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Is 'Sludge' Slowing Down Your Fund Firm?

Focus Consulting Group's Jim Ware discusses the corporate culture that lets some fund firms thrive while others lose ground.

Christopher Davis: Hello, I'm Christopher Davis. I'm a senior mutual fund analyst with Morningstar. Today, I welcome Jim Ware. Jim is the founder of Focus Consulting Group. Focus Consulting's mission is to serve investment organizations of all stripes, helping them improve their cultures so that they could thrive as investment organizations.

Jim, welcome today.

Jim Ware: Thank you Chris. Happy to be here.

Davis: Jim, as you know, investment cultures are really what make a firm, what makes firms tick. If a firm has lots of personnel turnover, if people are leaving every other day, if they have no defined investment cultures, and if they are really able to raise assets rather than to manage money, they are probably not going to be very successful as investors.

You know during tough times that's really when a culture is tested and the best stress test of all was in 2008, during the financial crisis. And your group took a look at several fronts, I think about 60 of them or so and how they fared during the crisis. And you singled out the firms that did best. You call them the Focused Six. Could you talk a little bit about what allowed these firms to thrive and maybe talk about the ones that didn't do well and why they didn't?

Ware: Exactly, Chris. So, let me first say, we have a lot of data on investment firms. I get the pleasure of working with asset management firms all around the globe. And in rooms full of investment people, where we are collecting data, we now know that in response to the question, "Is culture important to your investment firm's success?" 93% of investment professionals say yes.

Davis: What are those 7% thinking?

Ware: 7% are in the neutral category, because we use a Likert Scale. We say you can vote 1, which is strongly disagree, 5 strongly agree, 3 is in the middle.

And 93% are either agree or strongly agree with the statement that "Investment culture is important to our firm's success," and the other 7% are pretty much all in that neutral category.

But, overwhelmingly then, we've got the investment community agreeing with your statement. That early statement you made that investment culture is important to success, and we think that's true.

Now, when we ask them why is it important to success. In other words, if you are one of the 93% that says, "Absolutely, culture is important." Then we say, "Well, what benefit does it provide?"

And what we find is that overwhelmingly there is a benefit that investors identify and it is effective decision-making. If you have a strong culture, it leads to effective decision-making.


So, then we dig into that and we say, "Well, why would that be?" And it's because a lot of the, what we call, sludge. Sludge is something that slows a car engine down. And so, we call that sludge in an organization, in an asset management firm, it would be that stuff that slows the efficient running of the firm down. Things like gossip and rumors and negativity and politics and bureaucracy--these kind of , behaviors slow down the quick ability to ... low trust would be another example, where if a team has low trust, then the ability to be really candid, have high-level debate about an investment idea, that tends to go away.

So, we know now, effective decision-making is what firms are after when they say, "We are trying to build a strong culture."

Davis: So, bad cultures have a lot of sludge.

Ware: Bad cultures. In fact, what we've found is that if a firm reaches 30% sludge ... now, let me explain briefly what that means. Our surveys look at everybody in a firm. We're not just hitting the senior people or the junior people. We hit everybody in a firm. So, let's say, an asset management firm has 100 people. We give this survey to everyone. If 30% or more of those people, if 30 people or more, vote for the sludge factors, we now know there is a greater than 50-50 chance that firm will fail, it will go out of business. So it's a pretty serious situation if you've got a lot of sludge in the organization.

We worked with, for example, a firm that had trouble with the SEC and Eliot Spitzer and whatnot and took the founders away in handcuffs. You can imagine what was left, a bunch of very upset people, and of course, their sludge was high. I asked one of the people, "What are you doing around here now that the founders have been hauled off to jail?"

"Well, we're talking a lot about rumors, who's going to run the firm now, what's our future look like, and we're not getting a lot of work done."

So we say, you get rid of the sludge, it frees up mental energy to do what you're paid to do, which is think, which is think about markets, make good decisions. That's not going to happen if there is a lot of sludge.

Davis: Now, Jim, you and I get to meet with investment leaders all over the place, and so we have sort of an inside view as to how these organizations work. But for investors on the outside, they only can see fund performance. Maybe what they read about their fund firm in the press; that's about all they have. How can you tell whether there is a high amount of sludge--and usually there aren't going to be SEC investigations going on? Usually, there's some sludge there, but it's not glaringly obvious.

