All Kingdoms Fall

All kingdoms fall. Kingdoms are top-heavy with no foundation. The command-and-control structure centralizes power, stifling imagination and innovation. The same is true in business, especially financial services, particularly investment management. As generations of Wall Street leaders know, their most valuable assets go up and down in the elevators. Investment management firms succeed or fail because of their people. This makes leadership crucial.

The managers who would be king are often surrounded by a few trusted lieutenants. These deputies focus on protecting their own position and power. Talented people join these firms, learn there and move on to start new businesses. The kings who are left behind don’t know the cost of their mistake. Unwittingly, they are paying to train people and not benefiting from the fruits of their investment. How ironic. This is why firms like Apollo, BlackRock and TCI were created.

People say hedge funds are secretive. They’re not. Hedge funds are discreet and private, as their investors demand and deserve. But hedge funds don’t tend to be structured and managed as well as they need to be in order to endure for the long-term. The industry is in transition and the firms that will last are led by those who heed the lessons of the investment banking industry. The history is instructive.

Why does Goldman Sachs still exist?

In the 1950s, John Whitehead and John Weinberg understood that they could not continue to rely on John’s father Sidney to generate most of their business indefinitely. They decided to diversify by service, product and geography – and they created a culture of entrepreneurship. To this day, the finest bankers want to work at Goldman Sachs, creating a self-perpetuating phenomenon that makes it the finest firm. The best people want to wear the pinstripes, which enables the team to keep winning, which makes the next generation want to wear the same uniform. And so on.

The hedge fund business is at a crossroads like the one bankers faced in the 1950s. Explosive asset growth has given way to a period of differentiation, requiring more alpha than beta. The tide has stopped rising. Now the question is, Which ship is built for the open water? Which one can navigate the rough seas and still maneuver near shore? Which one is led by the right captain and staffed by the best crew to cross safely, move at a steady pace and reach the opposite shore before setting off again?

Observers have been predicting the demise of hedge funds since the industry reached $1 trillion in assets. Preqin estimates that figure at $3.2 trillion as of November 2015. Critics argue that hedge funds are too opaque, complex, illiquid and expensive. Still, if hedge funds are generating sufficient returns net of fees, it doesn’t matter how much they charge. One troubling factor is the recent decline in performance. Some large firms generate a fortune in management fees while producing lackluster results. This will not last, though the industry will. The hedge fund business is inherently Darwinian. The firms delivering adequate results will survive; the others will disappear. It is self-correcting.

To succeed, the best hedge fund founders will go beyond managing money and become leaders. As such, they will attract and retain the most talented colleagues who will thrive in an open atmosphere of opportunity. The result will be a dynamic, stimulating work environment in which dedicated people collaborate, challenge accepted wisdom and develop profound ideas. Their insight and judgment will enable them to generate excellent investment performance. The performance will lead to asset growth, which will lead to retaining the talented people who produced the excellent performance. And so on.

Strong leaders empower people

All kingdoms fall. People rise. To build a business that lasts for generations, strong leaders empower people. Once empowered, these people rise inside their current firm instead of leaving to launch new ones. Leaders hire smart individuals whom they train, encourage and support. This approach continually replenishes the greatness of the firm, allowing it to adapt, innovate and endure. What firms will outlast their founders? Who among today’s money managers will be remembered as the Marcus Goldman and Samuel Sachs of our time? The men and women who rise to become leaders by investing in their one invaluable asset: Their people.