Every organization faces the same dilemma, over and over: how much to stay the same and how much to change. But each organization has its own natural spot somewhere along the spectrum between seeking change and avoiding it. A comfort zone, if you will.
That location is a product of philosophy, leadership, life cycle stage, and accumulated norms, rules, and processes. The penchant for change can vary in response to recent results or outside events, but it is hard to speed up or slow down an organization that is used to a certain pace of change. That said, many organizations need to be more innovative in order to thrive in the future.
Exploration and exploitation
Before looking at investment organizations, it is good to start with some general principles. A short report, “The dual mindset organization,” published jointly by Strategyzer and Emergn, is an excellent entry point. It begins:
Successful companies constantly innovate and reinvent themselves. At the same time they never neglect running a world class operation. It’s a balance between two different cultures that can feel impossible to attain.
Dual mindset organizations are good at both exploration (“inventing the future”) and exploitation (“managing the present”). A simple comparison in the report between those two vectors shows the contrasts in mentality and approach that are required in each. For instance, exploration activities involve a high degree of uncertainty, but exploitation targets improvements at the margin. The goals are not alike at all; neither are the optimal cultures and operating modes. Juggling the disparate objectives is challenging, but:
The best organizations seamlessly toggle between these two modes and have operating models that support this duality when it comes to how innovation and the development of products happen.
The report outlines three types of innovation: efficiency (with a near-term time horizon, focused on making existing strategies, products, and processes “more effective and efficient”); sustaining (for the intermediate term, extending the life of the current state), and transformative (those longer-horizon initiatives that will determine the future success of the organization).
It is easiest to imagine all of this in terms of a product portfolio, but the motif applies more broadly, as evidenced by six themes of operating model transformation referenced in the report: strategy; organizational structure; processes; metrics and reward systems; skills and people; and infrastructure and the technology stack.
Risk work and uncertainty work
A posting by Vaughn Tan, “Organizational technology for uncertainty work,” also provides a helpful perspective. It is subtitled “Or: The importance of mundane organizational processes.” To wit:
Organization becomes a strategic technology when the approach to organizing is intentionally chosen to be appropriate for the type of work to be done.
Tan explores the difference between uncertainty work and risk work, using the standard division of those terms rather than the mushy application of them in the investment world. That is, knowing the range of outcomes and their probabilities is “risk,” while “uncertainty” involves dealing with the unknown.
In concert with the Strategyzer and Emergn report, Tan writes:
Organizations need to do both risk work and uncertainty work to survive and succeed, but the two are fundamentally different.
Importantly, he examines the problems that arise from relying on “industry best practices,” which “secretly embed risk assumptions”:
Best practices nearly always assume that the work that needs to be done and the definition of success won’t change, and that the environment is stable.
Those kinds of assumptions manifest themselves in a hardening of approach, which shows up in ways large and small, so that a shift in mindset requires a reexamination of work throughout the organization. As Tan points out:
Paying attention to mundane processes allows them to be thoughtfully redesigned to be appropriate for uncertainty work. At base, this simply requires explicitly acknowledging that the organization faces uncertainty, not just risk.
Applying the ideas
Neither of those sources was written with investment work in mind, but the concepts should inform the evaluation of any kind of investment organization. That starts with the broad sense of an organization’s philosophy about change.
Many sell stability. Think of the notions of process that asset management firms portray — it is rare to hear anyone lead their narrative with the need for ongoing change in a process. Few even emphasize it and most don’t reference it at all. There are some exceptions, such as quantitative managers who acknowledge the decay in the effectiveness of strategies and highlight the ongoing research and creativity involved in staying in front of that decay.
Or consider an advisory firm, marketing a specific approach to individuals. It may involve a simple formula (prescribing consistent exposure to cheap betas) or the opposite (embracing a range of alternative assets and chasing the “best” managers). Projecting with confidence and armed with supporting data, either set of beliefs can be presented in ways that inspires trust among clients and prospects. But the allegiance to a particular approach means that certain aspects of what those firms do are highly unlikely to change.
