The ‘No Jerks’ Rule of Investing
Managers who are arrogant, rude, and selfish aren’t just unpleasant to deal with. They’re also bad at generating returns.
Recently, I found myself debating the proposed profit-sharing mechanism of a private equity fund in due diligence talks with the fund’s general partner. This particular manager had been extremely successful in previous funds, and so the new fee structure included premium profit sharing for him. Instead of a 2 percent management and 20 percent incentive fee structure, this manager now wanted to charge partners 2 percent and 25 percent for the privilege of investing with him.
My argument — at least I thought — was a fairly rational one. Since the firm was targeting a larger check size, a higher profit split could not be justified by prior superior performance. Further, the new, bigger fund was generating vastly more management fee dollars anyway. In short, they could stay small and charge more, or grow and keep fees the same, but I thought doing both was inequitable and I couldn’t justify paying for it.
The manager’s response ended the debate, but perhaps not in the way he had hoped.
“What difference does it make to you?” the manager asked. “It’s not your money anyway.”
Needless to say, we did not consummate an investment with said manager. But the discussion did remind me of a due diligence rule I was taught years ago: the “No Jerks Rule.”
It’s fairly self-explanatory: Don’t do business with jerks. People who are arrogant, selfish, dishonest and rude in trivial situations — jerks, you might say — shouldn’t be expected to magically become humble, charitable, honest, and considerate when the stakes are far higher.
It certainly seemed a reasonable lesson, and fortunately for me, there appears to be more behind this simple precept than the gut instinct of my past mentor.
A study in the Personality and Social Psychology Bulletin published in October 2017 looked at the personality traits of 101 hedge fund managers with a collective $4.6 billion in assets under management. By analyzing a videotaped interview of each of the managers, the researchers were able to asses and record behavioral characteristics of the individuals, focusing specifically on the so-called Dark Triad — narcissism, Machiavellianism, and psychopathy.
First, let’s describe each personality spectrum.
Narcissism primarily entails feelings of self-importance and dominance — such as a sense of superiority, grandiosity, and entitlement — combined with intolerance to criticism. Machiavellianism includes superficial social charm, deceitful behavior aimed at undermining others, and a reliance on manipulation to achieve objectives. Finally, subclinical psychopathy is associated with a lack of empathy or remorse, little to no emotion, high impulsivity, and interpersonal hostility. (You really don’t want to work with the clinically diagnosed ones).
The single most common thread uniting these continua is a tendency for deceitful and malicious behavior focused on the exploitation of others for your own ends. Such characteristics probably aid in the achievement of personal success in many activities by facilitating the determined pursuit of success through adverse conditions and heavy competition. Put another way, jerks are singularly, and callously, focused on reaping benefits for themselves.
And there’s the rub.
Benefits for themselves don’t equate to benefits for others; in fact, for those at the intersection of the Dark Triad, they come at the explicit expense of others.
So, what did the study above find about managers with these attributes? In comparing the individual manager’s scores on the Dark Triad with their investment returns from 2005 to 2015, an interesting insight emerged.
While the average return for the overall group during that period was 7.27 percent annualized, the biggest jerks trailed significantly. The managers that scored highest on the Dark Triad put up just 6.39 percent a year, 0.88 percent behind the average. And those who scored more than 2 standard deviations above the others on the psychopathy scale specifically did even worse, trailing the averages by nearly a third.
Moreover, the authors compared not only nominal returns, but also risk measures, and found that risk-adjusted returns were even lower. Narcissistic managers in particular took far more risk than others, and were not commensurately compensated for it.
Interestingly, these findings echo earlier work by the same authors on the presence of Dark Triad traits in U.S. Senators. In their prior study, the researchers demonstrated that senators who scored higher on the psychopathy measure were less likely to win support for their proposed bills. The most influential senators — those able to win broad support for their initiatives — were instead virtuous, or in the words of the authors, “displayed courage, humanity and justice.”
Upon researching the topic of the Dark Triad further, it becomes apparent that there is a growing amount of well-supported evidence that while these traits may well be associated with individuals successfully attaining positions of power, they are also correlated with poor job performance and unethical behavior, including fraud, across numerous fields.
Pretty solid reasons for sticking with the No Jerks Rule.