Compensation and Credit: How to Give It, How to Get It
#talent #leaders #compschemes
It is an age-old question for leaders and talent alike: when it comes to compensation, what is fair? What conversations should leaders initiate and what should talent advocate for? What are the intangibles to consider? Managing expectations (when and how) and clear communication are key. Here, I’ll break down the advantages and disadvantages of compensation through discretion, splits, and pure formula to aid your future conversations.
I’ve spent 40 years thinking about this piece, as both a manager paying people and as someone getting paid by somebody else. The investment management business is not a charitable cause. People don’t play the market as pure hobbyists unless they’ve already ‘collected their bag’ doing something else. Our intention most often - however we get there - is to monetize and grow our own status via markets. As younger players, there is more willingness to be subjugated to a greater good – i.e., the fund’s success or the boss’s success - because there’s a feeling it will be a good long-term investment. But self-interest is never too far from the surface, and we need to stop thinking that’s a bad thing. Instead, we need to create some clarity about how and why this ideally equitable split of profit generation is to be parsed. We’re talking about getting the credit. And unlike other realms, where simply asking for it can be construed as selfish, in this business, credit equals currency, the actual usable spending kind, not the metaphor. This piece is for all of us. Whether you’re the boss or the junior analyst, it’s good to know how the sausage gets made.
Part 1: The apprentice (aka when I was starting out).
For those of us lucky enough to have had someone take a genuine interest in our careers, time allows us to look back fondly on the lessons learned. Some of these were intentional: how to write, how to model, how think about an idea, how to ask a question, how to be intellectually honest, how to apply logic and data to problem solve, how to think about risk. They knew things, and we were apprentices. We watched. We learned. We adapted our thinking and processes to get to a successful outcome. And sometimes, we watched how it didn’t work (often more important) and learned there, too.
As a business model, such mentorship and tutelage can be the highest form of value an old boss or co-worker can give. It opens the door to a new domain, one that would have been much more of a struggle to attain (if it was ever attained at all). For this, we are grateful… but gratitude seems to be definitionally different between mentor and mentee, doesn’t it?
Hands off, that’s mine (or so I thought).
It’s hard not to think about those sayings like ‘possession is 9/10ths of the law’. For every helpful yelp of ‘teamwork makes the dreamwork’, there’s a feeling that we can’t help but scratch that persistent burr under our skin that itches: am I getting the credit I deserve in this team construct or not? Wasn’t that my idea? Wasn’t that my trade? Oh, it can really itch. Let’s say we have been good apprentices, patient ones, helpful ones. But for how long? How much? What’s the “fair” discount? And ominously, when is enough, enough?
I’ve been managing investment professionals for years. Most people that choose markets are not only competitive, but they are at the top of the intelligence curve. Their idea may well be theirs. But being “right” doesn’t make parsing the credit any easier. As managers and players, we need a good system to drive clarity, eliminate conflict (good luck!) and create a productive environment.
Managing Expectations (things we can all live with).
Let’s start with what the manager needs to hear: let it go. You have done a great job cultivating a team. Your approach yields effective results backed by strong empirical evidence of success. There are lots of ways to define this (as we discuss below), but the bottom-est of all lines is, you are making money. You not only feel good about your work, but you are proud of your team and expect them to be appreciative of you. Now let it go. Get over it. Move on. Because in this business, the only thing close to certain you can pretty much bank on is that your players will eventually leave. Try adopting the following philosophical construct: good people leave. Talent is attractive. It is discoverable to others and not your secret stash or possession.
If you manage your own expectations accordingly, the inevitable goodbye can be a happy one, not an anger fest. Talent will still leave, but it is not primarily because you are not paying them enough or because they don’t feel credit. They will leave because that is the nature of the work. Instead of thinking how ungrateful they are or the credit you deserve for molding them, think about how good a job you did mentoring, how you developed the talent that made them so attractive! And keep the friend for life. As I’ve learned, this makes for a nice collection of assets. Knowing and being able to connect periodically with smart people to understand markets makes the roller coaster ride more fun, less ache. You will be a better investor, too. Be nice. Be fair. Accept a little kingdom shrinkage. Allies are better than enemies. Try sharing the wealth.
And now, player expectations.
