When Tina Turner sang “We don’t need another hero” in Mad Max – Beyond Thunderdome, she was longing for freedom sans hero. Psychologists will tell us heroes and their stories have their place to inspire us. Sure, but can they build and sustain enterprises?
With many years inside and consulting to asset managers, the longevity of boutique asset managers built on star or “hero” portfolio managers has always intrigued me. Here I consider key-person risk research, various risk models, and ask: can we do better?
Top portfolio managers, chefs and rockstars all share some common traits: a healthy ego, enjoyment in performing, building excellence, and significant key-person risk. We then witness the irony of the best portfolio managers avoiding key-person risk in their investee companies, yet struggling with their own succession. Let’s beware the “do as I say, not as I do” trap.
In 2022, we saw the headlining missteps of one of Australia’s most successful asset managers. Clearly many investors were scared by, at least, perceived key-person risk.
Strong risk management is about protecting all stakeholders, including smaller investors, who trust us with their savings. They expect more than just investment success. If our best firms struggle here, then where does that leave us?
It’s a large firm thing too
In 2018, Morgan Stanley found that across the S&P500, asset managers were more vulnerable to key-person risk due to greater exposure to key individuals. They found meaningful impact on shareholder value when key executives suddenly left. Over 12 months, underperformance averaged 11 per cent while a third fell by over 20 per cent.
Furthermore, the AICD’s 2019 review of global research on CEO succession planning found the “better disclosure of succession planning” and “the more extensive the grooming process, the better” for the firm’s future value.
The international CPA journal, in 2019, looked at key-person risk management in financial services firms. They found common practice was to focus on key senior executive risk. Some contributors considered a broader echelon of non-executive, mission-critical specialists. This can be our ‘individual heroic model’.
An alternative ‘strategic position model’, based on long term research, finds that key positions rather than key individuals contribute to sustainable success. Let’s review these models and a third, blended option.
Individual heroic model
This model assumes key people drive sustainable success. In addition to the obvious high-ranking positions and designated experts, this model sometimes includes go-to specialists – the quiet heroes, upon which many teams rely.
Think of a sports team’s reserves bench, or theatrical understudies, who provide enough cover from a continuity perspective while other replacement plans are actioned.
Strategic position model
Kings College Professor Dana Minbaeva, founder of the Human Capital Analytics Group at Copenhagen Business School, states her research points to well-structured positions, not individuals, contributing to sustainable success.
Strategic positions must have three characteristics: direct impact on strategic implementation effectiveness; the quality of the work will depend on who holds the position; and, strong company-specific knowledge. These positions minimise the loss of individuals, can be reshaped and moved as required.
A blended model – the masterchef approach
These models have some limitations for a boutique with fewer key contributors. Let’s consider a blended model that top chefs use to scale their restuarant. They step back from the stove into executive chef roles and may run a test kitchen. They grow restaurants via developing talented chefs and supported by specialist sector investors.
Our successful portfolio manager could step back to a CIO role while developing their team to take over key portfolios. The CIO coaches the team, develops new portfolios then transfers these to the team. This approach requires consistent execution and an ongoing conversation with stakeholders, as per the AICD report, as part of the long-term growth plan not a final year key person exit.
In addition to “alignment” equity plans and growth capital, the strategic disciplines and expertise offered by experienced specialist investors and independent directors is often critical. The rule “start as you plan to finish” applies here.
Doing better for all
Speaking to CEOs, a regular view is they want a hero with the “outperformance gene” that attracts sponsors, investors and intermediaries. Some CEOs would load up here and worry about succession later. Does this serve long term investors? Maybe not, with only 22 per cent of active managers outperforming the ASX 200 over 10 years, per S&P’s SPIVA Australia 2022 report. Could the masterchef approach, which builds organisational robustness, solve for sustainable outperformance while reducing key person risk?
All industry stakeholders must play their part. Super funds selecting their asset managers, together with investment consultants and financial advisers being as important as regulators to investors by demanding stronger business sustainability measures before recommending asset managers.
Key-person risk is considered the hardest risk to mitigate and lethal for personality-led businesses. Robust succession planning is a key governance responsibility. All stakeholders, particularly fund members or retail investors, deserve no less. To paraphrase the ancient philosophers on heroes and their often tragic ends: “Don’t let ego be the enemy!