Money management is all about the talent, yet there is little economic analysis of human capital as an input in the creation of returns for the money management industry. That gap in research has changed with the new paper, “On the Role of Human Capital in Investment Management”. This provocative paper studies over 10,000 RIA’s across a number of years and asserts that more human capital may not help return generation. Having more advisory personnel may help with attracting assets. More investment advisor employees creates the appearance of more talent, but having more bodies is more likely to generate behavior like a closet index with less active shares and lower tracking error. They call it – money management – and staff is needed for management and the gathering of assets. Investors just have to be careful understanding why more staff is needed.
If we get the conclusions of this paper straight, the extra employees provide window dressing in order to create the appearance of more or better management. Firms assume that investors like more staff and will choose those managers that have advisor depth.
Reading the paper in detail and reviewing the data leaves me with a lot of questions. There is no issue that the authors were careful with looking at data, but the complexity of the data and the econometric problems with the samples suggest any bold conclusions should be tempered. Nevertheless, their conclusions make intuitive sense and opens up some interesting questions for due diligence.
The paper also provides some interesting insights on the amount of talent applied to different asset classes. For example, private equity seems to require more talent than managing large cap equities.
If we apply this to managed futures or other hedge fund strategies, is there an optimal talent size? Many CTA’s are small operations, are they properly staffed? The conclusion that I draw is that a good investment processes and philosophy are more important than the amount of staff associated with the firm. More talent is likely to generate decisions by committee and lead to closet index behavior. Don’t count the investment staff. Study the process. Don’t be fooled by the number of bodies.