Can wealth managers spot a bad culture before it hits performance?

Culture has always played a role in fund selection, but wealth managers are putting greater scrutiny on how asset management businesses operate amid concerns around groupthink, staff turnover and over-reliance on star managers.

While performance, risk and investment processes have long been part of fund due diligence, understanding the culture sitting behind an investment team has been harder to quantify.

Yet how decisions are made, whether individuals feel able to challenge senior colleagues, how mistakes are dealt with and the way people are incentivised can all have an impact on investment outcomes.

Hannah Evans, who has worked in manager selection for more than 20 years and is head of manager research at Omnis Investments, explained culture has always been part of the process, even if fund selectors have historically struggled to articulate exactly what they are looking for.

“Historically we've always had things like performance, risk, investment processes and people in enormous detail, and a lot of that will have culture embedded there,” she said.

“But actually, all these organisations and all of those things - from risk to portfolio construction - are driven by people, and those people have decision-making power.”

For Sophie Kennedy, joint chief executive at EQ Investors, assessing culture should therefore be viewed as part of risk management rather than simply an assessment of an asset manager's HR or diversity policies.

“What we're really assessing is whether a manager's culture creates diversity of thought: a genuine mix of ideas, perspectives and experiences that drives creativity and better decision-making, not a demographic checklist,” she said.

“Ultimately, it's about mitigating the risks that quietly erode returns over time - groupthink, unchecked bias, and over-reliance on a single 'star' manager - the things a purely financial analysis will never show you.”

The missing piece of due diligence

The difficulty for fund selectors is how to measure something as intangible as culture.

Before founding City Hive, Bev Shah spent a large part of her career as a fund selector: “A core part of my role was understanding whether I could have confidence in the people I was entrusting with clients' assets over the long term,” she said.

“That meant looking beyond investment process and performance to understand how decisions were made, who had influence, whether people were able to challenge, what behaviours were rewarded and how mistakes were dealt with.”

Ms Shah added culture was an important part of understanding investment risk in her work, but there was no consistent way to assess it.

"We were all asking our own questions, looking for different signals and making largely qualitative judgements. For something so important to understanding an investment manager, that lack of standardisation was a real gap."

This was the driver for creating the ACT – standing for Action, Challenge, Transparency - Framework and Standard, which was developed with practitioners and peers from across the investment industry to create a common language and consistent set of disclosures around culture.

“ACT doesn't define one 'right' culture,” Ms Shah explained.

“It gives anyone responsible for selecting, overseeing or governing investment managers better information to understand the environment in which investment decisions are being made, how the organisation operates and whether its culture supports its investment approach, its people and ultimately the outcomes it delivers for clients.”

Ms Evans said having this framework also makes it easier for selectors to compare managers – she also sits on the ACT Stewardship Council, which is responsible for ensuring the ACT Standard is attuned to achievable industry practice and evolving to drive firms’ progress over time.

Previously, asking an asset manager about its culture could elicit little more than an assertion that it was "good", Ms Evans said.

A common framework allows selectors to dig further into those claims, while the work required from an asset manager to provide the information can itself demonstrate how seriously the firm is considering the issue.

Spotting the red flags

However, fund selectors are unlikely to learn everything they need to know from formal disclosures. Unexpected staff turnover and concentrated decision-making are among the red flags Ms Evans looks for when assessing an investment team.

Star-manager structures are not necessarily a problem, she sadvised, but selectors need to understand where decision-making power sits and whether there are sufficient checks around it.

There can also be less tangible warning signs: “People appearing uncomfortable, not speaking up in meetings,” Ms Evans highlighted.

Informal conversations with other people in the business can also help build a picture of how an investment team operates and whether tensions exist.

Meanwhile, green flags include clear accountability, transparency and openness, as well as seeing junior members of teams given the opportunity to speak.

But Ms Evans said selectors should not take any single indicator as evidence that a firm has a ‘good’ culture.

“Good culture isn't about one thing,” she explained.

A business could look after its staff well in some areas but still have an environment where employees are afraid of missing targets or challenging senior colleagues.

“You need it all to hang together.”

‘Micro-cultures’

Additionally, there is also no single culture that will work for every asset manager or investment team. Ms Evans gave the example of a concentrated value manager where challenge is deliberately built into the investment process.

The nature of value investing means some cheap companies will turn out to be cheap for good reason, so the team needs to be comfortable questioning investment cases and acknowledging mistakes, she explains, and responsibility for stocks is also rotated between team members.

“The whole team has to be bought in because the next day that could suddenly be under your remit,” Ms Evans said.

That level of challenge is particularly suited to the way the strategy invests, but another type of fund could require a different environment.

A long-term, low-turnover growth manager, for example, may need a culture that gives investors the conviction to stick with holdings through periods of underperformance.

Ms Evans said there can therefore be different “micro cultures” between investment teams within the same asset management business.

For fund selectors, the question is not simply whether a firm has a ‘good’ culture, but whether the culture fits what the investment team is trying to achieve.

Tracking change

Andy Ford, head of responsible investment at St James's Place and also a member of the ACT Stewardship Council, as is EQ’s Ms Kennedy, said culture can shape decision-making, risk-taking, stewardship behaviour and talent retention.

High staff turnover, for example, can disrupt an investment process, weaken team cohesion and increase key-person risk, while a culture that discourages challenge can allow poor investment decisions to go unchecked.

Mr Ford said introducing greater structure into how culture is assessed gives selectors the opportunity to establish a baseline and monitor changes over time, as well as integrate the findings into manager selection and ongoing monitoring.

Ms Evans added the value is not simply in producing an annual assessment, however, but in opening up a more meaningful conversation between asset managers and their clients.

Managers that take culture seriously should be willing to discuss changes as they happen rather than waiting for the next reporting cycle, she said.

Ms Kennedy also noted this matters when wealth managers consider the promises they make to their own clients.

"Our clients trust us to make sure the managers we select will behave the way we've implied they will," she said.

Performance will inevitably remain central to fund selection, but it is backward looking.

But understanding the environment in which those returns are being generated could give selectors another way of identifying risks before they start showing up in the numbers.