board, rather than engaging the Board with an open mind toward higher level strategic decisions. The exchange is primarily uni-directional, rather than more even among all the Board members (not a good sign, by the way). More importantly, the quality of information focuses on reporting what has happened (financial reports, progress on business development and the like). This information is important, but it should take about one-third of the meeting at the maximum with two-thirds of the time spent on strategic issues (how should we grow, which product or service do we focus our efforts on, should we expand our geographic footprint now or wait?). Effective Boards spend most of their time on strategic issues and direction for the firm.

3. Lack of Strategic Information – This can particularly haunt start-ups as access to strategic information may be limited or inaccurate. Much information can be private or not easily accessible. Many of the industries move rapidly and strategic information changes at a fast pace. Nonetheless, it’s imperative that the Board get the appropriate information they need to help set strategic direction. This is where it’s really imperative that people with industry knowledge are on the Board. Ideally, it’s good to have several people with deep knowledge. Early stage venture-backed firms are often dominated by venture capitalists. While many VCs have great industry knowledge, most have not been operators of businesses. Make sure to get independent directors with operational experience and a working network that can access the right strategic information (what are the alternate solutions trying to solve the same problem(s) your firm is trying to solve, where is the regulatory climate going and how will that affect your firm’s strategy, which financing strategy will best match the firm’s business strategy?)

4. Dysfunctional Boardroom Dynamics – We can’t underscore how destructive a dysfunctional board can be to a company’s success. We are not talking about low level dysfunction where people are talking too much or not fully engaging due to over-commitments. No, we are talking more about second-guessing the CEO after strategy has been agreed at the Board level, being overly critical about personal quirks and withholding ideas as a result of being scared to sound dumb or being criticized by others on the Board. Let’s be clear: the Board meeting is intended to air ideas from diverse thinking individuals so that ALL the realistic options can be considered in strategy decision-making. Any activity that supports that process is welcome. Trust and respect for people on the Board (and in management) are the foundational elements for a high functioning Board. Work towards that goal in every meeting and the Board will set the stage for high performance.

Five Key Areas for Wealth Management Firms to Focus on for High Performance in Current Environment

In the financial advice business, a key success factor in the business development process is the degree to which advisors make an accurate assessment of themselves, others and situations. So it was a surprise to find advisors and prospects see things differently in some meaningful ways on certain elements in the business development process. At least, this is the result of joint research by our organization, Atherton Consulting Group, and Upside Consulting Group based in Toronto.

The groups collaborated on a recent study comparing how advisors market services with what prospects seek in a financial advisor. They developed a survey examining advisor and prospect perspectives on the sales process as two sides of the same coin. Specifically, advisors were asked “what are the most important elements of your sales process?” and prospects were asked “what are the most important attributes that you look for in an advisor?”

In the post-financial crisis climate, wealth management clients are more circumspect about advisor capabilities and motivations. Trust has to be earned, rather than advisors assuming it is there to be lost. Clients are also paying closer attention to the value received for fees they incur. New business models, a movement toward passive investing and improved online investment and financial planning information all threaten the way traditional wealth management businesses operate. With this as the backdrop, our collaborative research pointed to five key areas firms should prioritize for high performance in the current environment:

1. Listen. It’s not about the advisor, it’s about the prospect. Capabilities are irrelevant unless they relate directly to a need that has been clearly articulated by the client. Develop and master questioning strategies and listening skills aimed at understanding and creating an emotional connection. Write questions in advance and practice paraphrasing, validating, appreciative inquiry and other active listening skills with prospects.

2. Substance is more important than form. Focus on the concrete value of the service. Personal relationships are earned over time by delivering results that are important to the client. Go into detail on what tax-sensitive investment management means (e.g., .25%/year improved after tax returns). Keep an on-going log of results to show clients as the relationship develops (e.g., investment returns compared to benchmarks, tax savings, total fees, referral to mortgage broker).

3. Tackle the fee structure openly and early with prospects. Be transparent and specific about how you’re paid and how this aligns with the value received by the client. Firms must ensure incentives are aligned with client results. Probably more than any other business, the private client relationship is centered on trust. Transparency around all sources of fees (asset management, underlying manager, redemption, incentive fees) will help solidify that trust.

4. Do not shy away from showing investment performance. It seems to have been lost by many in the wealth management industry that investment performance matters to prospects. Prospects are clearly saying it matters. While no industry standard for communicating private client investment performance has emerged, advisors have the opportunity to differentiate themselves through appropriate historical performance analysis communicated in a way that matters to prospects.

5. Continually ask clients and prospects what products and services they are interested in and figure out a way to offer them, directly or through collaboration and partnership. Being in the dark about what clients and prospects seek is an invitation for other advisors to convert them. Periodic on-line survey tools and questionnaires at quarterly or annual reviews can help with this process. Assign and make accountable a highly skilled team member to collect data, develop client recommendations and create new solutions-focused services specific to client needs.