Tuesday, November 3, 2015

"Execution is god!" - So the focus should be on process

Perhaps the comment by Andy Grove, the driver behind Intel, is extreme even from the man who said, "Only the paranoid survive." However,  a focus on process or strategy execution is critical for good money management. It is often overlooked by managers and investors making fund investments.  You have to sweat the details.

By strategy execution, I mean the implementation of the investment approach to generate returns. Due diligence focuses on knowing strategy and reviewing operations, but does not often know how to frame questions on process engineering, or the work taking the strategy and generating a repeatable set of steps that will lead to success.

Good execution is usually just classified as good performance. If there are two managers who follow the same strategy, the one who has high returns must be executing their ideas better. That does not really account for strategy execution. Unfortunately, there are no standards for execution. Operational due diligence will ask about back office, compliance, and IT, but may not spend a long time on the step-by-step process of how ideas or trades are generated and then added to the portfolio. The combination of research, strategy, trading, back office, and IT are not linked as an execution process.

The devil is always in the details for execution. The analogy I often use is from cooking. There is a big difference in the end result of a prepared meal between two chefs even if they are following the same recipe and have the same ingredients. That difference is execution.

So how is strategy execution measured for a money management firm? Good execution may be measured through four parts:

  • Defined steps - Good execution occurs when there is no "hand-waving" Every step in the investment process is defined and can be described by those who engage in the process. This can be as simple as the data collection and scrubbing process to how reports are generated. Execution is about effective trading to get the ideas in the portfolio. The investment process may identify trades and size them correctly, but the trades have to be made in an effective manner. If you can measure it, you can manage it. If you cannot, then execution will be sloppy.
  • Exception analysis and preparation - If there is a process in place for handling normal activities, exceptions can be dealt with easily. Good execution can deal with those situations which are abnormal and can lead to significant errors. Good execution can handle exceptions.
  • Performance review - Execution can run smoothly if there is a review of performance so attribution and contribution of returns can be measured. Contribution is measuring what made money and attribution is how the money was made. Both are critical for good execution.
  • Feedback loop -  There has to be a clear process for learning. Learning requires feedback from information to change. If information is collected but does lead to change, there is no learning. The question should be clear, "How do you learn?"
The value of sitting with a manager for a day is that the execution of the strategy can be analyzed in real time. It is not enough to hear that a manager has a value focus. You have to watch and discuss how value is discovered and then converted to dollar exposures and placed within the portfolio. How this position is discussed and reviewed once it is established tells you how performance feedback is given. This discussion is deep and digs at what are the root causes for a gain or loss.

Andy Grove had execution intensity with Intel and it showed in the results. His type of intensity is required for success in the competitive money management industry. 

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