Sunday, April 15, 2012

It DOES take a village...

I have written extensively about bringing back the partnership investment bank (also see previous posts here, here and here). Now consider this NY Mag account of John Mack's of when he first began working at Morgan Stanley [emphasis added]:
Back when Mack started as a bond trader at Morgan Stanley, in 1972, things were a little different. “There were only 350 people,” he says. “They had $6 million in capital. Any time we priced a deal, every partner at the firm came to the meeting.” is first brush with disaster came during the 1987 stock-market crash.
The key quote is every partner came to the meeting when they priced the deal because the partners' money was on the line. Do you think that today's Morgan Stanley behaves in the same way when the senior directors are playing with Other Peoples' Money?
I see two problem in the structure of today's financial services firms. First, rewards are asymmetric. Today, if they win, bankers make out like bandits, but if they lose, someone else takes the hit. If a partnership investment bank loses, the partners lose their houses, their cars, their kids education, etc. That kind of double-edged incentive system makes people far more sensitive about risk control.
The second is this underlying belief of the superstar who can do it all and thus needs to be rewarded. Yet, as Tom Brakke wrote, the myth of the superstar is largely a myth:
When Chesley Sullenberger landed Flight 1549 in the Hudson, he was hailed as a hero, but bringing the plane down and getting the passengers off safely was a team effort. Co-pilot Jeffery Skiles somehow had completed restart attempts on both engines and was also able to run through most of the procedures to ditch the airplane — “something [the crash investigators] found difficult to replicate in simulation.” And the flight attendants (Shelia Dail, Donna Dent, and Doreen Welsh) ensured that 150 people were able to get out of the two of four exits that were viable, within three minutes.
A organization that has a superstar has to bear the cost to its corporate culture:
As anyone who has spent time around investment stars knows, the kind of culture that is created to support them usually doesn’t lend itself very well to the investment equivalent of landing in the Hudson. Instead, the environment can be much like that which Gawande has seen in operating rooms, where a head surgeon rules the day and is rarely challenged. Few are willing to speak up, leading to “a kind of a silent disengagement, the consequence of specialized technicians sticking narrowly to their domains. ‘That’s not my problem’ is possibly the worst thing people can think,” but it happens all the time (even in the investment world where people tend to be smart and opinionated).
I wholeheartedly agree with that characterization. Early in my career, I personally witnessed a "star" investment banker who was allowed to run wild blow up a major investment bank, much to the detriment of his partners.

Brakke wrote that, most often, there is a team around the star:
The star system isn’t universal in the business, but it is dominant. And often one of the stars is also given the title of chief investment officer at some point along the way, a further acknowledgment of their track record — and a position for which most are wholly unprepared. Oh, the part of it where they are supposed to opine about the market? That they can do and do well. But the real work, of creating an organization that builds on an array of talent and a confluence of ideas to meet the needs of clients? Not so much.
This study published in the Harvard Business Review shows that, in the business of investment management, the top firms are built around teams:
Success if predicated on teamwork, built on trust and the right incentive structures. In investment banking, that also means creating the right incentive structures, not only to make money for the bankers, but to put the right risk controls in place so that society doesn't bear the cost of failures.
Dare I say it? In investment management and banking, it does take a village to succeed.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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