In many corporate structures or organizational models, senior leaders make the important decisions. But that approach has its flaws: By the time information reaches the top, it can get diluted and result in sub-optimal decisions. David Hunt, president and CEO of PGIM, a division of Prudential Financial that has more than $1.3 trillion in assets under management, believes that investment firms would be better off with a meritocracy of ideas in which managers closer to the ground are empowered to make decisions. This creates what is often described as an “upside-down” or meritocratic culture.
According to Hunt, it is important for investment firms to have a culture that encourages managers to think differently and then to support them fully. One of the most important corollaries of such a model, he adds, is to have strong and independent risk management.
In a recent conversation with Knowledge at Wharton at PGIM’s offices in Newark, N.J., Hunt discussed why it is important for investment firms to have a so-called “upside-down culture” and why varied asset classes need different groups of managers.
An edited version of the interview appears below. (Listen to the podcast at the top of this page.)
Knowledge at Wharton: You have an interesting concept about upside-down cultures that exist at some investment firms. Could you explain what you mean by this?
David Hunt: The culture of a successful investment firm — and I do use the word “investment” quite determinedly, as opposed to an “asset-gathering” firm — is very different than most other cultures. For one thing, we’re a fiduciary, which means that we are obligated to put our clients’ interests first. We are motivated by delivering outstanding investment performance for our clients, as opposed to generating financial profits for ourselves. One of the most important aspects of that is the delegation of decision rights.
In many traditional companies, you have a hierarchical approach where important decisions are escalated up. In successful investment firms, we make as many decisions as we can as close to either the investment or as close to the client as possible. We believe in having smart, experienced people who are knowledgeable about the asset class, who are close to the asset itself, make those calls. It’s much better than moving it up the hierarchy where you have effectively less and less information as you get more senior.
Knowledge at Wharton: What are the components of such a culture? What impact does it have on the investment firm’s organization and ability to shape diversity of thought and decision-making?
Hunt: One of the most important parts of a long-term investment firm is the ability to both generate and support people who have non-consensus views. If you basically have the same view as the market, you’re not going to generate alpha. We need to have a culture that will both generate alpha ideas — which are by definition different — and then support people who have those views, which are often unpopular, sometimes for a long time. You can be wrong for two years before you’re right.
“In successful investment firms, we make as many decisions as we can as close to either the investment or as close to the client as possible.”
Many organizations strive for consensus. We do the opposite. We try to foster lots of discussions. We try to have all points of view in the room. We take meritocracy of ideas very seriously. It’s not just something we aspire to; it’s an obligation — whatever your role is — not just to participate but also to have a point of view. As an investor, you get paid to have conviction. Out of these heated debates come people who have views that are not what you read in the newspaper. And then we have a culture that allows people to take those views and hang with them for long periods of time. That’s what’s unique about an investment firm that does this well. It’s the opposite of what you find in a traditional corporate, more consensus-oriented, culture.
Knowledge at Wharton: Could you give an example to illustrate what you mean?
Hunt: We have many value strategies in equities. Value has now been out of favor for, I think, around 20 months. The entire industry has rotated into growth — which has certainly done very well — and out of value.
We’ve done a lot of careful analytics on whether or not these companies are cheap for a reason or cheap just because sentiment has moved against them. We are absolutely convinced that they are cheap because of sentiment and that the quality indicators are very good. So we are maintaining our approach to value, even though so far, for 20 months, that has been quite difficult. We believe that’s the hallmark of a good investment firm. If we deviated from that, I think for us that would be somewhat of a black mark, in waiting for that cycle to come back.
Knowledge at Wharton: That’s interesting — to maintain the courage of your convictions, regardless of the circumstances.
Hunt: Yes — and that’s not to say we don’t question it. There was a lot of research that went into this. We still fairly regularly hotly debate, “What are all the reasons that we could be wrong about this?” But ultimately, we’ve stayed with the courage of our convictions, and that’s really important. Many of us who are a little long in the tooth — we saw what happened right before the dot-com bubble. We saw people who gave up on value right before that. They missed one of the big bonanzas in the last couple of decades.
Knowledge at Wharton: What are the implications of such a culture for long-term performance as it relates to your clients?
Hunt: It’s pretty critical for long-term performance. We want to have experienced professionals near the assets that they’re responsible for because those assets do change over time. If we thought we were going to get out of things one day to the next, maybe we wouldn’t care so much whether our people were close [to the assets or not].
Let’s take another example — this time from real estate. I take great comfort in the fact that our senior investment professionals know everything there is about the underwriting of an office building when we buy it. And we buy it with a seven- to 10-year view – sometimes longer. Obviously we have underwriting committees, and we have risk management closely involved in it, but [the decision] remains with investment professionals who will continue to look after that. I think that is really important. It’s one of the big differences between, say, the buy side and the banking industry where the team that originates things is often not the team that then manages the portfolio long-term. You have a real agency problem when you do that.
