Incentives (i)

Technology functions can be split into two groups. There are those where the technology is the product; the tech start-ups, and in my world the systematic hedge funds & prop shops. The other is where tech is a cost of doing business, e.g. macro funds.

One would hope that there shouldn’t be much difference; good tech is good tech, but that’s not been my experience, which is that where the technology function is a cost centre; it is dramatically worse.

This is maybe not too surprising, and the most obvious cause is that this comes down from the top. The more technically minded your head honcho is, the better understanding they have, the more they can call out bad practice etc.

The other issue I have noticed with technology cost centres is that the incentives aren’t there to produce good technology; and they might even lean towards producing bad technology.

Near the start of my career I found a bug causing us to buy some data from Bloomberg which we didn’t need. This at the time was equivalent to hundreds of thousands of dollars of annual savings; multiples of my salary. I really thought fixing this would help my standing greatly.

Taking this to my boss I was surprised to find him apathetic, and long story short I had to actually fight to put the fix in. When the next invoice came in from Bloomberg he came over in a panic; “What’s happened!?! What are we missing?” I referred him to the email I had sent which had quite an accurate estimate of the savings; and given that we were now a whole billing cycle through there probably hadn’t been any unintended consequences.

At least it was easy to come up with an achievement on my appraisal that year, not that it did me any good; my bonus was the same as it was the year before, as I was buying my house at the time and my complete lack of political acumen I didn’t make anything of it.

So clearly after this I was less incentivised to attempt to fix such issues, which probably isn’t great for the fund. For a time I assumed my boss took the credit, but I think the actual situation was far worse; I don’t think there was any credit to be given out.

Now if one of our portfolio managers had made the same amount on some risk free arbitrage opportunity in an afternoon then that would have been rightly celebrated by our CEO, but as a cost centre this saving was far more likely to be seen in a negative light; why had we been wasting this money for years? Obviously there’s fat to trim; where else are we wasting money?

Here’s the sad reality I have found; there’s generally no incentive in a cost centre to actually cut costs. Cetaris paribus, the person running a function with a team of a hundred is getting paid more than someone getting the exact same output with two men and a dog. Numbers wise if someone’s budget is 100m it’s quite reasonable for them to be paid 1m, if their budget is 2m then it seems outrageous, despite the 98m saving.

This is true across all departments, but is particularly egregious in technology because of two factors. Firstly there is generally a much larger difference between what a competent and incompetent software engineer compared to other employees. An accountant in the back office is much less likely to bring down production, but is also a lot less likely to automate somebody’s whole job. Secondly software is more ethereal than most functions, the range of things that “technology” could be doing in any fund is vast, never mind the multitude of ways in which they could be doing it.

So how can we make functions we know little about more efficient? It’s tricky; I’m taking as a given that you can’t hire someone who knows what they’re doing as you don’t have the knowledge to judge what “good” is.

Specific terms to trim budgets (e.g. 1% of what you save) also end up being gamed; arguments over ownership, and loss of quality quickly occur. Really the issue is still that these things aren’t quanitfiable.

I have two suggestions, which you can apply to all functions. Firstly to regularly ask for feedback from across the firm about any aspect of it. Especially from new hires, and even from outside the firm if you can. This is your best way of getting new points of view which is where solutions are often found, even knowing that you’re doing something better than your competitors is valuable information.

Secondly to document your processes and requirements. There’s a lot of waste in the unknown, whether it’s duplication of effort or simply George Costanza acting annoyed. The more you know what you need to do the easier it is to determine alternative approaches.