By Clare Flynn Levy 

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Active investment management knows that it needs to change. But whilst we’ve seen some preliminary action at senior management levels, any talk of real innovation is often met with resistance by members of the investment team. The good news, for internal agents of change, is that innovation doesn’t have to be radical: a Kaizen approach means it can be achieved intelligently and at a pace that’s comfortable for your organization.

I’ve been watching with interest as investment management firms start building dedicated “innovation teams” in response to the change that’s coming their way.

Whilst digital disruption has already made its mark across the broader economy, the Fintech Revolution has recently started parking its tanks on the lawn of traditional fund management. It’s now hard to avoid speculation about how artificial intelligence will replace human fund managers, or when Google or Facebook will start building investment products.

These new threats come at an already difficult time for active managers: assets continue to shift to passive products, fees are under pressure, and there are new regulatory moves against ‘closet indexing’ (where managers charge active fees but in reality hold positions that nearly mirror the index).

I don’t actually believe traditional fund management will disappear overnight – there’s still a strong infrastructure of power, regulation and lethargic retail money supporting it. But there’s no question that the human-based investment process has to evolve if it is going to survive and prosper in the medium and long term.

This change will become even more pressing when Millenials come of investment age. This powerful but flighty demographic are already showing themselves to be less ‘sticky’ than their parents when it comes to holding underperforming assets, and surveys suggest they’ll be more likely turn for advice to trusted digital brands than persistently toxic banks.

No one said it was easy

Innovation is, however, one of those corporate goals which – like higher productivity or the paperless office – is easy to endorse but difficult to achieve.

The new internal teams tasked with change know they are late to the game and that defining innovation – and creating the conditions in which it can be implemented – won’t be easy.

Asset management is a sector known for its conservatism. Buy-side institutions have rarely been leaders in the adoption of new technology and many of their practices haven’t changed fundamentally in decades.

I’ve experienced this first hand – both in my time as a portfolio manager and since, as a fintech leader.

Whilst behavioral finance has been mainstream for decades, it’s only in the last couple of years that active management firms have started to incorporate it, finally challenging the accepted notion that a run of good fund performance accurately denotes investment skill. Data, science and new technology like Essentia’s are now being used to evaluate and improve the decision-making process, but it has taken time for the industry to wake-up to the performance gains available and the bias towards the status quo is strong.

To counter this tendency and to achieve anything of value, asset management innovators must first win the hearts and minds of the investment team – and that will be more easily done with an evolutionary approach than a radical one.

Reframe and prosper

So what does an evolutionary approach to innovation look like? Asset managers would benefit from looking to the continuous improvement philosophy that powered the rise of Japanese businesses from the ashes of World War II: Kaizen.

If Japanese car manufacturers are the first thing you think of when you hear the word Kaizen, you’re not alone. Although actually invented in the US, it has been a massive hit in Japan.

As very well summarized in Robert Maurer’s book, The Spirit of Kaizen, Kaizen is a process-improvement ethos based on making small, progressive changes – not big, scary ones – with ongoing measurement of how those small changes affect financial returns.

One reason Kaizen works so well is that our brains are more comfortable with, and less resistant to, small, incremental changes. Another element of its success is the culture of innovation that it gradually engenders: one where experimentation and tolerance of error is something to be lauded. (For more on this, see our earlier piece, Will Google Eat Your Lunch?, on the dominant role we believe culture will play in powering innovation on the buyside).

Intuitively, Kaizen makes sense: We all know that changing one small habit can often bring about positive improvements in other areas. Use your Fitbit to manage your daily steps, and you will likely find that you’re more willing to go bed on time. The same positive dynamic can be applied to the investment process: change one small thing for the better, and the organization becomes more open to further change and improvement.

This is how we do it

If you follow Essentia, you’ll know the work we do in helping professional investors to improve their investment decision-making is very much in line with the Kaizen ethos.

The data-driven feedback loop we provide has been deliberately designed to integrate easily and unobtrusively with existing investment processes. Using a range of reporting tools and behavioral nudges, we then help our clients to isolate and accomplish small but measurable improvements to their investment process. From this point, they can pause, review and then iterate further, for broader, cumulative performance improvement.

We’re very deliberate about the fact that our decision-support tools and services work within the confines of a portfolio manager’s existing investment style and approach. A more radical, disruptive proposition for behavioral change amongst the current generation of professional investors would be almost guaranteed to fail.

Now it’s your turn

The good news is that any investment team can quickly begin to implement Kaizen. All you need is Excel, a defined improvement that you want to make, and a single piece of data in time-series format.

Let’s say your question is How can we improve the consistency with which we outperform our benchmark? Your attribution and factor analysis are a starting point in helping you analyze this, but they can’t tell you why you were positioned that way, or what you should do differently in the future.

Start by selecting a single data point related to the reason behind each decision to trade or not trade. That data point might be Conviction Level, Target Price, Reason for Trade, Idea Source, Mood or countless other things. But only start with one, and collect it across every portfolio manager or analyst. If you’re already recording that piece of data somewhere, in a format where it can be analyzed as a time series, great. If you can add a field to your order management system, great. Worst case, just use Excel.

This act of beginning to measure the investment process, itself, is one of the most powerful things you can do to improve your performance results.

Ideally, you capture this initial data without inconveniencing the existing workflow. Once you have it, ask your risk/quant team to analyze it to see if it yields any useful insights with regards your stated goal. The answer may well be no. But that’s OK – in data science terms, that result has a value and you’re already beginning the process to define and measure your investment process drivers.

What’s equally important at this stage is that you report back to the investment team anyway, with as little delay as possible. Ask them, “What one change can we make to this measurement that would make it more useful?” The speed of the feedback loop matters a lot to whether they will embrace the process. They’ll have some ideas – listen to them. You’ll also be surprised how much the younger team members will have to contribute to this process – they’re a generation who have grown up exposed to the best of applied data science everyday through the technology they use at work and at home.

Consolidate your feedback loop

I’ve suggested a very simple exercise, but by starting with a limited but methodical focus, I guarantee that the investment team will begin to take an interest in the process and internal feedback loop that’s been initiated. With one small step, you’ve opened the door to improvement and innovation; now iterate and watch how your investment professionals – even those who were reluctant before – start to embrace the evolution.

That said, if getting this initiative prioritized within your organization sounds like it will be hard work, let’s set up a call and I’ll be happy to explain how Essentia makes it easy.

As you build experience in this area, you’ll find that your culture begins to change and your organization will be on a path to better leveraging the science, data and technology now readily available for improving its decision-making performance. And that, after all, is what human-based active management is all about.


Innovation doesn’t have to be radical – in fact, where humans are concerned, it’s less likely to succeed if it is. In our experience at Essentia, the key to winning the hearts and minds of an investment team is to innovate using Kaizen: making small, frictionless progressive changes aimed at continuous process improvement.

Need some help integrating behavioral finance into your investment process? Our consulting services can get you started.


Behavioral Finance, Applied: The Professional Investor’s Primer
This white paper provides a practical reference guide to some of the behavioral biases most humans exhibit, but with a focus on those that will resonate with professional investors.

Can Traditional Active Management Be Saved?
Eric Rovick highlights some of the areas of cognitive risk evident in active investment management and provides a managerial and operational framework for addressing them.