Knowledge at Wharton: Do you think that this culture exists just in investment firms or also in other fields? Which other industries do you think could benefit from such a culture? You worked with McKinsey in the past. Would management consulting be one of the fields in which such a culture might be valuable?
Hunt: It has applicability in industries where talent — and not brand or systems — is at the heart of the value proposition. Of course, each industry is different, but the notion of trying to keep the decisions down close to the client, I think is broadly applicable to leading law firms. I also see it in outstanding groups of physicians. The higher you bubble up a health care decision above the actual practitioner of it, generally the worse the outcomes. Certainly management consulting is a good example of that, as well.
“It’s an obligation — whatever your role is — not just to participate, but to have a point of view. As an investor, you get paid to have conviction.”
Knowledge at Wharton: What are some of the major risks of this culture? Could they include investment professionals feeling empowered to act in contrarian ways that might endanger the enterprise, like say, a rogue trade bringing down a firm by taking unwise risks? How would risk management work in such a culture?
Hunt: One of the most important corollaries to having a culture that is meritocratic — and keeps decisions close to the assets — is to have a strong and independent risk management culture. We’ve seen this maybe more in banking than anywhere else — when that culture has not been in place and short-term incentives for traders get misaligned, bad things happen.
In general, our incentive processes are quite long-term, which I think helps, but we also do have very clear and independent risk management processes, which monitor both individual guidelines on behalf of clients as well as the overall portfolio risks that we’re taking. We’re careful in making sure that we stay within all of those guidelines and that we have senior people who are looking at the overall portfolio risks. When you think about the benefits of having been through a few cycles, it’s less about the office building and more that you’ve actually seen what happens to the real estate cycle through time. You want those folks looking hard at the overall portfolio characteristics that you have and the risk limits that you’re employing.
Knowledge at Wharton: Would you say PGIM has such a culture? How did it evolve?
Hunt: We have a meritocratic culture, and we have independent businesses that make decisions around different asset classes. We’re one of the largest real estate investors in the world. We have a very large private credit business. We have one of the world’s largest public fixed income businesses. And we have two public equity businesses. We believe that having different decision processes for different kinds of assets makes enormous sense. Many asset managers who have tried to become much more integrated find out that those assets perform very differently, and the kinds of culture that you need to manage them well are pretty different. We like the fact that we have what we call our “multi-manager model,” which keeps the decisions around both investments and most businesses to that asset class because they are so different.
“One of the most important corollaries to having a culture that is meritocratic and keeps decisions close to the assets, is to have a strong and independent risk management culture.”
Knowledge at Wharton: Did this culture evolve organically or did you have to shape it proactively?
Hunt: The origins of PGIM go back about 30 years and were shaped by John Strangfeld, who last year stepped down as the CEO overall of Prudential. He believed that the investment business is all about talent and decided to set it up independently. He moved it out of the insurance company and set it on a path to build third-party assets and third-party clients, while of course maintaining the role that it had in managing the Prudential general account and other assets.
That model, which has at its core a belief that the most important thing was investment performance, not financial performance, remains today. [Strangfeld’s] belief was that small groups of people in real estate, in fixed income, and in equities should be different. They have different cultures. They have very different approaches to valuing assets, and therefore, those should be encouraged to grow up independently. So our multi-manager culture started back at the formation of the business.
Now, as the industry has evolved, it has become clear that scale is increasingly important. And so over time, we’ve been doing things collectively across the managers, like technology, investments in data, investments in vehicle structures like UCITS [undertakings for the collective investment in transferable securities] or ETFs, [exchange traded funds], as a trillion-dollar manager, rather than having the eight different managers do them separately.
Knowledge at Wharton: What are some of the pros and cons of the structure you’re describing? Does it work well in all market conditions?
Hunt: There are pros and cons. It depends on what your pure objective function is. We’re very clear that our objective function is our clients’ investment performance. We see — through good times and bad — that smaller groups of highly specialized, dedicated people tend to outperform both benchmarks and peers. If your objective is financial performance, then I’m pretty sure that the multi-manager [model] does not necessarily maximize that. But for us, it’s worth having a bit of duplication in places in order to get the kind of concentrated expertise that we have. That’s the tradeoff that we debate, and of course as the industry changes, we change our views on that. I mentioned technology — that’s probably the best example of this.
Knowledge at Wharton. Would a multi-manager culture work well in a financial crisis or would the firm be better off with a centralized authority, concentrated at the top, until the storm has passed?