Eliminate surprise. Begin here: when you’re not the boss, your agency in decisions is not perfect. The best it can be is aligned. And I’m not just talking about deciding which stock to trade, or which idea is better, or how to hedge, or whatever. I’m talking about the money. Seek alignment in a fair and effectively communicated way. Heck, even if it’s not fair, effective communication is the critical variable. Nobody likes surprises. The only thing worse than getting paid less than you want (ask anybody in our business ever!) is the negative surprise of being paid less than you thought you’d get. Most of my management time has been with analysts. I regret not writing it down, but statistically, I think the percentage of post-comp conversations with analysts that were unhappy because their expectations were higher than the bag they got was 125% of them. Yes, more than all of them. Now here’s the rub – it is preventable. You may not be able to fully control your compensation outcomes, but you should certainly ask. And as you get more reps, require that the puts and takes that go into it are disclosed and disseminated, so that even where there is some discretion, you have the ability to understand how much impact it could have. In other words, you can eliminate a lot of surprises. Can’t do anything about disappointment, but that can be cured. Just ask the right questions. Accept as few “we’ll see how it goes” responses from your boss as you can. Ask the questions up front. The best way to be sitting with a bonus you don’t like is not to agree with it but to understand how you got it. From there, you can re-direct energies to different outcomes – either internally or yes, externally.
Attribution thoughts for all: three approaches. I’ve seen a variety of approaches to handling how success or profits or available bonuses are allocated, but they generally fall into three bucket types. As a more junior investor, think about the world as follows. As a manager or boss, think about what worked for you in the past and what philosophy you trend towards now.
1. Discretion-based compensation. Mystery Factor Rating: HIGHEST.
For the young investor, this is very common and can be uncomfortable, not because of some deliberate mission to take advantage, but because there is truly ‘no say’ in how you get what you get. Most of the time, as new players, we make our peace with “well, it’s their show and I need the opportunity”. And the logic of wanting to get some reps at firm is valid. So begins the tolling process.
Pay to learn is low.
The tutelage is an acceptable shorter-term cost for the manager (i.e. “they won’t be all that useful to me in decision-making at first”) with the goal of creating longer-term value. So the money is light, by comparison. There is a base and a discretionary bonus based on how much progress is made against certain skills. Asking for a few KPI’s in some kind of measurable way – how many models, how many names, how many times you catch something – is the best way to have some control over outcomes, but the rail is thin here. How long to toll before moving to something with true accountability and measurability depends on the parameters you think are most valuable and your patience.
Modeling.
As a new team member, often a junior analyst, responsibilities tend to hew more toward data collection and aggregation with some insight, but decision-making and recommendations are limited. You need to build models. These can be crude objects. They need some TLC to be useful. And the boss provides that. We (bosses, managers) teach, you learn, etc. Evaluating measured progress is therefore often quite subjective. Did you include everything? Are there errors? How quickly do you adapt to a methodology that is practiced by the team? And of course, the trickiest of all, how much benefit /value does this accrue to the actual investment decisions made in a book or portfolio? Tricky bit for sure.
Coverage.
Most analysts work alongside or under supervision of a more senior person to learn the ropes. Typically, a sub-group of names is parsed to them. Within autos there are OEMs and suppliers, for example. A junior takes one part, while the senior guides and in the best case does some expansion on their own. Parenthetically, hiring a new person to cover new things is difficult, most often because they can’t understand decisions and probabilities going into those decisions without first understanding the business itself. We teach, and at best, we measure how the new hire learns. This is very subjective and hard to measure. We can accompany juniors on meetings to ensure they ask the right questions or better, simply have them watch us “drive” before taking the wheel.
Data collection and insights.
As noted above, for coverage models, (the most common template), a junior has a piece of waterfront or group of names for which they build literacy and competency. News items can be crucial, but they are many. Much of the news is garbage and without use. Unfortunately, digital connectivity provides many, many bad or false signals. But guess what new guy? You get to run it down anyway. And you decide what matters. Advice? Ask questions. Be deliberate in your research and know when it’s time to move on.
The short of it: you are at the whims of a boss here. Hope is your only strategy for the most part and disappointment will come if you start thinking this game is set up as a fair bargain for you in the short term, because it’s not. You get what you get most of the time.
2. Team share/ team splits. Mystery Factor Rating: Medium.
Moving along the attribution curve to identifiable measurables comes next, with a model that splits team bonus according to some prescribed measures between managers (boss, PM) and players (junior, senior analysts). These have a variety of forms, but importantly, they begin to identify the player as a source of value, at least in part. There is often decision-making and recommendations involved here. And in some respects, such splits are not always that bad. Because part of the split is “how the team does”.
