NY Office

110 E 25th Street
New York, NY 10010
1.914.393.7555
Book Review

No Rules Rules

No Rules Rules for Asset Management

Synopsis

  • Employees inherit an inertia of bad practices from working in either mismanaged or bureaucratic organizations.
  • To leave that baggage at the door, your organization needs to nurture a culture where good practices supersede the festering nature of internal jockeying and politicking.
  • Reed Hastings (Netflix Co-Founder/CEO) inadvertently learned early-on that achieving a certain level of talent density is the key to hurdling this baggage.
  • Talent dense staff can be empowered through reductions in bureaucracy and increased latitude to innovate. Both of these allow for a fast-moving culture of innovation.
  • The application of these to asset management firms can be indirect, due to increased regulatory scrutiny and reduced cost/benefit of experimental learnings versus rigorous underwriting.
  • Nevertheless, applying some of these practices to un
  • nt should be at the top of the agenda for any asset manager.

The last time we posted a book review on this blog, we lamented the sad state of most business books. We call these stories ‘biztainment’. They often recount a founder’s meteoric rise. They grab an audience’s attention, often with advice that fails to separate luck from translatable process. This is decidedly not the case with Reid Hastings and Erin Meyer’s No Rules Rules, a case study not of the astounding success at Netflix, but of the process behind the culture which fosters it.

Hastings and Netflix made a splash in corporate America with their now infamous deck discussing their culture. Once released into the wild, it raised eyebrows. People have drawn parallels to notorious cultural outlier organizations such as Bridgewater, and this book in some ways acts to set the record straight on their unique culture. Having personally worked at varying organizations from law firms to consultants to fintechs and ultimately founding my own asset management firm, I found this book absolutely delightful. It provides powerful insight into corporate culture. It also gave rise to what can translate directly to the asset management industry.

Lost in Translation

Various cultural idioms in tech such as Move Fast and Break Things may not be well-suited for the asset management space. As a highly regulated sector, the opportunity for disruptive innovation is somewhat curtailed. Perhaps more importantly, as a fiduciary, we have a duty to our clients that is quite different from a technology startup’s duty to find product/market fit. However, there are things that do translate. No Rules Rules is about building a culture of success that is predicated upon unleashing talent. Any industry can benefit from that. To that end, we will highlight some of the key takeaways of the book and provide a lens of application to various parts of the asset management ecosystem.

Lesson 1: Create Conditions that allow company values to thrive, not to be lame posters

Every company with some modicum of success will attempt to articulate its values. Most will have platitudes around excellence, mission, and self-worth. Many are unfortunately bullshit. Or as the authors more eloquently write, “company values—as articulated—rarely match the way people behave in reality.”

Hastings is acutely aware of this, stemming from his first startup. He and his HR team have deliberately worked to curate an environment ensuring alignment between the values of the organization and the organizational ethos. A lot of this starts with the hiring and firing practices of the organization.

Hastings recounts a tough decision the company made in its early days. This was right after the tech bubble had burst. With sources of funding running dry, he had to make significant headcount cuts. He and the management team lamented at this painful reality, choosing 1/3 of their team-members to let go. To do so, he reviewed the existing roster, attempting to differentiate good from great. Having feared the loss of such substantial output could lead to a vicious cycle with moral and voluntary attrition, he braced for the worst. Soon after the firing, he paradoxically noted improvements in morale, execution, creativity, and alignment (1).

This is commonly referred to as “A players want to play with other A players.” While that quip is often said, very few companies develop the conditions to allow it to flourish. To this day, Netflix is adamant about letting go of competent, nice, hardworking employees who simply aren’t stars (mind you, with a healthy severance). It’s easier to talk the talk than walk the walk. Everyone has worked in an organization with that person who tries hard, has done good work, but doesn’t raise the bar. Very few organizations actively cull these individuals from their ranks. The purpose is not to be cut-throat, but to unlock the virtues of talent density, which is the key to spinning the Netflix cultural flywheel.

---

In this respect, there are interesting applications to fund management. Talent density is arguably above average in the financial services sector, in large part because the compensation tends to be higher than average, but also because of the scalability of intellectual property. You can have a 5-person fund management shop managing 10 million dollars or 10 billion dollars. This is often not the case in any other industry, where order of magnitude growth is followed by significant headcount growth. As a result, many firms are hyper-focused on talent acquisition as a means of unlocking profitable scaling.

What I find peculiar in the active fund management space is the hesitance in certain organizations to follow-through on maintaining a high bar through quick reversals. Every organization makes mistakes in hiring, but fund managers are loath to admit it to their LPs. They are very careful in how they message organizational change because of any fear in ‘rocking the boat’. This is a significant problem at certain organizations and is largely a reflection of the principal/agent issue when managing external capital.

Lesson 2: Unshackle talent by providing agency, reinforce through less rules, then incubate candor

Netflix is famous for having a culture of open feedback and minimizing bureaucratic oversight. They preach an unsupervised system, allowing employees to make executive decisions. Employees can sign vendor contracts themselves, rather than farming that responsibility up the hierarchy. This gives every employee agency in the decision-making process and reduces unnecessary bureaucratic bloat. This invariably leads to mistakes. Rather than recoil from inevitable errors, the company leans into those mistakes, shares them openly to instill learning and destigmatize failure, and doubles down on the process. This allows talent to shed bad habits from their prior professional lives and act like owner operators.

