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Psyching Out Money Managers

How an asset owner at Texas Municipal boosted private equity returns to 39% in 2018, in part, by giving psychological evaluations to asset owners.

Art by Katherine Streeter


High intelligence, intensity, and integrity are critical qualities in investment managers, but can be hard for asset owners to evaluate during the due diligence process. Chris Schelling, director of the $2 billion private equity program at the $29 billion Texas Municipal Retirement System (TMRS) in Austin has found a way to test his managers, align teams, and ultimately make 19% returns over the past three years, in part by using finely-honed psychological evaluations.

Schelling, a former Mercer consultant, deputy chief investment officer, and professor of finance, is the kind of guy who reads white papers on weekends and loves to come up with new ways of looking at things. When his peers spoke about competing with him for CIO’s NextGen award last year, they said he was “always brilliant.” His boss, CIO TJ Carlson, told CIO he is “one of the smartest investors that I know,” with “an incredible depth and breadth of knowledge across not only asset classes, but vehicle structures and markets.”  

But before getting his MBA from the University of Illinois, and his MS in Financial Markets from Illinois Institute of Technology, Psychology was his main game—and the subject of his bachelor’s degree from the University of Illinois in 1998.

About three years ago, Schelling got curious. He wanted to know just how much he could find out about potential hires as part of his due diligence process. He read research about screening for certain characteristics when selecting politicians and successful CEOs, and which qualities seemed predictive of better performance.

And then, with a goal to find the very intelligent, the intense, and the honest, he began giving his potential managers psychological evaluation tests.

Chris Schelling, director of the private equity program at Texas Municipal Retirement System.

Why those qualities? He chuckles and refers to a Warren Buffet quote: ‘In looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.’

Schelling explains, “I do think there are three really strong characteristics that are important in being a good investor. You’ve got to be very smart. This is a competitive industry.”

But even if you’re a genius, that’s not enough. “Intensity is a combination of things. You really have to want to be good. You have to be hardworking. There is a certain hustle that matters. You can outwork your competitors. You’ve almost got to be obsessed—not completely obsessed but you don’t meet people who are great at anything who aren’t completely engrossed in what they’re doing,” he said.

Team Think vs. Group Think

 Schelling’s found some interesting ways to use the psych evaluation tests when choosing teams.

He starts by measuring nine qualities: energy level, assertiveness, sociability, manageability, attitude, decisiveness, accommodativeness, independence, and judgment. (The test gives definitions on each quality and a 30-page report on each candidate.)  “There’s not a magic score we’re looking for, but we want teams that are better than the sum of their parts,” he said.

In so doing, he’s also trying to suss out a few other traits in his managers. “You’ve got to have intellectual honesty. You’ve got to really be curious.”

But even if you’re curious and believe you have the next great idea, you have to be just as willing to kill that idea.

“If you own an idea that’s not the best, you’ve got to be willing to move on from that. You’ve got to be willing to admit when you’re wrong,” he said.

What Schelling is doing may not be as easy as it sounds. Psychologists have wrestled with factors that determine team productivity for years. And Schelling is trying to get as close to a meritocracy as he can as he hones his management teams.  During his career, he’s met with some 2,000 managers, invested $4.5 billion across roughly 100 accounts in public securities, hedge funds, real assets, and private equity.  At Texas Municipal, he’s sourced and met more than 600 general partners, and made $2 billion in commitments across 35 limited partnerships, while leading the standardization of due diligence efforts and cross-functional research across private credit, real assets, and hedge funds.

“You’ve got to really vet stuff. Good investment organizations don’t have dog and pony processes where capital is competing for the best pitches internally. It’s got to be that the best ideas have to win. And so, we want to find a team that describes a process that’s consistent with that: They describe their people as playing different roles, and then, when we measure their personality profiles, we get scores that are consistent with those processes.”

Schelling isn’t looking for a group think, however. He’s hoping his tests show the strengths and weaknesses of each team member and how they find a balance.

“We don’t want everyone to be decisive. We don’t want everyone to be low on decisiveness. What we want is, if there are two partners, if one should score higher on decisiveness, we want that person to have told us that ahead of time and say, ‘But I really listen to my partner’s opinion and we’re a good team because my partner is very analytical.’ Because then, we’re getting this image of better fully vetting of investment risks and wholesome debate.”

