For example, much of my time is spent working with businesses in financial services, including the asset management sector, which remains in the midst of ferocious headwinds. Its firms are having to serve a wider range of investor needs and objectives for ever-shrinking fees, while also facing up to the awkward reality that most active managers continue to underperform versus their benchmark.
But what’s behind these trends? In the past, the general assumption was that by recruiting industry ‘rock stars’ (largely though pay and not interfering with their approach) over-performance would be guaranteed and client assets would follow. However, the idea of such ‘star managers’ has been fading for a while. Most firms now focus on creating team-based, institutionalised, repeatable and clear investment processes. That said, there are still multiple parts of those procedures that are vulnerable to individuals’ preferences.
This means that firms need to elevate their thinking about bias by moving beyond narrow investment decision-making moments and instead think bigger across their leadership teams. For example, they should, among other things, take a closer look at the personal characteristics of their leadership teams and consider how these individuals might also be affected by their collective biases.
The good news is that most investors are extremely well versed in different types of bias — it’s prominent in behavioural finance and is a key part of the CFA level one curriculum. The bad news, however, is that despite the well known challenges of how biased thinking can effect investment decision making, when it comes to how asset management firms organise their own business, this knowledge often appears to evaporate.
Diversity is still weak, leadership teams often come entirely from the investment industry and embrace diversity of thought or perspective. When it comes to strategy they are either afraid of not embracing risk in the same way they encourage their investors to, or they show the worst herding instincts in piling into the latest products too late (we see a lot of this in hiring strategies).
But underperformance can also be linked to unconscious bias. For example, just as investors can also be susceptible to status quo bias, as seen when they hold on to investments even though they are performing badly, we see business leaders supporting failing business units or teams for far too long.
With a changing investment landscape, asset managers face a tough task ahead. To effectively deliver outperformance they need to identify their core purpose and expertise, build a flexible and empowered workplace and outlearn others in order to survive. As part of this, they also need to consider the right operational structure to minimise the adverse impact of unconscious bias on performance. They can do this in several ways:
1. Reduce groupthink in decision making to overcome investment biases
There are many ways to reduce groupthink. These range from encouraging professional development to critically evaluating all ideas to seeking out external perspectives. But there is no one-size-fits-all solution — asset managers need to tailor the right blend for their teams and individual circumstance.
2. Encourage appropriate risk taking and reduce uncertainty bias
Organisations need to address biased groupthink because the more similar the investment partners, the lower their investments’ performance. Role-modelling risk-taking mindsets, balancing between a performance-heavy and performance-healthy environment and fostering diversity, equity and inclusion can help reshape conventional norms.
3. Adjust performance incentives to enhance risk appetite
Asset managers need to develop an approach that enables them to grow managers’ capabilities, competitively incentivise performance and monitor progress of a portfolio over time without encouraging trend chasing behaviours.
No quick fix
Breaking down biases in the asset management sector — or any sector for that matter — won’t happen overnight. The issues are too ingrained, too systemic. But here are five steps you can take to make a start:
- Step one: Get educated about different types of unconscious biases.
Step two: Hold up the mirror to your blind spots.
Step three: Use objective information and data to inform investment decision-making.
Step four: Build teams around diversity by having individuals with different backgrounds and perspectives to challenge groupthink.
Step five: Seek external feedback to challenge your reasoning driving your investment thesis.
Unconscious biases, like trend-chasing, can provide valuable insights into an individual’s intrinsic potential and deeply held preferences, motivations and style when carefully assessed.
Acquiring the level of understanding of a person’s true character and underlying potential is critical to making informed talent management decisions and for fostering personal growth.