Along each main node of the investment ecosystem (in terms of organizational type), there are tendencies regarding innovation driven by the regulatory regime and rules that apply, as well as the history and culture of the particular type of entity. And there are further differences within. So, for example, asset owners tend to have different attributes regarding innovation than asset managers do. That’s also true for the next layer down, in the categories of foundations, endowments, and pension plans. Then there are the unique characteristics of individual organizations.
For any and all of them, the questions persist: How much change should we be seeking? Why? How do/should the answers vary across different parts of the organization? How do we balance the essential uncertainty of the investment endeavor, the evolution of markets (and the erosion of alpha in places where it has appeared before), and the desire for stability from clients, employees, and stakeholders?
The answers to those questions vary by organization, as should the evaluation of innovation practices and subsequent plans for organizational transformation. Some suggestions for evaluating your own organization:
Self-assessment. Start with an objective assessment of where you are now. It is important to get a mix of perspectives, from across the organization and different levels of it — as well as outside views from clients, stakeholders, and others.
Pay particular attention to patterns that permeate the organization, even in functions that are remote from each other, since those are good indications of the overriding culture. Try to assess the attitudes toward change. Some organizations are marked by defensiveness and stasis, others by an orientation to learning, development, and evolution.
In addition to noting the similarities, acknowledging the subcultures that exist will help to identify how the exploit versus explore dynamics play out in various areas. For example, those directly involved in the investment function can have a different orientation than the rest of the organization around it — and often are very interested in exploring for new investment ideas and quite uninterested in (and even dismissive of) other innovative pursuits. Contrasting approaches to innovation across functions can lead to conflicts, disconnects, and turf battles.
Identification of beliefs, assumptions, processes, and habits. The self-assessment needs to extend into an identification of the underlying principles and activities that are the foundation of your approach. From broad beliefs (both stated and implicit) to prosaic tasks, the questions should be asked: Is this subject to change? Why or why not? In what ways? Do we look for improvement? Do we actually improve?
Obviously, that top-to-bottom scope is an impossibly large job, but asking the questions starts to change the orientation, to thinking in terms of fixity and flux, to working toward that dual mindset across the organization. You want to start with big matters, but if you stop there, the philosophy won’t spread as you need it to.
Look for key lynchpins that haven’t been examined in quite a while, especially watching watch out for sacred cows that people are too afraid to subject to fresh review. And, as Rick Rubin wrote, “Beware of the assumption that the way you work is the best way simply because it’s the way you’ve done it before.”
Mapping out a strategy. The nature of your innovation strategy will naturally be a function of your starting point. Using the explore/exploit and risk/uncertainty spectra, think about where you are and where you want to be over the next year and the next decade. Then map out some specific types of innovation you would like to foster and how to get them started.
Since innovation is chiefly a combination of ideas, look for ways to bring new interactions across organizational siloes and to seek out multi-disciplinary expertise internally and externally. The imitation of admirable aspects of other investment organizations can be one element in an innovation portfolio, but playing a same-as game all the time is unlikely to lead to success.
And, as Tan indicates, altering the strategy necessarily means revisiting the organizational design and making the adjustments that are required.
Culture and leadership. As with most things, the approach to innovation won’t change in a lasting way unless the underlying culture does — and that depends upon the relentless efforts of leaders throughout the organization. A shift in mindset is not a one-time thing but an ongoing process, a lived belief.
At every level of the organization, there needs to be “the permission to think unconventionally,” to use a phrase from a TED talk by David McWilliams. That implies a willingness to consider ideas that might seem heretical, to explore new concepts with open minds, and to actively investigate emerging questions of investment practice well before they become conventional wisdom.
One persistent problem is the distinction between two phrases: “what works” and “what has worked.” The first one indicates permanence, something that should not be assumed in an environment of uncertainty. The second phrase acknowledges history, while leaving the door open for change. Recognizing the inevitability of change — and preparing for it while continuing to exploit the learnings of the past — are essential for the sustainability and success of every organization.
Here are some of the areas within an organization that can benefit from a focus on innovation.
Published: January 5, 2024
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