Ware: Right. We use a term that simplifies it down. When we look at any asset management organization, we say there are "green" organizations. Green organizations are the ones where there are pretty high levels of trust and respect, and they are pretty low sludge. And then there are red organizations, where there is – red for blood – there is a lot of blood being spilled, lot of bad blood in the organization, high sludge levels.

Now, the average investor doesn't go and interview the senior team, the way we would at our firm. We get the luxury of having one-on-one private interviews with senior executive. So we hear a lot of the sludge firsthand. We hear people saying, "I can't trust these guys as far as I can throw them." We hear that sort of stuff. Of course, an executive would never make that statement to the press or outside of closed doors, but you do get some signs of it.

When you read good articles in Fortune, or Forbes, or Bloomberg, or any of these publications, and you read that there is a lot of upset--like you said earlier, a lot of people leaving the organization, that's a telltale sign that there's sludge in the organization.

And what we now know, leadership and culture go hand in glove, and our study of the 60 asset management firm showed very conclusively, and we're talking about pretty rigorous statistics here, that the better firms, we picked six that came through out of 60, so the top decile firms, they had strong leadership and that meant things like they were very clear about their mission: What are we trying to achieve? Who are we serving? Very good client satisfaction numbers. They had high levels of trust, respect, among the senior people. They valued and appreciated the contribution, and importantly, and this is really out of Jim Collins in Good to Great, they had the right people around the table.

Now, these things, again, you don't know so much from the outside, but if you're doing your work as an individual investor, and you are reading about the company and you are following it, and of course, these days with the Web, you can get all kinds of information about any company. You can pick up on whether things are sludge-like, that would be red. Or green, things are operating at a pretty functional level.

Morningstar provides a lot of help in this way, I think, with your  Stewardship Grade. So, the Stewardship Grade is a terrific way to look and say, this firm is running above board. They seem to be doing a lot of things right. They seem to look after the clients, and that's correlated with strong leadership, strong culture, good results, success.

Davis: Any Premium Member of can get information on our Stewardship Grades, and so I think that's a great resource for our individual investors.

Lastly, I'm wondering if you have any examples of firms just that you've observed maybe they haven't served them in your capacity at Focus Consulting, but firms that you really admire that you think have top-rate cultures.

Ware: Well, the firms that came out on the top, the six firms that really did well, one of them asked not to be identified, and we respected that. The other five are in the paper, which is on our website, You can go look at the paper.

The firms are Forest Investments, which is a timber investment firm down in Atlanta. We also worked closely with disciplined growth investors up in Minneapolis. They have been so highly valued by McGraw-Hill that they asked them to write a book on "how does Graham and Dodd investing applied to growth shops?" So Graham and Dodd are famous for value investing. This is a growth shop, terrific track record, no sludge, cohesive culture up in Minneapolis--just got their heads down, doing their thing day after day, terrific performance track record, about 20 people in the shop. So that's another great one.

Ted Aronson runs AJO in Philadelphia. We have a longtime relationship with them. 10 years ago, when I wrote the book, Investment Leadership, they were cited in that book 10 years ago as being a really premier company with 15-year track record. 10 years later, we are saying the same thing about them, and our numbers in the survey show it. They've got great leadership, great culture, the very low turnover, same top people are there. It's a very happy group of people who are also fanatically interested in being successful. So there are three that we can cover right of the bat and there are others as well, but those three are doing a great job.

Davis: It seems like the best firms have always been the best firms. It's just really hard to go from good to great. You're better off just picking great to start with.

Ware: That's a very good point, Chris, I appreciate that. Yes, now, we are, of course, in the business of consulting and trying to help firms get from good to great. So I don't want to take that point completely, but there is a lot of truth to it that the firms you really want to be with are – again, the Morningstar Stewardship Grade – the firms that have the 10-year track records, the firms that have low turnover of key people, the household names in the investment world: the Dodge & Coxs, the Wellingtons, the Capital Groups, these sort of firms. They haven't gotten to be household names by accident. There is a reason.

Davis: Well, thank you very much for your insights, Jim. Thanks for joining us today.

I'm Christopher Davis, senior mutual fund analyst with Morningstar. Thanks for watching.