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The Death Of The Star System At Fidelity

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There was an interesting story in this morning’s Wall Street Journal I’d like to highlight.  Click on this link to find the article.

I think the reporter is getting two very different stories mixed up.  The first concerns issues with the “start system” at Fidelity. The second is the issue of an alleged toxic corporate culture.  I don’t think the two are directly correlated although there is some interrelation.

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Concerning the alleged toxic culture – this is, of course, unacceptable as it puts the firm at legal, reputational and financial jeopardy. This type of culture also hurts the generation of alpha due to cognitive homogeneity within the organization (there are numerous studies that show that groups with greater cognitive variance among its members outperforms ones where everyone thinks the same way). This last point – cognitive variance – is critical to the theory we are developing (stay tuned).

Concerning the “star system”,  the article says “…a team-based approach… …gives analysts and senior managers more comparable footing in choosing securities…” and “…the compensation system had an adverse effect on relationships between fund managers and analysts and ultimately hurt fund performance.”

The goal of an organization is to maximize outperformance – the generation of alpha. The way to do this is not by putting analysts and pms on “…more comparable footing in choosing securities…” or by changing the compensation system. It is accomplished through better communication which results in improved idea generation.

There are two areas where any organization can improve in terms of idea generation (generating ideas that will ultimately prove to outperform the market – generate alpha).

  1. An organization can focus on adding or increasing resources, skills or expertise.  This can be accomplished through two intertwined ways – nature and nurture.
    1. Adding resources is done primarily through “nature”.  It is hiring individuals who have certain personality traits that have been proven through rigorous research to result in an increased probability of generating non-consensus ideas which prove to be right.  This is a longer-term solution.
    2. Increasing resources, skills or expertise is accomplished primarily through nurturing. Nurturing is encouraging the growth or development of a particular skill or set of skills of individuals already in the organization. An organization can nurture in two ways. The first is altering or augmenting the working environment to foster the generation of ideas. The second is through training or mentoring of individuals or teams.
  1. Second, an organization can focus on maximizing or better utilizing its existing skills, resources or expertise.  This is accomplished through better communication. In many (most) organizations there is an enormous amount of “scrap” or underutilization – untapped resources. Think of an organization as a group brain or “hive mind”. In the brain, there are two primary areas of long-term memory – declarative and procedural. Declarative is made up of semantic (facts and figures) and episodic (memory of certain events). Procedural is skills – the way to perform tasks.

Within an organization, there is an enormous about of declarative and procedural knowledge that is underutilized due to communication. A simple example of an inefficiency of declarative knowledge is if a portfolio manager is researching an idea in the auto parts area, he might not know that a junior analyst as a hobby rebuilds cars. Obviously, the junior analyst can add some value to the process.

In terms of procedural knowledge, a junior analyst might be asked to perform a “channel check” but because they have never done one, they learn from trial and error. A more senior analyst might have a lot of experience performing channel checks and could help the analyst and increase efficiency.

This second area of improvement is a simple matter of better communication within an organization which brings us back to the “team-based approach” discussed in the Wall Street Journal article.  Moving from a “star system” to a team-based approach does not need to be disruptive to the organization as implied by the article in the statement, “If enacted, the changes would mark a major overhaul of Fidelity’s lucrative stock-picking business, which executives have been loath to disrupt. They could mark the end of an era that created such star stock pickers as Peter Lynch and William Danoff…”  Changing to a team based system is really just improving communication. And increasing efficiency and the ability to generate ideas by improving the communication within an organization is anything but disruptive.

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