On Process and Implementation:

A friend of mine’s brother co-founded the firm AQR (Applied Quantitative Research) Capital.  This firm is one of the more successful quant funds in the world with $30 Billion AUM.  I recently watched an interview with one of the other co-founders, and most outspoken, Clifford Asness.  Ironically, Dr. Asness’ dissertation advisor was Nobel-Prize winning Eugene Fama, best known for the Efficient Market Hypothesis(EMH).  Asness wrote his dissertation on empirical evidence of out-performance by momentum and value-based strategies in equity markets.  The interview can be seen here:

http://www.youtube.com/watch?v=PcpLuQxidN0

This got me thinking as to what makes a good quant fund, a good hedge fund, a good wealth management firms, and more broadly speaking, what makes a good company.  I have been lucky enough to have several good role models in my life which have imparted some of their wisdom onto me.  Watching the above linked interview with Asness reinforces the ideas of what it takes to run a successful money management firm (or business).  I believe I have identified 6 steps which are the keys to any successful hedge fund, money management firm, or service-oriented business:

1. Reliance on process, and not results. 

Asness talks about how, following the Liquidity Crunch of 2007 (see Khanandi and Lo, 2007), he re-examined his investment processes and models and made an accurate, well-informed, and unemotional decision as to whether those models and processes were still valid.  You can not control how markets behave (in the case of a hedge fund) or how will your customers behave (in the case of a business).  In short, worry about the things you can control and not the things you can’t.

2. Continuous and Never Ending Improvement (CANI)

Edward Deming called this the Continuous Improvement Process or Kaizen. The drive to succeed and bring forth superior risk-adjusted returns to your investors should cause one to continually refine and improve ALL processes.  You should constantly be: focusing on improving your overall investment strategies and asset allocation techniques; reducing commissions via algorithms or leveraging your prime broker relationship; building a strong back-office system;  and maintaining compliance and regulations in order to act in accordance with your investment prospectus. 

3. Communication with your clients and a customer-service orientation

Asness talks about getting on a plane and going to talk to customers after a year of rocky performance.  He explains to customers why, despite some bumps, he believes in his process and why it will continue to work in the future.

One good example of this customer-service orientation is a private wealth management firm by the name of Trust Point in my hometown of LaCrosse, WI with a satellite office in Minneapoolis, MN.  I have two friends that work at this firm and the President told me that their secretary that was memorizing all of their clients by their voices so she could call them by their first name when they phoned.  This is just a minor example of one way in which a once down-trodden investment firm was able to reinvent itself as a process and customer-oriented private wealth powerhouse in the middle of small-town USA. 

4. Willingness to fly in the face of conventional wisdom and research all possible ways of providing returns

This hits very close to home with Asness.  His mentor, Dr. Fama, created the Efficient Market Hypothesis.  Although Asness has tremendous respect for Dr. Fama, he still went as far as doing his doctorate dissertation on an idea that directly contradicts efficient markets.

5. Willingness to forego short-term gain in the interest of long-term success and doing what is “right”

Despite slumping performance, Asness sticks to his process and models, believing that despite abandoning them for short-term gains, eventually they will come back into favor.

Another local example I have is the Marc Orgel Investment Group, located in Eau Claire, WI. Marc has grown his AUM to over $3 Billion and ranked top 50 Financial Advisor in the country by Barron’s.  Post ’87 crash, Marc did a regression analysis on just how much alpha the average money manager adds.  His study concluded that 50 basis points (bps) was all the alpha that the average money manager provided, and subsequently has only charged that amount to his clients, an amount substantially lower than most advisors.  Orgel also goes as far as never taking a prospective client’s money after one meeting and frequently telling clients that they need to put more money into their child’s 529 instead of investing with him.

6. An absolute passion and love for what you are doing

Lastly, Asness talks about his love for finance and that running money was really an after-thought to being a finance professor.  He questions the 17 year-old that just wants to manage a hedge fund for the money.  Without a real passion for the industry, no matter what that industry may be, it is unlikely that you will be able to comply with the first 5 steps.