Alpha & Accountability

Alpha and accountability: Why skin in the game can meaningfully influence client outcomes

In large organisations, responsibility can drain into accountability sinks. In boutiques, there is no place to hide, which changes decision-making in ways investors should care about, argues Tom Caddick.

Asset management has never had more governance, and yet rarely felt less accountable.

The economist Dan Davies describes this quirk of reality as an “accountability sink”.^[1] In such systems, decisions are delegated to complex rulebooks, procedures, committees and dashboards – until mistakes occur and no one can identify the source. It’s a wicked form of institutional autopilot.

This matters in investing because active management is essentially a decision business. And decision businesses live or die on accountability: who makes the call, who bears the consequences, how quickly errors are recognised and what changes when disagreements arise.

I believe this is where boutique managers have a crucial edge.

How big firms manufacture places to hide

Large asset managers have good reasons to build layers. They run multiple products, serve multiple channels, answer to multiple stakeholders, manage brand risk and operate under significant regulatory scrutiny.

Yet those same layers create issues in that responsibility becomes a group activity and subsequently gets diffused. Decisions are typically made by committee, accountability is shared and internal audit’s sway on incentives becomes overbearing. It’s a classic “bystander effect”: When everyone has input, the decision becomes nobody’s.

We all know what this looks like from the inside: a world in which success depends less on truth-telling and more on navigating an organisation’s shifting coalitions and incentives. People try to avoid being blamed rather than doing the right thing. 

Asset management is especially vulnerable to these issues because successful outcomes are not always tied to the quality of inputs. The further the decision-maker is from the end client’s lived experience, the more that plausible excuses exist, and the easier it is to confuse activity with progress.

Metric tyranny and the economics of hiding

An obsession with measurement can help create even deeper accountability sinks.

In The Tyranny of Metrics Jerry Muller argues that many institutions fall into “metric fixation” – the belief that what is measurable is what matters, and that measured performance is the same thing as real performance.^[2] The consequence is that people start optimising for the metric rather than the mission.

The parallels in asset management are obvious. Firms create internal scorecards, risk targets, tracking-error tolerances, style purity monitors, ESG checklists, drawdown guardrails and so on. None of these are inherently bad; the problem arises when they become substitutes for accountability.

Metrics create a very particular kind of hiding place: proxy success. The portfolio may have “done what it was meant to do” in the firm’s internal language – stayed within risk bands, adhered to guidelines and maintained factor exposures – even when the client experience is disappointing, confusing or not worth the fee.

Incentive structures can further exacerbate the situation. Jensen and Meckling’s foundational work on agency costs explains what happens when ownership and control separate.^[3] Managers (agents) do not automatically act in the best interest of owners (principals); monitoring and incentive schemes can mitigate the gap, but residual losses remain.

In a large asset manager, the chain between decision and consequence can be long: portfolio managers are employees; products are business units; business units sit inside platforms; platforms answer to shareholders; clients are served by distribution teams that may not sit close to investment teams. At each layer, incentives shift subtly. Career risk, brand risk and the desire for revenue stability all congeal to become stagnating forces.

Boutiques behaving differently

Boutiques are not immune to politics, ego or error. But their structure can help mitigate many of the effects and significantly cut the distance between decision and consequence.

When a firm is smaller, the portfolio manager is automatically more visible to clients and prospects. And when ownership is concentrated, reputational and economic consequences attach more directly to outcomes. These factors force a higher-touch, more relationship-driven approach to winning and retaining business.

This is what Nassim Taleb calls having ‘skin in the game’ – not just exposure to upside, but alignment of consequences.^[4] When the person making the decision bears meaningful downside, behaviour changes; it becomes harder to hide behind process or defer uncomfortable decisions.

Active management is ultimately at its best when it is willing to look wrong before it looks right. Large organisations can absorb blame and diffuse it and yet boutiques don’t have the same luxury: either you have a view you can defend and own, or you shouldn’t be charging for it.

Feedback loops and accountability hoops

ccountability is all about feedback. Systems thinker Donella Meadows emphasised that missing or delayed feedback loops are a common reason systems behave badly because they prevent learning.^[5] If signals arrive too late, too distorted or too easily explained away, the system cannot correct. Instead, it keeps doing what it knows how to do: adding more process to create the appearance of control.

Big firms can design themselves to be more accountable and adaptive. But it is hard, and requires fighting the default tendencies of large systems. By virtue of being smaller and closer to consequences, boutiques have tighter feedback loops and get some of that design automatically built in.

NB. A version of this article originally appeared in Professional Paraplanner.

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[1] The Unaccountability Machine: Why Big Systems Make Terrible Decisions – and How the World Lost Its Mind, Dan Davies.

[2] The Tyranny of Metrics, Jerry Z. Muller.

[3] Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, Michael C. Jensen & William H. Meckling, (1976).

[4] Skin in the Game: Hidden Asymmetries in Daily Life, Nassim Nicholas Taleb.

[5] Thinking in Systems (2008) and “Leverage Points: Places to Intervene in a System” (1999), Donella Meadows.