After meeting with thousands of managers across multiple asset classes, I believe there are three critical personality fields that should be assessed in due diligence on individuals responsible for investment decisions. I call these three characteristics the three ‘I’s: Intelligence, integrity, and intensity.
Like all hiring decisions, manager
selection ultimately boils down to the people.
Intelligence
In 1963, psychologist Raymond Cattell proposed a theory of intelligence that described two distinct processes or types of intelligence: fluid and crystallized. Fluid intelligence refers to an individual’s capacity to think logically and solve problems. Largely independent of acquired knowledge, it is what most IQ exams purport to measure. While not entirely static over an individual’s life, it is often thought of as raw brainpower. Crystallized intelligence, in contrast, represents the aggregate sum of knowledge acquired over the course of a lifetime. Naturally, this expands greatly with age (up to a point). If fluid intelligence is ability, crystallized intelligence is experience.
Both types of intelligence factor heavily
into successful job performance in general, and investing specifically, as a
great deal of research confirms (for instance, see here, and here, and here). A good deal of typical due diligence
focuses on a qualitative evaluation of two questions: How smart are the people
making the decisions? And how experienced/knowledgeable are they? These
evaluations have historically been largely subjective, which is concerning given
the importance of the job.
Integrity
In investing, integrity should be the cost of admission. It is a necessary but insufficient condition. The quality can be tough to suss out, but is often most apparent in the little things—in what the manager does rather than they say. Certainly, the manager should demonstrate commitment to complying with all applicable regulations (at the very least), but also to industry best practices on transparency, personal trading policies, and codes of ethics.
Due diligence must attempt to distinguish between people who do not like to be wrong, and those who do not want to look wrong.The potential investor should search for alignment of interests and, at minimum, fair terms. Better yet, outright limited-partner favorable arrangements: Fee step-downs, significant general partner commitment, limited partner advisory committee consents, 100% fee offsets, etc.
Formal background checks and informal reference checks—including vendors, portfolio company executives, former employees, and past investors—can also provide invaluable insight into how the manager actually treats business partners, as opposed to what they merely represent in a meeting. Conduct enough reference calls, and clear patterns of behavior will emerge.
Intellectual honesty relates jointly to integrity and intelligence. I believe a good manager must be willing to search for evidence that contradicts their initial investment hypothesis, rather than merely looking for confirmatory data. Essentially, they must be willing to admit when they are wrong. This is actually harder than it sounds, as a great deal of research on confirmation bias indicates. Humans enjoy listening to their internal ‘yes man’!
Finding someone who readily admits to errors may be the greater challenge, given the competitive nature of many in the investment industry, where preventable mistakes are highly undesirable. Due diligence must attempt to distinguish between people who do not like to be wrong, who proactively address and correct their own mistakes, and those who do not want to look wrong, who cover up mistakes rather than address them. Managers in the second group often double down when they err, moving bad trades into other accounts, or fail to address process errors by blaming externally.
Humility and acceptance of fallibility is
necessary for long-term success. And the latter behavior tends to come from a
place of overconfidence (“I can make it back”) or fear (“I don’t want to look
stupid”).
Intensity
The last ‘I’ combines several related characteristics into one broader cluster: Intensity. To me, this means a manager must have a passion for the work. Investing isn’t just a job for them, or worse, a paycheck. It’s a vocation, a higher calling almost. They must love to get up every morning and come in to the office to invest. Perhaps it’s learning about new technologies, helping companies solve capital needs, or just the thrill of participating in the perpetually shifting and increasingly complex capital markets. But whatever it is, they’ve got to love the work.
This passion should translate into a strong work ethic. Great investors tend to be the ones who turn the office lights on in the morning and then off at night. While there’s value in being well rounded with outside interests, just out-hustling your peers can often compensate for other shortcomings.
Investing isn’t just a job for them, or worse, a paycheck. It’s a vocation, a higher calling almost.Finally, this intensity should involve competitive drive, stopping just short of obsession. Whether installing a patio, building an electric car, or constructing a portfolio, great craftsmen truly want to do the best job they can do and strive to create a superior product to their peers. Of course, not everyone can generate above-average returns, but they certainly won’t without the drive to try.
At Texas Municipal Retirement System, we are investigating the use of aptitude tests and personality inventories during the due diligence process. Numerous private-sector firms have long utilized such tests for direct hiring decisions, as have many government agencies for certain types of critical contractors. Since hiring managers is really all about hiring people, the parallels are obvious. Psychometric tests are far from perfect, but have been shown to be reasonably accurate. And in addition to scoring cognitive ability and measuring select personality traits, they often test for internal consistency and can highlight individuals engaging in self-promotion and potential prevarication. At the very least, tests provide hard data and a means to objectively quantify inputs in an otherwise purely subjective and qualitative process. For me, that process is identifying managers who are high 3i.
The biggest hurdle will be adoption by
prospective managers, particularly the ones that are access-constrained. To be
continued…
Have a brilliant idea? CIO welcomes original contributions from asset owners. Send op-eds, research drafts, rants or raves to Managing Editor Leanna Orr at lorr@assetinternational.com.
References:
Cattell, Raymond B., 1963, “Theory of Fluid and Crystallized Intelligence: A Critical Experiment,” Journal of Educational Psychology, 54(1), pp 1–22.
Schmidt, Frank L., John E. Hunter and Alice N. Outerbridge, 1986, “Impact of job experience and ability on job knowledge, work sample performance, and supervisory ratings of job performance,” Journal of Applied Psychology, 71(3), pp 432–39.
Korniotis, George and Alok Kumar, 2007, “Does Investment Skill Decline due to Cognitive Aging or Improve with Experience?” draft white paper, July 20.
Chaudhuri, Ranadeb, Zoran Ivkovic, Joshua Pollet and Charles Trzcinka, 2013, “What a Difference a Ph.D. Makes: More than Three Little Letters,” SSRN White Paper 2344938, October 15.