Organizational alpha: Investment Committees

At money management firms, the investment decision making process is one of the crucial elements. While the investment process/philosophy itself often gets lots of attention, the investment committee making the investment decisions does not always get the same level of scrutiny.

Being part of an investment committee myself, I experienced the pro’s and con’s of making investment decisions in group. I do believe it is worthwhile to make investment decisions in group. Research shows that almost 60% of equity mutual funds are run by groups or teams of individual managers, up from 30% in the early 1990s. So I guess I’m not the only one who believes in group decision making.

For an investment meeting to be efficient and effective, there are some guidelines to take into account. Lots of them are applicable to meetings / organisations in general. Some of them are specific for investment teams.

Let’s start with a summarizing paragraph from the research piece Building an effective team from Mauboussin:

The key is to assemble a small, cognitively diverse group, work hard to surface unshared information and avoid bias, and decide in an independent and unbiased fashion. The details are important. Leaders must define clearly who is on the team, determine the responsibilities and authority of the team, and hold the team accountable for its decisions. 

Next, I would like to deconstruct this a little bit further and go over some elements that should be taken into consideration.

Diversity. Mauboussin refers to three types of diversity: social, cognitive and value. He states that the most effective teams have high cognitive diversity and low value diversity. Some clarification:

High cognitive diversity ensures that the team has the requisite tools and information to solve problems effectively, and low value diversity means the team is unified in its purpose. 

Cognitive diversity: Collective error = average individual error – prediction diversity. Collective error captures the quality of the group’s decisions. Average individual error reflects how accurate the people are within the group. And prediction diversity captures the dispersion of views, or how different the group members are. You can think of average individual error as “smarts” and prediction diversity as “diversity.”

Cognitive tilts. This goes a little bit against the need for diversity. I believe however it is important to source the right type of people for the type of decisions that are going to be made. By that I am referring to the difference in thinking patterns between economists, portfolio managers, traders, analysts, etc. Diversity is good but tilting your investment committee towards a certain type of experts (depending on your investment policy and beliefs) can be beneficial in my opinion.

Size. Most research comes up with a number ranging from 4 to 6. Personally I also feel a meeting with around 5 people has the highest success rate. The incremental value/productivity gains from adding more people declines while managing the meeting gets more cumbersome.

Preparation. As the saying (from Abraham Lincoln) goes: “Give me six hours to chop down a tree and I will spend the first four sharpening the axe”. Personally I am a fan of written preparation because it forces you think in advance. Although guilty of it myself, powerpoints are sometimes too easy as preparation (for example: just putting some bullet points and hoping the meeting takes over the discussion). I am with Jef Bezos (Amazon CEO) here when it concerns written preparation:

“In senior executive Amazon meetings, before any conversation or discussion begins, everyone sits for 30 minutes in total silence, carefully reading six-page printed memos. Reading together in the meeting guarantees everyone’s undivided attention to the issues at hand, but the real magic happens before the meeting ever starts.  It happens when the author is writing the memo. What makes this management trick work is how the medium of the written word forces the author of the memo to really think through what he or she wants to present. “Full sentences are harder to write,” [Bezos] says. “They have verbs. The paragraphs have topic sentences. There is no way to write a six-page, narratively structured memo and not have clear thinking.”  (I done this and Quora)

Another element of preparation is setting the agenda beforehand (and also reading it out loud at the beginning of the meeting). This helps to get everybody in sync and also stimulates members to hand in their memos/reasoning beforehand.

Running the meeting. Running the meeting itself is a crucial one, an attribute that probably grows through experience. I would like to refer to Principle 33 from Bridgewater which among other things mentions:

• Make clear what type of communication you are going to have in light of the objectives and priorities. 
• Lead the discussion by being assertive and open-minded.
• Navigate between the levels of conversation clearly.
• Watch out for ‘topic slip’.
• Achieve completion in conversations.
• Have someone assigned to maintain notes in meetings and make sure follow-through happens. 
• Be careful not to lose personal responsibility via group decision-making.  

Mauboussin adds the following paragraph with regard to leaders:

The goal of a team leader is to establish and maintain the handful of organizational conditions that foster competent teamwork and, ultimately, quality decision making. Simply stated, the role of the leader is to make sure that the process of revealing information, weighing alternatives, and voting on the best option is done correctly. 

Follow-up. It’s important to have a good follow-up (for accountability, keeping track of decisions, for spreading information to other stakeholders, etc.).

Investment beliefs. As an investment committee you should debate your investment beliefs from the beginning and write them down. This is a crucial exercise and often it is the cornerstone for the type of money manager you are (e.g. quantitative, bottum-up, top-down, trend, macro, etc.). To quote Tom Brakke of the research puzzle:

What makes for an effective committee?  A clearly-identified purpose and range of duties and a shared set of investment beliefs to guide the members in their decisions.

Voting. Having been through a few decision making cases myself, I believe there is no ‘best’ way to vote. I believe there should be consensus about broader issues such as investment beliefs and decision rights of the committee. For specific investment decisions, expecting a consensus every time might be out of sync with reality. I believe you should strive to get one, but fall back on majority voting if no consensus can be reached. Veto rights can be possible but depend on the nature of the organisation and activities. In practice they are not always easy in use. Naturally: the rules of the game should be clear before you start playing. Make sure everybody is aware of the voting procedures.

Openness. As an investment committee you should find the right balance between being open-minded and sticking to your (time tested) beliefs. For example: you should not change your views or beliefs in light of one other opinion or question from in- or outside the organisation (but outside the committee). On the other spectrum, an investment committee should not be an ivory tower gathering.

I believe that at least paying attention to elements above, creates the potential to make higher quality investment decisions.  In a follow-up post I might talk more about the behavioral biases such as group think, confirmation bias and overconfidence. Another area of interest are the ‘exercises’ you can do with your committee members (also check Vanguard resource below).

In the meantime: be sure to check out following sources if you want to learn more about this topic:

• Michael Mauboussin
• Massena on investment committees
• Bridgewater Principles
• the research puzzle
• Vanguard Investment Committee resources
• Google Rework blog

Extra: after writing the original post, I came across following interesting piece of Ben Carlson and the Master in Business podcast with Ken Fisher:

Control is about quality control. […] In a service business integrity ends up being crucial to your outcome. The greatest investors in the world have bad years. And bad years are just normal. But that’s not what I’m talking about. I’m talking about having control of the process while you’re having the bad year. So that you actually are delivering what you say you’re delivering in that there’s no lack of control that goes haywire. Because once that happens…

The reality in this business is you need control so that you deliver consistently with what you promised you would deliver, which is not a return number, it’s a ‘here’s what we do, here’s how we do it, here’s what we’re going to be trying to do for you, here’s where our bets are gonna be.’

Carlson further adds:

The process over outcomes mindset is a difficult way of looking at the world because the time frames in which investors judge themselves and clients judge their money managers continues to shrink. The best investors realize that a sustainable process comes not only from an intelligent investment strategy, but also from an intelligently designed organization.

Organizational culture is something that is highly underestimated in the investment industry.

Me again: clearly I believe that optimally structuring and organizing your investment committee is a crucial part in creating so-called organisational alpha as a money manager. An honest and professional investor knows how hard it is (if even possible) to add ‘risk/return-alpha’ (i.e. ‘outperform’ in some risk/return matter). So my suggestion is you go and look for additional kind of alphas and edges to help your investment organisation and its clients (and of course they are interrelated).