Hunt: There’s a belief that in bad times centralization will help. This thinking is wrong. We believe that we’ve been extremely well served, and we’ve been doing this for a very long time through a couple of the big financial crises, by the independent managers. If we take private credit as an example — even through the big financial crisis our returns were very good. And they were very good because we had people close to all of those companies that we had lent money to. I am absolutely convinced that if we’d all of a sudden changed our minds and made those decisions at a higher level in the company, we would be much worse off. We were very happy with real estate, private credit, our fixed income returns through the financial crisis because we felt we had superior decision-making, supported by this multi-manager process.
“We see — through good times and bad — that smaller groups of highly specialized, dedicated people tend to outperform both benchmarks and peers .”
Knowledge at Wharton: How do you view the role of leadership in nurturing a meritocratic culture?
Hunt: One of the strengths of the long-term development of PGIM has been that there have only been four leaders since it first started. There has been great consistency of our view of the strategy and our view of the model and the benefits, right through those 30 years. So, consistency of strategy is one of the most important pieces.
To your question on leadership, I think all of us in the leadership role have viewed our job to be a conductor of a lot of very talented people, and to serve them, as opposed to being a charismatic leader that went around and told everybody what to do. We get more out of our people than leaders who have a top-down, autocratic nature.
Knowledge at Wharton: What would you recommend as some of the dos and don’ts for leaders who want to nurture a similar culture in their organizations? How should they measure whether it’s working or not?
Hunt: I don’t know if I have the perfect answer for that. I can say that the role of the leader in this kind of an organization is primarily to ask the tough questions rather than to provide the tough answers. If you focus on getting the questions right, and then hold your leaders accountable for coming up with their answer to those problems — as opposed to imposing your own — you will find that their answer is generally better than yours would have been. And, at the end of the day, they own it. I think that has unbelievable power.
The way I measure this is whether or not we have remained innovative and nimble, even as we’ve grown larger. One of the fears that I wake up with is, as one of the largest asset managers in the world, are we losing the edge that we had when we were smaller? As far as I can tell, in terms of measurement of products and product development and offices and expansion of clients, we have it. But I watch that really carefully, and I do worry about it.
Knowledge at Wharton: As you think back on your own personal leadership journey at PGIM, what is the biggest leadership challenge that you have faced? How did you deal with it? And even more importantly, what did you learn from it?
Hunt: The most difficult aspect of leading in the investment world is that you are around people who don’t really want management and don’t like management very much for themselves. They want to be investors. They’re never happier than to come into their office and dive into the spreadsheets around whatever asset they’re doing. They don’t want interference from headquarters, management, anything else.
But unfortunately, as these businesses grow, they do need some level — I would say not of management — but of leadership. They do need a strategic direction. They do need a sense of where we’re investing for the future. They do need a sense of how we’re actually evolving with our clients. While the need for day-to-day management is relatively low, because most people here are very high-ambition and hard-working, the need for leadership is pretty high. It took me a long time to figure that out and to figure out how to stay out of the day-to-day management, while still providing the overall construct and orchestration capability that you need in order to lead.
Knowledge at Wharton: As you look to the future, what do you think will be some of the greatest challenges that investors will face? What’s a prudent way to think about the future?
Hunt: We are never at a better time to contemplate that than as we enter a new decade. So the last decade, if you had just invested in the S&P, you’d be up about 13% a year. Even with a nice balanced portfolio, you’d be up 9%. Human nature loves to anchor on the past, and as we look around, many investors think, “Oh, well, that’s a decade long. Maybe that 9% is a reasonable estimate for what could be made.” Now, of course, this was the fifth best decade since the 1860s for investing, and that’s often lost.
Our biggest worry is that people have an inflated sense of what returns actually should and could be for the next decade. If you have too high an expectation, how do you reach it? You reach it by taking more risk. So we’re seeing this big movement toward higher-risk assets. People think, “Even with rates really low, I need to make 8%. I need to make 9%.” Well, you can do it with enough leverage, but we do know how that works. So if you were to say, “What’s the seed of the next crisis that’s being sown now?” I would say, “It’s people having too high an expected return.”
For us, we look at the next decade, and we say, “Four to five percent? You should consider yourself doing fine.” But I don’t think that is the dominant view out there.
Knowledge at Wharton: How do you define success as a business leader and personally for yourself?
Hunt: Personally, for myself, I believe in balance. My professional life is only a part of who I am. I’ve always tried not to allow what I do to become who I am. I think that kind of balance is very important. It also allows you to survive the ups and downs of any professional life.
What I value most out of the professional part is feeling that I’m making a difference. I’m not very motivated by title. I’m not that motivated by money. I think that building a firm the way we have, over what’s now coming into almost a decade, is fun because it has made a difference. You can see it happening. If that stopped being the case, I wouldn’t be happy, no matter how wonderful a title I had. Being driven by impact is a really important part of professional success.