Once staff are acting like owners, they amplify this by reducing rules and red tape. For example, there is no review process for expenses. In terms of strategic objectives, employees can pursuit controversial projects, without the ability of management to curtail an idea. This provides latitude for employees to express their own judgment. To enforce such a free system, they swiftly punish malfeasance (surfaced through random audit).

Finally, with candor, Netflix wants employees to eschew office politics and be focused on superior decision making. This starts with the top. Lower-level employees are encouraged (and often do) provide constructive feedback to Reid himself. Feedback isn’t meant to be snippy. They have a system to ensure the feedback is functional (they call it 4A). It can be brusque, but it is meant to be helpful.

---

These three arms (empowerment, reducing red-tape, provide transparent feedback) could be applied much more effectively in asset management. Many cultures shy away from empowerment because hierarchy is an integral form of control. Control of talent, but also control of portfolio risk. Feedback is less direct in markets, so there is an overemphasis on immense quality control versus trial and error. Anyone can float out an investment idea, and given the amount of noise within markets, some of those ideas may indeed work. But any professional investor will want to focus on process, and to that end, they try to streamline the input by ensuring the idea generation funnel is well vetted.

How can asset managers embrace more employee-level empowerment? Perhaps it is a rung or two below the actual portfolio selection process. Foster an environment where idea generation is open. The analysis and synthesis of those ideas can then go through a strict but fair structure. That way, innovative thinking is not curtailed. Junior staff might see the process as meritocratic rather than hierarchical and feel empowered.

Another element of empowerment can be through actual ownership. Just look at the ADV of various hedge fund firms and marvel at the lack of employee ownership beyond the (often eponymous) founder. Furthermore, in terms of candor, upward feedback is highly irregular in asset management. There is often such a power asymmetry at play between the patriarch of a firm and the staff that true feedback rarely bubbles up. I have personally witnessed management behavior that could only be described as reprehensible at some of the most venerable hedge fund firms in the world, and it is accepted as the cost of doing business with genius. This is patently false; a dying breed mentality.

Less 3: Be Serious about Maintaining Talent Density.

We highlighted how the culling of “B” players in Netflix’s early days led to a paradoxical improvement at the firm. They took that lesson and applied it to the ongoing management of the firm. One simple rule helps guide this approach:

If a person on your team were to quit tomorrow, would you try to change their mind? Or would you accept their resignation, perhaps with a little relief? If the latter, you should give them a severance package now, and look for a star, someone you would fight to keep.

Hastings goes further: “I want each manager to run her department like the best professional teams, working to create strong feelings of commitment, cohesion, and camaraderie, while continually making tough decisions to ensure the best player is manning each post.” The point is to divorce the notion of strong corporate culture as “a family.” Instead, the analogy should be an exacting team of professional athletes. Highly selective professionals that gel together to achieve excellence but are not exempt from exacting standards. The reality is A-players have options in terms of career mobility. Just look at their LinkedIn inboxes. Sometimes their ambitions outstrip their current job, and they may choose to leave. This is to be expected when you have this degree of talent. But never settle for mediocre but acceptable talent if you want to truly spin this flywheel.

---

At many venerable investment management firms, the imprimatur of an employee’s time at the firm sets up their next stage of success: launching their own firm. This is social capital that is imparted as part of employment, and it is immensely valuable. It comes with a cost to the organization: the best and brightest will be hungry for more responsibility than the structure of the firm can often handle. They will also attrite and look to hang their own shingle. Great asset managers understand this and lean into it. They seed their star talent and use their success as the carrot to bring in the next generation of talent. Those that are vindicative, those that curtail the dissemination of track record or data, and those that have punitive garden leaves will fail to cultivate the best talent over the long term.

Every asset manager can benefit from reading No Rules Rules and thinking about the nature of their culture. We can benefit from a careful examination of the strengths, weaknesses, and comparative advantages we enjoy with our most valuable asset: our talent.

1 – Hastings goes to great lengths to explain that maintaining high talent density is different from programmatically culling the bottom n% of employees, a practice done at other corporate stalwarts. He and Meyer highlight how this poisons the culture and creates in-fighting and backstabbing rather than internal alignment.

—-

The information contained in this article was obtained from various sources that Epsilon Asset Management, LLC (“Epsilon”) believes to be reliable, but Epsilon does not guarantee its accuracy or completeness. The information and opinions contained on this site are subject to change without notice.

Neither the information nor any opinion contained on this site constitutes an offer, or a solicitation of an offer, to buy or sell any securities or other financial instruments, including any securities mentioned in any report available on this site.

The information contained on this site has been prepared and circulated for general information only and is not intended to and does not provide a recommendation with respect to any security. The information on this site does not take into account the financial position or particular needs or investment objectives of any individual or entity. Investors must make their own determinations of the appropriateness of an investment strategy and an investment in any particular securities based upon the legal, tax and accounting considerations applicable to such investors and their own investment objectives. Investors are cautioned that statements regarding future prospects may not be realized and that past performance is not necessarily indicative of future performance.