The previous posting, “Building an Organization Oriented to Improvement,” summarized a recent essay from Michael Mauboussin and Dan Callahan in order to question whether the kind of ideas expressed within it are being applied by asset management firms.
This time, we will consider how the same ideas can be used by those doing due diligence to gain greater insight into the organizations that they analyze. Such avenues of inquiry offer the opportunity for explanatory depth beyond the narratives provided by the firms.
(Many of the ideas presented here are expanded upon in the Investment Ecosystem Academy course on due diligence and manager selection. The need for “explanatory depth” is one of the core concepts within it; “look both ways” is another tenet of the training.)
Look both ways
While investment organizations across the spectrum differ from each other in fundamental ways — asset managers are not like asset owners or investment advisory firms, and even within those categories there are recognizable subsets — many of the principles that can be used to analyze them are remarkably consistent.
Take the categories of evaluation that were the historical “4Ps” of philosophy, people, process, and performance. All of them are relevant no matter where you go or what kind of organization you’re looking at. Many of the finer points in those categories and others apply universally too.
So “look both ways” is a reminder that insights that allow for a more intensive look at asset managers also open doors to evaluating your own organization. Therefore, the piece by Mauboussin and Callahan can first be used in that way, to examine your practices and consider opportunities to get better over time.
An uncomfortable topic
Since a large part of a due diligence analyst’s job is to crack open the narrative of an asset manager and determine what’s real and what’s not, one goal should be to accumulate topics and techniques that facilitate that effort.
A fruitful line of inquiry involves asking about what things need improvement. It is surprising how often people struggle with questions like that, even senior people, who are most expert at reciting the narrative and are often reluctant to share anything that seems negative. For example, they tend to be protective of the investment process as advertised, using the industry catchphrase of “consistent and repeatable” to describe it, when words like learning, evolving, and improving would represent the qualities that are likely to win over time.
Their inability (or unwillingness) to identify concrete areas for improvement indicates one or more of these dynamics at work: a) they haven’t really thought about it much; b) they genuinely don’t believe that the organization needs to improve; c) there is a cultural aversion to talking about shortcomings within the organization; and/or d) they don’t want to be open with investors about what they need to do to get better (not a great foundation for a long-term partnership).
Whether an interviewee is cooperative or intransigent in response to general (and more detailed follow-up) questions on potential areas for needed improvement, there are opportunities to unearth unusual insights about a firm by asking them. The fact that those exchanges may be uncomfortable are an indication of their value.
Angles of discovery
That brings us back to the ideas put forth by Mauboussin and Callahan. They show ways in which feedback can be used in organizations guided by an ethos of continuous improvement, providing a convenient set of variations on a theme for engaging with an asset management firm.
The suggestions below also apply broadly to the use of other sources of information — from within the investment world and outside of it — that can be used to reveal aspects of an organization that otherwise tend to remain hidden. The Mauboussin/Callahan piece is a particularly good example of how it can work.
Like any organization, an asset management firm makes choices, large and small, that define it. Many of them happened years ago, while others (especially investment decisions) occur on an ongoing basis. Much of the engagement with those doing due diligence on the firm focuses on what the manager has done (and what it intends to do): Here’s the philosophy, here’s the structure, here’s the people, here’s the process.
Much more important in getting to the heart of the matter are the why questions along each dimension — and that’s where the advantage can swing in favor of someone doing due diligence, if they are more well versed in those topics than those they are interviewing.
Consider just a few of them referenced in the last posting: forecasting, training, team composition, and environment/culture. It is not at all difficult to build a base of knowledge to be able to ask revealing questions (in search of that explanatory depth) in any of those areas. Asking why or why not questions about well-researched organizational topics can lead to a dialog that takes you beyond the narrative descriptions on which most due diligence reports are based.
The items on the Mauboussin/Callahan list can be used that way, allowing you to move past the rote topics to more fertile ground, where there usually aren’t pat answers at the ready.
But, to take it a step further, imagine showing up for a due diligence meeting and saying, “I know your meetings with allocators aren’t usually like this, but I’d like to spend the time today talking about how improvement happens in your organization. That will help me to understand how your firm got to this place and how you might grow and adapt over the coming decade or more of our relationship together.” Such an approach would result in more differentiated insights than come out of the typical manager meeting.
Another good time to use outside ideas like this is in those boring quarterly update calls where not much is said of value. Instead, they should be seen as opportunities to expand your knowledge of the firm. Exploring uncovered ground and introducing new concepts is a good way to do that.
Your scorecard
In the previous posting, asset managers were asked to complete a scorecard on where they are on the various means of improvement that were discussed. Now it’s time for those of you doing due diligence to fill out your own report card.
How often do you incorporate ideas into your process that would be considered uncommon topics in due diligence but which can provide you with deeper insight into the organizations you are trying to understand?
What are the impediments to incorporating angles of discovery like that into your work?
If you look at the twelve facets of process improvement identified by Mauboussin and Callahan, how much do you know about what the firms you cover think about the possibilities around each and what they actually do in practice?
Published: April 24, 2022
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