For example, one can have a “bad group” with no alpha, but a team that enjoys greener pastures elsewhere. The Healthcare and Tech spaces are a great example here. You cover semis, but software is moving. You cover biotech, but the whole group is tubing, while med-tech is booming. Your stock selection identifies you as picking the absolute best house in the bad neighborhood, and you therefore lose the least amount of money possible when everyone else on the team is crushing it. Such scenarios are very common. Doing the dirty work is sometimes just the luck of the draw. But by doing well, (think identifiable alpha and short alpha measurables vs. a group benchmark), you keep the team in the game and provide good optionality for the book overall:
Column A. a piece of the bonus pool from team success, which in the case above is better than yours, giving you “more” than your own outcomes would have as a standalone, and
Column B. your own measurables, which might be objectively “good” vs. benchmarks, but make little profit contribution even while providing diversification benefit or some ammo for the short book, hence providing you “less”.
Good teams and good managers keep tend to keep their heads together in this model because they see the big picture for what it often is: everybody and every group that plays stocks and markets eventually finds their way to the woodshed for a good old fashion whooping. Mr. Market never plays favorites for long. On these teams, we count on a good manager to ”risk manage” a book and limit the effects of drawdowns, etc.
The short of it: this model tends toward a nobody ever gets really screwed and nobody is ever totally happy type outcome. It’s egalitarian, but imprecise. In the same way you may be happy owing to being a bad neighborhood, you will be unhappy if you’re in the best neighborhood and in a position of sharing what you may rightfully believe is your “full” contribution. This is a common attribution dilemma. Good management guiding expectations up front helps. Teamwork/dreamwork, etc.
3. Pure formula. Mystery Factor Rating – Lowest
At last, we come to the big time. It’s all anybody ever wants. A measurable, definable, discreet, unambiguous outcome. Living and dying by the sword. We leave jobs for this approach most often after being unhappy with what we got from someone else. Just remember, not everybody lives…
I created an analyst-based business model at Point72 in 2016 called Idea Lab. It was in the true spirit of innovation. It asked many what-ifs and thankfully had sponsorship by a great firm and unrelenting leader always striving to refine and perfect a business that was, at its heart (like the very markets themselves) imperfect. After years of managing compensation outcomes at a multi-manager platform with over 100 teams and what seemed at times like at least close to that number of compensation systems, I was given permission to noodle on something fresh, out-of-the-box and authentic. I am grateful for the opportunity because of how validating and instructive it was on the core point of this essay. Eliminating surprise is the best way to eliminate most of the distraction relating to attributing and paying for performance.
We measured everything as best we could. We set goals and defined ranges, prescribing financial outcomes in advance based on achieving various benchmarks. And the kingdom was peaceful and happy. Did people want more? Of course. Markets attract “dogs” in the best possible way. They fight. They claw and even when they win, they are not totally satisfied. Maybe it’s the dopamine? Who knows? But in the world of imperfection called getting paid for one’s worth, attributing and defining in advance what that attribution means in dollars is a great system. Some successes here:
Use ranges.
When we forecast, humans are better at ranges that point estimates. Instead of tiering payment to the achievement of specific thing, try laddering in a range of 3 or 4 things. You get x at this level, y at this level, z at this level and z+ at this level. It keeps people engaged and striving when they know that even if they miss the top of the range, there will be something. All or nothing approaches are also fair, but deflating (sometimes we die by the sword).
Add kickers.
Many PM-based based compensation systems adding performance “kickers” in addition to prescribed payouts for achieving things like high returns or high Sharpe ratios. This is an important signal to the organization as a whole and costs little as a manager or firm. It also provides the opportunity to highlight standouts and create aspiration in everyone else.
Measure the shortfalls and target improvement.
For managers, the game doesn’t end when the bonus is paid. It literally starts again the next day. There’s no off-season. We get to celebrate our 12.31 results for one lousy extra holiday on New Year’s, watch some football, and then right back at it. Hmmm. DON’T WASTE THE OPPORTUNITY. Use the data provided by the soft spots to teach, coach, help, and bring along your players to the next level. Ask questions, don’t make accusations. And listen. There may be more in the response than simply why they got it wrong.
The short of it: a system that clarifies how compensation is to be paid and does not introduce subjectivity provides the player the best motivation to succeed, but they need to be ready for it, and ready for the negative outcomes, too.
For leaders craving a more personalized touch on compensation, attribution, and keeping your talent in house, see more of what I do at Greener Pastures.