Strengths Per Asset Class

Using the company Profiles International, Schelling asked all of his new and existing managers to log into a computer website and take a basic aptitude test for verbal and math skills, and a personality profile test. “We’ve had one refusal that was based upon some kind of compliance or legal reason where they didn’t want to take it, but everyone else has complied,” he said, adding, “most private equity managers completely understand the importance of getting the right executives. I mean, that’s part of what they do.”

Intelligence was the easiest to measure, but in testing about 80 different people, (and benchmarking them against thousands of respondents from different roles such as analysts, managers, and executives,) Schelling is finding some unexpected revelations.

“We’ve seen, for instance, in comparing private equity to real estate and real assets, the private equity specialists score much higher on numeric ability than the real estate specialists and the real asset specialists.” But when it comes to real estate, the personalities shine. “The real estate and real asset people tend to score higher on sociability and attitude.”

Within private equity there’s even some evidence that the buyout specialists score higher on numeric ability. “Venture managers score higher on verbal skill and reasoning, which again also kind of makes a little sense: It’s creative thinking, whereas in buyout, math skills, and understanding balance sheets and true finance, matter a lot more,” Schelling said.

Practical Applications

Schelling puts it into perspective: “Let’s say you meet two managers and one says, ‘I’m the analytical one and he’s the decisive one, and together we’re very complementary.’ But it’s very hard to measure that. And now we literally have a test that can score that.”

The tests have also given him deeper insight to ask better questions of teams.

“If two partners score low on the same spectrum, we can ask a question like, “Do you two struggle with this part of the job since you both are more like this, and how do you manage that?” We’ve had some good conversations. We’ve had GPs say, ‘Yes, actually business development sourcing is the hardest part of the job for us because neither one of us are really outgoing and so here’s how we systematize that.’ And they’ll walk through a CRM system that makes them sort of do things.”

Schelling also had an option to test for narcissistic or Machiavellian characteristics but chose not to. He believes managers would be less amenable to taking the tests.

Yet, he still needed to measure a person’s integrity.  He decided to try to measure if people were lying. The method he chose was to test how consistent their answers were. The test gives an overall “consistent” or “not consistent” answer. “So getting that score gave us some clear signals,” he said. There haven’t been many “not consistents,” but he tends not to hire them.

He believes the test will become increasingly valuable during a key event, when, say, a founding partner of firm chooses to leave. Generally, when asset owners have the opportunity to vote on a replacement, there’s a phone call with the potential replacement and a resume.

“Now we can say we would like to request the candidate take the test before we vote, and then, when we get results, we would have a better understanding of the role they would play.” For instance: What if the person they’re replacing was very thoughtful and analytical, and the new person is highly decisive. It could conflict with the other leader at the company.  An asset owner can ask: ‘How are decisions going to made?’”

Testing Emerging Managers

Because the psych evaluations were instituted within six months of Texas Municipal’s first private equity commitments, there’s not a basis for comparison on whether they’ve effected returns.  Still, Schelling believes the tests can be a great indicator of a manager’s potential. “I do believe it’s part of the reason why our results have been strong so far,” he said.

In 2018, returns, which were also helped by the very strong equity bull market and private equity tailwinds, were 39.4%, averaging 19% over the past three years.

The investments that made the difference were those in emerging managers and Funds I, II, and III, comprising some 30% of the portfolio. “We don’t have a mandate to do it, but I think that you have better chances of picking a higher-performing manager from that subgroup,” he said. “So it’s not the whole portfolio, but it’s just a tilt we have that I think increases our odds of generating even higher returns.”

Of the emerging managers, roughly half are diverse women and minorities. “We just think that that’s where more attractive segment of returns is available,” said Schelling.  However, because the emerging managers’ track records are less easy pitched into a pitch book or a performance analytics toolkit, they require more due diligence, and the psych evaluations have become an important part of the process.

They define the new emerging managers in a way that the people haven’t yet been able to prove themselves. “I think it’s even more critical to have tools like this in your diligence toolkit when you’re taking on the incrementally higher business risk of doing earlier-stage managers,” he said.

The $29 billion fund is still building out its private equity component, with a 5% target of the overall plan, under $1.5 billion. Schelling is starting a busy year with four new private equity commitments (and $250 million to middle-market private equity strategies) in the first quarter. “There’s a mix of new relationships and some re-ups with existing managers and it’s kind of a diversified portfolio. It’ll be some growths, some buyout, some venture, and it’s a good start to the year,” he says.

All of the managers have taken psych tests.

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