Orbiting the Asset Management Hairball

The first section of the most recent Fortnightly posting cited some readings about the asset management industry and the pressures bearing down on it.  As mentioned:

Drawing conclusions about the state of “asset management” can be tricky, since there are different trends at work among traditional long-only managers, hedge funds, and the purveyors of private capital strategies.

That said, overviews of the industry often lump them all together, as is the case with the newly-released 2023 Global Asset and Wealth Management Survey from PwC, which garnered headlines due to its prediction that one-sixth of the organizations would be gone by 2027.

The report stated that “a set of existential challenges exceeding those of any previous era” would require “industry players . . . to adapt to the new context or fail.”  It’s a message you’ve heard before.

Rather than repeat the details here, let’s take a more fanciful journey.

Flights of creativity

In 1998, Gordon MacKenzie published a quirky little book with a quirky title, Orbiting the Giant Hairball.  The subtitle provides a bit more context:  “A Corporate Fool’s Guide to Surviving with Grace.”

MacKenzie worked for Hallmark, the greeting card behemoth.  When founder Joyce Hall was creating a new company (and a new industry) in 1910, he “had to base many of his decisions on common sense, intuition and creative instinct.”  MacKenzie’s book is about the dilemmas faced by organizations and the people within them when a small entity grows into a large one and its learned lessons create “a Gordian knot of Corporate Normalcy,” i.e., the Hairball.

Notions of normality tend to suffocate originality.  The elements that are thought to have led to success become entrenched — and policies, procedures, and structures are created:

Every new policy is another hair for the Hairball.  Hairs are never taken away, only added.  Even frequent reorganizations have failed to remove hairs (people, sometimes; hairs, never). . . . The Hairball grows enormous.

In that environment, an act of creation — of standing apart from orthodoxy — can seem heroic, but without people willing to take such actions, failure is on the horizon.  MacKenzie argued that people need to learn to orbit the Hairball, for the sake of the organization’s health and their own sanity:

Orbiting is responsible creativity:  vigorously exploring and operating beyond the Hairball of the corporate mind set, beyond “accepted models, patterns or standards” — all the while remaining connected to the spirit of the corporate mission.

To find Orbit around a corporate Hairball is to find a place of balance where you benefit from the physical, intellectual and philosophical resources of the organization without becoming entombed in the bureaucracy of the institution.

In practice, that’s hard work:

Unfortunately, while the heart of Hallmark sings the virtues of creativity, the company’s intellect worships the predictability of the status quo and is, thus, adverse to new ideas.  This incongruity creates a common corporate personality disorder:  The organization officially lauds the generation of new ideas while covertly subverting the implementation of those same ideas.

So what does all of this greeting-card fluff have to do with asset management?  Hairballs are found in every organization — because of human nature; career risk concerns; “contrived travails;” the limiting containers of job descriptions and normative expectations; and the tendency to create to-dos that are “culturally appropriate” but “functionally inappropriate” for the business at hand.

The implications of these tendencies for an asset management firm depend on where it is in its life cycle.  Large, well-developed organizations have well-developed hairballs.  While being in completely different businesses, the nature of the bureaucratic challenges at Hallmark cited by MacKenzie are similar to those found at mature asset managers.

Emerging firms are like the Hallmark of the early days; while it may not seem to be the case, “countless hairs” stemming from business decisions and policies are building up.  Therefore it’s important for leaders to think about how to manage and minimize the tangled mess that will develop over time.  That’s complicated by the fact that they have their hands full, so choices often are made on the fly, with the ramifications to be sorted out down the road.

Looking at the asset management industry as a whole, regulation poses a challenge for everyone, making a certain amount of bureaucracy unavoidable.  And then — to extend MacKenzie’s analogy — there is one more hairball to consider.

The other hairball

This other sphere of orthodoxy is that of the asset management industry itself.  A series of conventions have evolved over time that entrap organizations in webs of conformity that are defined by their respective asset classes, geographies, and style boxes.

That conformity can be easily seen when lining up the managers of a given cohort for evaluation, starting with the incredible similarity in how they communicate through their one-pagers, quarterly reports, websites, presentations, etc.  The reason given for this commonality is the “ease of use” for current and prospective clients, who are said to want to see information in a certain way.  Asset managers choose to follow convention and eschew potential improvements that veer away from it.

That urge to comport to the industry’s ways extends to matters of structure, investment style, fees, and most everything else, meaning that the qualitative distinctions between organizations tend to be minor.  Everyone is in the hairball together, so the selection of managers is dominated by performance considerations (even if obligatory narratives on this and that are included in due diligence reports).

The asset management business model has been so wonderful for so long that it seems stupid to rock the boat, even if accepting the current condition amounts to rolling the dice on the vagaries of performance-chasing clients in a business where results are dominated by noise.

One of MacKenzie’s concepts applies here.  Like people within a bureaucracy, firms find themselves “wrapped in a cocoon of realities” that has evolved over time, which provides a sense of security.  But that cocoon “is also a shroud that binds and cripples us.”

While the goose is still laying golden eggs at established asset management businesses (look at those margins and compensation packages!), it might be time to launch some exploratory missions intended to orbit the hairball of industry convention, even if it’s only in a minor way, to a low orbit rather than one further out.

It’s worth noting that some organizations are more disruptive by nature, willing to attempt moon shots that escape the pull of the hairball.  If you follow the threads of today’s established categories far enough back in time, you’ll find the moon shots that marked their beginnings — and the people who now look like visionaries but whose ideas were doubted, laughed at, or ignored at the time.

For both investment strategy and business strategy, there is a question of what kinds of risks to take, of how aggressive to be.  Let’s assume that PwC is right in thinking that one-sixth of the current firms will be gone in a few years.  It seems logical that they will mostly be run-of-the-mill organizations caught in the hairball.

Individuals within an organization are constantly gauging the risk of being different and adjusting accordingly.  If the status quo is comfortable, most opt for that.  The same goes for organizations, especially asset managers, for whom following a well-trodden path that has been “verified, confirmed and accepted by the establishment” (to use Mackenzie’s words) has been so lucrative.

There is comfort in settled ways, but the risk of being the same is increasing, while the risk of being different is always daunting.  Which path will you choose?

There are many dimensions of innovation that should come into play as a part of what we call “Investment Organization R&D,” as indicated in this short PDF.